Image credits: Gwydion M. Williams

by Katerina Batzaki

Have a chat with Greeks in Athens in mid-March, and many would tell you they want to take their hats off to Cypriots for having said ‘no’ to their own elected deputies when Greece was faced with the same dilemma as Cyprus: haircut[1] or bankruptcy. Not long after, those same Cypriots probably felt embarrassed, weak, and above all surprised when they heard the Cypriot Parliament’s decision in late March to go ahead with the haircut regardless. But not Professor of Political Economy Nikos Kazakis who predicted this course of events well in advance. “The ‘no’ of the Cypriot Parliament is only a pretext and will not save the deposits of Cypriot households nor avert the ‘haircut’. The Cypriot deputies already know their voices will not be heard, which is why they have opted for that ‘no’ to be on the safe side,” Kazakis says.

When the newly elected government announced to the people in Cyprus that there would be a one-off levy of up to 10% on savings as part of a 10 billion euro bailout agreed in Brussels, the Cypriots reacted with shock. The new president Nicos Anastasiades defended it as a "painful" step, taken to avoid a disorderly bankruptcy. According to the BBC, the haircut for such deposits e.g. in the Bank of Cyprus is expected to be about 60%.

The Cypriot deputies already know their voices will not be heard, which is why they have opted for that ‘no’ to be on the safe side --- Nikos Kazakis, Greek Professor

While banks were shut and ordinary Cypriots queued at ATMs to withdraw a few hundred euros as credit card transactions stopped, other depositors used an array of techniques to access their money. Companies that had to meet margin calls to avoid defaulting on deals were granted funds. Transfers for trade in humanitarian products, medicines, and jet fuel were also allowed.

Banks root of the problem?

Banks had been at the root of the problem even before the announcement of the haircut. Why would two of the island’s largest banks default when the banks’ declared deposits were twice Cyprus’ GDP? “Bankers had overspent the money in black loans and grants before the haircut,” Kazakis says. “They had stolen depositors' money with the help of the political parties and the governments of Cyprus and Greece. Those deposits have gone into the coffers of political parties, offshore company accounts, overseas bonds, and other shady investments hidden in international capital purchases.” Kazakis further argues that Europeans had known months before, that a levy on deposits would be on the cards, since they knew there was no money into the banks’ coffers.

Director of European Political Studies, Karel Lanoo, blames Cyprus for not quickly adjusting its system. “I imagine that Cyprus in the past never wanted nor was forced to adjust its system. If you have a total banking sector assets which are seven or eight times the GDP of the country in question, then it must rapidly look again at its business model.” Lanoo also believes that Cyprus, like Greece, has now a kind of grace period during which it can put its house in order.

Can Cyprus really put its house in order?

Only last week, investigators had found that some key data about bond purchases by Bank of Cyprus were missing. The Cyprus Mail says information provided by Bank of Cyprus was incomplete, and data-deleting software was found on some computers.

So far, the Cypriot government has appointed a special judicial panel to clarify what happened in the country's financial crash and pinpoint any wrongdoing. Director of the European Centre for International Political Economy (ECIPE) Fredrik Erixon argues that there have to be ways to use the deposits in order to pay for the problems the Cypriot Banks find themselves in.

“The way the European Union has done it has eroded the entire notion one has on insuring deposits even below 100,000 euros and may create a precedent for other countries to follow. Cyprus has built a system that is far too big for its economy. The banks are too big in relation to the size of the economy and the second most important problem is that banks in Cyprus have made bad investments in the past, some of them in Greece. So, when Greece cut public debt it meant that some of the Cypriot banks that have bought Greek public bonds also suffered a haircut and lost a whole lot of money,” Erixon says.

Kazakis disagrees, saying that for 5 billion euros of damages from Greek public bond purchases, Cypriot banks actually received 7 billion euros in compensation, burdening Greek taxpayers with more debt than before. Yet, as a report by Greek magazine Hot Doc showed, when the branches of Cypriot banks in Greece were bought off by the Greek bank Peiraios to safeguard deposits - the price Peiraios paid was 524 million euros. The real value of those branches was 16 billion euros in deposits and 16.5 billion euros in loans, so 32 billion euros in total, even though 8.5 billion euros of those loans will never be repaid.

Greek investor accused

Michalis Sarris, who announced his resignation as Cyprus' finance minister on Tuesday, 2 April 2013, believes that he knows one of the individuals "responsible" for the recent collapse: Athens-based financial investor Andreas Vgenopoulos.

As recently as 2010, Vgenopoulos headed up Laiki Bank - at the time called Marfin bank - the second-largest on the island. The Greek business magnate directed billions in Greek bond purchases. The bank was then ruined, Sarris said on public television (26 March 2013), as a result of the 2011 write-down on Greek bond debt. Vgenopoulos denied any wrong-doing.

Petros Luca, a retired private sector employee says that the EU and the government ought to have protected Cypriot depositors. “It’s a solemn and sort of absolute right of people to have their money in the bank and feel safe. People of Cyprus are prepared to give not only 5, but 50 per cent of what they can afford to save their country. But in a right and fair way where people are not blackmailed to pay. It’s absolutely unacceptable and the Cypriot people are much against what has happened,” he says.

Some observers claim that the way the European Union has handled the Cyprus crisis marks the end of the last hope to create a truly integrated banking union in the eurozone. As Head of the Eurogroup (finance ministers of the eurozone) Jeroen Dijsselbloem bluntly put it, “a rescue programme agreed for Cyprus represents a new template for resolving eurozone banking problems and other countries may have to restructure their banking sectors.” What he really meant was that they would have to do it on their own.

Jeroen Dijsselbloem at the Eurogroup Meeting, 24 March 2013 (Photo Credits: EU Council Eurozone)

The marked change in attitude, which Dijsselbloem agreed was a shift in strategy for EU policymakers, has consequences for how banks are recapitalised and for how financial markets react.

One of the major steps the eurozone has taken over the past three years has been to set up a rescue mechanism with guarantees and paid in capital totalling up to 700 billion euros - the European Stability Mechanism (ESM). The expectation was that the ESM would be able to directly recapitalise eurozone banks that run into trouble from mid-2014, once the European Central Bank has full oversight of all the region's banks. Now, Dijsselbloem says the aim is for the ESM never to have to be used.

Russian influence

European regulators and politicians are convinced that a vast amount of cash in Cypriot banks belongs to Russian money launderers, a BBC business editor writes. "Few German politicians would vote for a Cyprus rescue that simultaneously rescued the launderers, so the only way to make the bailout palatable to the German parliament was to tax the launderers too,” Dijsselbloem says.

Few German politicians would vote for a Cyprus rescue that simultaneously rescued the [Russian money] launderers --- Jeroen Dijsselbloem, Head of the Eurogroup

According to Reuters news agency, almost half of the depositors in Cyprus are believed to be non-resident Russians. So, it is no surprise that Russians would react angrily to the news of the levy. “There is no way that Russian depositors won’t be hit as well”, Fredrik Erixon of ECIPE says. “They have to be part of the solution and that solution means that someone will have to lose money.”

But Russians are not to worry, Nikos Kazakis counterargues. “Russians will have their assets saved which mostly consist of directly transferable bonds and in the worst case scenario they will be compensated from the euro system. The Cypriot households are those that will suffer the biggest blow when they see their deposits shrink and their social and labour rights scraped. And a crisis in Cyprus will have side effects to banks in Italy, Spain and the rest of the eurozone too,” he says.

”There is a great willingness on the part of Cypriots to remain in the eurozone, but even if they are going to leave, I don’t think it’s going to have huge consequences threatening the survival of the eurozone,” Erixon says. What are the consequences for Cyprus though? Cyprus will be better off outside the Euro according to Kazakis, arguing that there is an issue of national sovereignty for the island. He suggests the only way out of this crisis is the return to the Cypriot pound so that banks can be nationalised and the economy can start fresh. Any other scenario would lead Cyprus to bitter adventures, he argues.

Cyprus will be better off outside the euro --- Nikos Kazakis, Professor

Even if the EU were prepared to let Cyprus go that would create another kind of template for resolving eurozone banking issues – outside the eurozone – that other EU members with shaky economies would want to follow too if they don’t want to see their deposits lost, and definitely not the kind Mr. Dijsselbloem had in mind. Surely, after Cyprus, the eurozone’s credibility is heavily wounded. Will the boat sink? The clock for once is ticking.

[1] In finance, a haircut is a percentage that is subtracted from the market value of an asset that is being used as collateral. The size of the haircut reflects the perceived risk associated with holding the asset.