March 26, 2013
Europeans Planted Seeds of Crisis in Cyprus
By ANDREW HIGGINS
NICOSIA, Cyprus — When European finance chiefs explained their harsh terms for rescuing Cyprus this week, many blamed the tiny Mediterranean nation’s wayward banking practices for bringing ruin on itself.
But the path that led to Cyprus’s current crisis — big banks bereft of money, a government in disarray and citizens filled with angry despair — leads back, at least in part, to a fateful decision made 17 months ago by the same guardians of financial discipline that now demand that Cyprus shape up.
That decision, like the onerous bailout package for Cyprus announced early Monday, was sealed in Brussels in secretive emergency sessions in the dead of night in late October 2011. That was when the European Union, then struggling to contain a debt crisis in Greece, effectively planted a time bomb that would blow a big hole in Cyprus’s banking system — and set off a chain reaction of unintended and ever escalating ugly consequences
“It was 3 o’clock in the morning,” recalled Kikis Kazamias, Cyprus’s finance minister at the time. “I was not happy. Nobody was happy, but what could we do?”
He was in Brussels as European leaders and the International Monetary Fund engineered a 50 percent write-down of Greek government bonds. This meant that anyone holding these bonds — notably the then-cash-rich banks of the Greek-speaking Republic of Cyprus — would lose at least half the money they thought they had. Eventual losses came close to 75 percent of the bonds’ face value.
The action had an anodyne name — private-sector involvement, or P.S.I. — and, it seemed at the time, a worthy goal: forcing private investors to share some of the burden of shoring up Greece’s crumbling finances. “We Europeans showed tonight that we reached the right conclusions,” Chancellor Angela Merkel of Germany announced at the time.
For Cypriot banks, particularly Laiki Bank, at the center of the current storm, however, these conclusions foretold a disaster: Altogether, they lost more than four billion euros, a huge amount in a country with a gross domestic product of just 18 billion euros. Laiki, also known as Cyprus Popular Bank, alone took a hit of 2.3 billion euros, according to its 2011 annual report.
What happened between the overnight session in 2011 and the one that ended early Monday morning is a study of how decisions made in closed conference rooms in Brussels — often in the middle of the night and invariably couched in impenetrable jargon — help explain why the so-called European project keeps getting blindsided by a cascade of crises.
“I cannot remember that European policy makers have seen anything coming throughout the euro crisis,” said Paul de Grauwe, a professor at the London School of Economics and a former adviser at the European Commission. “The general rule is that they do not see problems coming.”
Simon O’Connor, the spokesman for the union’s economic and monetary affairs commissioner, Olli Rehn, declined to comment on whether Mr. Rehn had taken a position on the possible impact of the Greek debt write-down on Cypriot banks.
As well as hitting Cyprus over its banks’ holdings of Greek bonds, the European Union also abruptly raised the amount of capital all European banks needed to hold in order to be considered solvent. This move, too, had good intentions — making sure that banks had a cushion to fall back on. But it helped drain confidence, the most important asset in banking.
“The bar suddenly got higher,” said Fiona Mullen, director of Sapienta Economics, a Nicosia-based consulting firm. “It was a sign of how the E.U. keeps moving the goal posts.”
Cyprus, she added, “created plenty of its own problems” and was not aided by the fact that the country’s last president, a communist who left office in February, and his central bank chief were barely on speaking terms. But decisions and perceptions formed more than 1,500 miles away in Brussels and Berlin “didn’t help and often hurt,” Ms. Mullen said.
Cyprus banks, bloated by billions of dollars from overseas, particularly Russia, had many troubles other than Greek bonds, notably a host of unwise loans in Cyprus at the peak of a property bubble, now burst, and, critics say, to Greek companies with ties to the bank’s former chairman, the Greek tycoon Andreas Vgenopoulos.
Mr. Kazamias, the finance minister at the time of the Greek bond write-down, said he had little idea of just how badly the move would hurt his country’s banks. “We worried but we never received any information that this was a red line” that should not have been crossed, he said. The Cypriot government, he added, initially calculated that “we were in a position to cover the losses,” and it was only later, after depositors began to flee and the Cyprus economy stalled, that “we found out that this was impossible.”
But Charles H. Dallara, the lead representative for the banking industry who negotiated with European officials in 2011 in a bid to keep the losses imposed on Greek bonds as low as possible, said the writing was on the wall.
It was “very clear that the effect of the Greek deal on Cypriot banks would be severe,” said Mr. Dallara, the former managing director of the Institute of International Finance, the banks’ lobbying group. “But there were elections coming up, and the tendency in Brussels is to let these things drift. So nothing was done.”
Slashing the amount that Greece paid on its bonds was necessary at the time, he acknowledged, because it helped reduce a mountain of debt that could have pushed Greece from the euro. “But looking back, in reality there was no way to avoid the eventual adverse effect on Cypriot banks,” said Mr. Dallara, now the chairman of Partners Group, a consultancy to banks and governments.
Even before the Greek debt bombshell, Laiki Bank “was already in a bad way because of bad lending,” said Kikis Lazarides, a former chairman of the bank. But, he added, the write-down on Greek bonds “was more or less the killer blow.”
Like many Cypriots, Mr. Lazarides is angry that Europe’s richer countries, particularly Germany, largely dictate policy. “We have to change some things in Europe in the way decisions are taken,” he said.
After the Greek write-down, Cyprus compounded its problems by dithering on whether to seek a bailout from the European Union. At first, it appealed to Russia, which provided a 2.5 billion-euro loan in December 2011. But this money quickly ran out, and when Cyprus did finally go cap-in-hand to its European partners for a lifeline, it received a rude shock: Germany, already gearing up for an election this year, wanted not just budget cuts and other conventional austerity measures but a complete overhaul of Cyprus’s economic model, built around financial services for foreigners seeking ways to dodge taxes and, Berlin suspected, launder dirty money.
“They did not want the Cypriot model to exist as it did — they wanted Cyprus to stop being a financial center,” said Pambos Papageorgiou, a former central bank board member who is now a member of parliament and on its finance committee. “It was very brutal, like warfare.”
Mr. Papageorgiou complained that the European Union had shown “the opposite of solidarity” in its dealings with one of its weakest and most vulnerable members.
In the three years since Europe’s rolling debt crisis first exploded in Greece, governments and citizens in the hardest-hit nations have fumed that decisions made in Brussels pay little heed to their interests and are dictated instead by the economic concerns and election cycles of Germany. Whether in Athens, Dublin, Rome, Madrid or Nicosia, ordinary people increasingly ask whether the European Union serves their own aspirations or those of remote institutions dominated by others, particularly Germans.
Such questions have grown to a furious pitch in Cyprus, where terms set early Monday for a 10 billion-euro bailout will deepen an already painful recession and send unemployment — now at 15 percent — soaring. They require the dismantling of Laiki Bank, with the loss of around 2,500 jobs, and a significant reduction in the country’s role as an offshore financial center.
“We are looking at a very grim future for Cyprus,” said Michael Olympios, head of the Cyprus Investor Association, an industry lobbying group. “Even firm believers in European project like myself see now that it was a bad idea and that we should have at least stayed out of the euro.”
As jobs disappear and the economy contracts, Mr. Olympios said, faith in Europe will wither. “I used to be a believer. Not anymore.”