Frus­trat­ing search for the cause of the Cypriot fi­nan­cial cri­sis

Financial Mirror (Cyprus) - - FRONT PAGE - By Dr. Jim Leon­ti­ades

Like most ma­jor events there is no sin­gle “cause”. No sin­gle per­son or group to be as­signed sole re­spon­si­bil­ity. That may not be very sat­is­fy­ing, but it is nearer the truth. Be­low are some of the con­tribut­ing el­e­ments:

Greek Bonds:

Prior to join­ing the Euro zone in 2001, the Greek gov­ern­ment had to pay an in­ter­est rate which at times reached over 25% in or­der to bor­row. Once it joined the Euro, things changed. The Greek gov­ern­ment found it could bor­row at a much lower rate (4-5%). Mas­sive amounts of Greek bonds (rated as ‘zero risk’ by the Euro­pean Cen­tral Bank) were is­sued by a gov­ern­ment run­ning mas­sive deficits. The re­sult was pre­dictable. Credit dried up. Greece de­faulted on its bonds. Hold­ers of Greek bonds, in­clud­ing the Bank of Cyprus, suf­fered mas­sive losses.

Lehman Brothers:

The 2007 bankruptcy of the Lehman Brothers bank in New York sent shock waves through the fi­nan­cial world. Banks in other coun­tries be­came more cau­tious. Credit for coun­tries with weak fi­nances such as Greece be­came more dif­fi­cult.

Laiki Bank:

When HSBC Bank sold its share in Laiki, con­trol of the bank was pur­chased by the Greek Marfin In­vest­ment Bank and a Mid­dle East in­vest­ment fund. The new own­ers, through mis­man­age­ment and deals which are still be­ing in­ves­ti­gated, presided over a steady de­te­ri­o­ra­tion of the banks fi­nances. The Cyprus gov­ern­ment in­jected 1.8 bil­lion euros of money bor­rowed from Rus­sia in a vain ef­fort to save the bank.

The Euro­pean Cen­tral Bank: The ECB, ul­ti­mately re­spon­si­ble for the pru­den­tial man­age­ment of the Euro­pean bank­ing sys­tem, ex­tended credit to Laiki in the form of ELA (Ex­tra­or­di­nary Liq­uid­ity As­sis­tance) long af­ter the bank should have been de­clared in­sol­vent. ELA lend­ing to Laiki even­tu­ally reached more than 9.5 bil­lion Euros, over 50% of Cypriot GDP. Pru­dent bank­ing prac­tice would have re­quired that this be ter­mi­nated much ear­lier, sav­ing the coun­try many bil­lions of euros of debt.

The

Cyprus

Cen­tral

Bank:

The Gov­er­nors of the Cyprus Cen­tral Bank per­mit­ted the takeover of Laiki and presided over its mas­sive ac­cu­mu­la­tion of ELA debt and even­tual bankruptcy. Pan­i­cos Deme­tri­ades, Gover­nor at the time of the cri­sis, con­tin­ued to sup­port the sup­ply of ELA to Laiki long af­ter it should have been ter­mi­nated and the bank de­clared in­sol­vent.

The Cyprus Gov­ern­ment:

The year 2008 found the coun­try with a rel­a­tively low na­tional debt of 8.3 bil­lion Euros (49% of GDP). Un­der the Christofias pres­i­dency, spend­ing in­creased. The na­tional debt al­most dou­bled to 15.4 bil­lion Euros. In­ter­na­tional rat­ing agencies down­graded Cypriot cred­it­wor­thi­ness. The in­de­pen­dent Com­mis­sion of In­quiry into the Fi­nan­cial Cri­sis placed pri­mary po­lit­i­cal re­spon­si­bil­ity for the fi­nan­cial cri­sis on the Cypriot gov­ern­ment dur­ing this pe­riod as well as the par­ties sup­port­ing it.

The

Size of the Sys­tem:

Money Laun­der­ing:

Cypriot

Bank­ing

The rapid growth of the Cypriot bank­ing sys­tem was re­spon­si­ble for much of the pre 2012 pros­per­ity on the is­land. How­ever, the very size of the sys­tem, over five times the size of the is­land’s GDP, also meant that the funds re­quired to pro­vide sup­port to a ma­jor bank moving to­ward in­sol­vency could well be be­yond the gov­ern­ment’s abil­ity. This turned out to be the case. (But note that the Lux­em­bourg Bank­ing sys­tem is much larger)

Prior to 2013, few ma­jor banks were ac­cused of money laun­der­ing. The ac­cu­sa­tions on this score against Cyprus, par­tic­u­larly in the Ger­man press, con­trib­uted to the harsh treat­ment Cypriot banks re­ceived in the Euro group as­sis­tance agree­ment of March 2013. Since this pe­riod, a wide num­ber of Euro­pean and Amer­i­can banks, e.g., Deutsche Bank, Bar­clays, Credit Suisse, HSBC, RBS, Gold­man Sachs, Citibank, etc., have been found guilty of nu­mer­ous il­le­gal­i­ties in­clud­ing money laun­der­ing , tax eva­sion, fix­ing in­ter­est rates and han­dling drug money.

Euro Group Ex­per­i­ments and Bungling:

In March of 2013, a bank­rupt Cyprus turned to the Euro group for as­sis­tance. It re­ceived 10 bil­lion Euros for cer­tain needs which specif­i­cally ex­cluded the use of such funds for re­fi­nanc­ing the two trou­bled Cypriot banks. The hair­cut on bank de­posits fol­lowed. The deal with the Euro group also in­cluded a num­ber of much needed re­forms to be im­ple­mented by the Troika.

The le­gal­ity of the hair­cut ex­per­i­ment and the treat­ment of the Bank of Cyprus, its in­vestors, as well as those of Laiki is still be­ing ques­tioned. How­ever, there is lit­tle doubt that the un­ex­pected and un­prece­dented ex­pro­pri­a­tion of de­pos­i­tor’s money trig­gered a cri­sis in the Cypriot bank­ing sys­tem as well as a dam­age to con­fi­dence in banks and bank­ing in Cyprus and be­yond. The is­land’s economy is slowly re­cov­er­ing.

In years to come an­a­lysts re­view­ing this pe­riod may well con­clude that, although the pa­tient re­cov­ered, the Euro group pre­scrip­tion of March 2013 was flawed in its eco­nom­ics and of doubt­ful le­gal­ity.

Who is re­spon­si­ble for the

Cyprus fi­nan­cial cri­sis? can­di­dates.

There

is

no

short­age

of

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