On The Cyprus Deal

As a Greek with contacts in Cyprus, his opinion is one of the most valuable ones out there. Here it is:

We have now the latest bailout plan and contrary to the spin in parts of the western media it is COMPLETELY DIFFERENT from the plan we saw last week.

What was utterly outrageous about last week’s plan was its seizure of money from deposits held in every account in every bank across the entire island of Cyprus. This offends against every principle of banking, the rule of law and of private property I know of. By what logic, if solvent debtor A owes me money, am I required to lose money to bail out insolvent debtor B with whom I have no connection at all? The Cypriot government and the Troika compounded the outrage by extending it even to deposits that held less than 100,000 euros. This was blatantly illegal since it violated the EU’s own deposit insurance scheme. As I said, what all this managed to do was transform a problem of two Cypriot banks into a systemic problem of the entire Cypriot banking system.

Though you would not know it from the way it is being reported by the western media this morning, the entire calamitous idea of a deposit raid has been entirely dropped. There will be no raid on deposits whether above or below 100,000 euros. What is happening instead is what should have happened last week. The two insolvent banks, Laiki and Bank of Cyprus, are being merged and restructured. Since they will not be bailed out and since Laiki is being effectively liquidated, the bondholders of Laiki (one of whom is a Russian businessman) will be completely wiped out. The big deposit holders in both Laiki and Bank of Cyprus will also take a big loss. This is not because their deposits in Laiki and Bank of Cyprus are being raided as was proposed last week. It is because they will suffer a commercial loss (or “haircut” if you prefer) as creditors of debtors who have become insolvent.

What proves that the Cypriot authorities and the Troika were at all times aware of the blatant illegality of last week’s proposals, is that the statement setting out this week’s agreement that has been issued by the the eurogroup specifically says that deposits below 100,000 euros (including those in Laiki and Bank of Cyprus) will be fully protected in accordance with the EU’s deposit insurance scheme. What is that if not an admission that last week’s proposed raid on those deposits was illegal?

We now therefore have a bailout agreement that at least conforms with the law. What are its further implications?

The immediate losers are the bondholders of Laiki and the big depositors in Laiki and Bank of Cyprus. Whilst I do not have private information about who these depositors are, I am going to make an informed guess and say that I doubt that many of them are Russians.

Laiki and Bank of Cyprus are the country’s two biggest retail banks. Historically Laiki has serviced the poorer people whilst Bank of Cyprus (which I believe is the country’s oldest banks) looked after the wealthier people and their businesses. I understand that Bank of Cyprus is the biggest lender to Cypriot businesses. It is likely therefore that the great bulk of the deposits in Laiki and in Bank of Cyprus (which are around half the bank deposits in the island) belong to local people. Since Laiki and Bank of Cyprus are essentially retail banks I doubt that many of the big Russian depositors have their money with them. They will have put their money in the newer private and commercial banks that have been set up in recent years on the island to service the trade with Russia. The most important of these is the Russian Commercial Bank of Cyprus though I suspect that VTB Cyprus is also a big player. I would guess further that the majority of foreigners who do have accounts in Laiki and Bank of Cyprus are Britons rather than Russians because of the long history of Britain’s connection to Cyprus and by extension to these two banks, both of which incidentally have several branches in Britain.

If this is correct, then the horrible anti Russian gloating of some of the British newspapers this morning is completely misplaced. Russian economic interests in Cyprus have come out of this affair (comparatively) unscathed. In a meeting with Medvedev this morning Shuvalov pointedly said that the Russian Commercial Bank of Cyprus (which is where I suspect most of the really big Russian money is) is unaffected. Moreover the restructing of Laiki and Bank of Cyprus does not affect the entrepot arrangements between Russia and Cyprus, which retail banks like Laiki and Bank of Cyprus are not involved in .

By contrast those who are going to be hammered are the Cypriot business community, who traditionally hold their accounts with the Bank of Cyprus and who take out their loans with it. They must now expect to lose between a third and a half of any money they have on deposit. Many of them are now going to go bust taking their businesses down with them. They form the core of Anastassiades’s political constituency and politically speaking he is now a dead man walking. This opens up the unattractive possibility that last week’s proposed deposit raid was an attempt to appropriate (steal if you prefer) Russian money to save the electoral base of a right wing pro European politician. If so then Russians doubly need to think through the implications of what happened.

What of the future? Firstly, the Cypriot domestic economy is now going to go into a tailspin. Paradoxically, this means that Cyprus is going to become more, not less, depend on its connection to Russia. European politicians and economic commentators who burble on about how the Cypriot offshore model is unsustainable should understand that the bailout makes Cyprus more dependent on it not less.

The question is however whether the model will now survive? Though the new bailout terms and the capital controls are probably enough to prevent an immediate stampede of foreign money out of the country when the banks reopen, the Russians have seen that the Cypriot government and the Troika egged on by Russophobic media commentators see no moral objection to helping themselves to their money. Despite the attempts to mollify them of the Archbishop of Cyprus (who has emerged as a towering figure in this crisis and just about the only person to talk sense) I cannot believe that they will want to keep their money in Cyprus or continue their trade with the island. I expect that over the next year or so they will quietly wind their businesses down and take their money with them. Shuvalov been talking this morning with Medvedev of the need to transfer Russian money in Cyprus back to Russian banks, presumably in Russia, and that is surely what will now happen. Since this fits in with Putin’s agenda of ending the Russian economy’s use of offshoring, contrary to the ugly jibberish and anti Russian gloating appearing in much of the western media this morning, he has come out the big winner from this affair.

By contrast, for the people of Cypriot this has been a complete disaster. Not only is the island’s economy and the trust in its banking system and government destroyed, but its major trading partner and key political and diplomatic ally in its standoff with Turkey, has been alienated, probably forever. Moreover given the way Cyprus’s GDP is now going to collapse I cannot possibly see how this bailout is going to work. On the contrary I firmly expect it to fail. As I have said before, as a Russophile I can see the benefit to Russia from what has happened. As a Greek with a strong sense of sympathy and of ethnic solidarity with Cyprus and its honest and hardworking people I am deeply angered and upset by it.

Lastly, what this ghastly shambles shows is the complete incompetence, economic illiteracy and rabid Russophobia of the people who run the eurozone. What they did last week was take a bad situation and turn it into a catastrophe. So blinded are they by their Russophobia that they were willing to agree to a scheme that broke every known law and principle of modern banking and which was bound to provoke a bank run. Behind all the Twittering and bluster of the last week they have now had to draw back in bewilderment as the Cypriot banks threatened to crash down around them. As it is confidence has been so badly shaken that we now have capital controls on a eurozone state, which has been landed with a bailout debt it can never repay.

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