Cyprus Bailout Boondoggle

“You can keep your piggy-banks intact,” Europe effectively told Cyprus yesterday. “Just smash one of your banks.” After all, who better to go bankrupt than a bank?

“Cypriot President Nicos Anastasiades agreed to shut the country’s second-largest bank [Cyprus Popular Bank Pcl (CPB)] under pressure from a German-led bloc,” Bloomberg announced, “bowing to demands from creditors to shrink its banking system in exchange for 10 billion euros ($13 billion) of aid.”

Why shrink its banking system? Because it is dangerously and disproportionately large, at “roughly eight times its yearly economic output,” reported Forbes. It adds, “Russia accounts for $31 billion in deposits alone. By contrast, Cyprus manages about $25 billion in gross domestic product.”

Now, having a large banking system is not necessarily a bad thing. There are plenty of countries around the world whose banking systems account for the largest slices of their economic pies.

Source: Business Insider

But in Cyprus’ case, its banking system had holes in the bottom. Sure, money was pouring in from abroad—especially Russia—for storage in its banks. But payments were being made right back to those foreign account holders and their countries—especially Russia—via other means.

As Forbes elaborates, “Some of Cyprus’ lenders—other eurozone countries, particularly Germany—criticized the island for being too reliant and too lax on where the deposits originate. It’s assumed that much is connected to crime.”

What is more, given the many number of years that so much of this money went untaxed—or at most minimally taxed—general opinion is that much of the money in foreign accounts at Cypriot banks would have belonged to Cyprus anyway if the proper taxes were applied and the circular money-transfer schemes were never perpetrated.

So you might say, Cyprus is merely taking what belonged to it in the first place. And they are claiming a lot of it.

As Forbes outlines:

“Laiki Bank [aka Cyprus Popular Bank] deposits above 100,000 euros—which aren’t protected by EU law—will be frozen and used to pay for the [bailout] deal. The frozen accounts are expected to yield 4.2 billion euros ($5.5 billion), and account holders will see an estimated 30% to 40% haircut on assets. Far greater than the original 9.9% levy.”

By increasing the levy on accounts greater than €100,000, accounts below that amount will now be completely spared the tax and will shift out of the soon to be dissolved Cyprus Popular Bank over to the Bank of Cyprus. The average Cypriot citizen’s hard-earned savings have been spared.

In a way, though, the Cypriot citizenry as a whole is still paying something of a price. As Bloomberg explains, “The Cyprus Popular Bank, 84 percent owned by the government, will be wound down. Those who will be largely wiped out include uninsured depositors and bondholders, including senior creditors. Senior bondholders will also contribute to the recapitalization of Bank of Cyprus.”

Owned by the government ultimately means owned by the taxpayers. The rupturing bank, then, will reduce a large part of the citizenry’s assets. Not to mention the losses that the average Cypriot will see in his or her investment plans, as the bank’s bondholders—many of whom were investment and retirement funds—are now holding bonds of no value.

And there is more bad news for the average Cypriot… “The squeezed banking industry,” continues Bloomberg, “will likely lead to a ‘sharp drop’ in Cyprus’s gross domestic product this year and next, according to Reinhard Cluse, a London-based economist at UBS AG. As a result, the euro group’s debt-to-GDP ratio target of 100 percent by 2020 ‘must be doubted,’ he said.”

And for the final nail to the coffin, “The Cypriot Finance Ministry said in a January presentation that bailing out the country may push debt to a peak of about 140 percent of GDP next year,” as Bloomberg informs.

Remember now, not only has debt risen by virtue of bailout loans, but at the same time income from foreign investors—especially Russian—will no longer be what they were before. In fact, some fear more than just Russian foreign investors will begin to shy away from conducting even legitimate business with Cyprus.

“Raiding the rich’s deposits creates a dangerous precedent,” Forbes establishes. “Cyprus is sure to make these folks squeamish about putting their cash back in the nation’s banks. If something goes wrong again, what’s stopping the government from dipping back into their deposits?”

Bloomberg reiterates the concern, quoting Moody’s Investors Service, “Policy makers’ recent decisions raise the risk of deposit outflows, capital flight, increased bank and sovereign funding costs and broader financial-market dislocation throughout the euro area in the future.”

Still, it is a pain that many feel must be endured. Submitting your child to surgery to remove a cancerous tumour, though painful at present, will save his life.

Similarly, cutting out the cancerous growth inside of Cyprus’ banking system will ultimately have an equally life-saving effect—on the nation itself.

Joseph Cafariello

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