Cyprus's plan B is still a dis­as­ter

The Pak Banker - - OPINION - Clive Crook

THE first at­tempt to bail out Cyprus was such a sham­bles that the sec­ond looks smart by com­par­i­son. It's get­ting gen­er­ally fa­vor­able press, too -- the best avail­able op­tion un­der the cir­cum­stances, and so on. Yes, it's an im­prove­ment. It's hard to think of any­thing that wouldn't be. That doesn't make it a good plan.

The new deal has re­moved the cra­zi­est part of the agree­ment reached March 16 -- the plan to de­fault on de­posit in­surance. Let's not dwell any fur­ther on that in­san­ity. But the new plan still has features that, seen in any other con­text, would surely arouse sur­prise.

For in­stance, the so-called troika of the Euro­pean Com­mis­sion, the Euro­pean Cen­tral Bank and the In­ter­na­tional Mon­e­tary Fund wanted to be sure that the new debt Cyprus is about to take on will be sus­tain­able -- mean­ing, pre­sum­ably, that Cyprus will be able to re­pay it. Yet, by writ­ing down high- value de­posits, the re­vised plan will also cause a sud­den con­trac­tion of the Cypriot bank­ing sys­tem, and thus of the whole Cypriot econ­omy, which de­pends on bank­ing to an un­usual de­gree.

Those debt pro­jec­tions of which the IMF is so fond? The arith­metic that in­vested 5.8 bil­lion eu­ros ($7.4 bil­lion) of de­posit taxes (to curb the need for new bor­row­ing) with such awe­some sig­nif­i­cance? For­get them. The de­nom­i­na­tor in the debt ra­tio is gross domestic prod­uct, and Cypriot GDP has just been pro­grammed for pre­cip­i­tous de­cline. While the IMF was fid­dling with its now-ir­rel­e­vant spread­sheets, Euro­pean Union fi­nance min­is­ters were ac­tu­ally con­cerned not with the sus­tain­abil­ity of the new debt -- that is, with Cyprus's ca­pac­ity to re­pay - - but with the short-term po­lit­i­cal im­per­a­tive aris­ing from "bailout fa­tigue."

The need to shel­ter EU tax­pay­ers from the con­se­quences of Cyprus -- or the need at least to give the ap­pear­ance of shel­ter­ing them -- is the cru­cial cir­cum­stance in "the best avail­able op­tion un­der the cir­cum­stances."

Let's un­der­stand, how­ever, that this self-im­posed con­straint ruled out ev­ery sen­si­ble op­tion. Europe's lead­ers should have grasped that fact and ex­plained it to their vot­ers. Their fail­ure to do so should- n't be ac­cepted as the sadly in­evitable con­se­quence of ex­hausted elec­torates. It should be rec­og­nized as an in­ex­cus­able deficit of lead­er­ship, and as a mor­tal threat to the whole euro project.

I'm cer­tainly not de­fend­ing the Cypri­ots' dis­tended bank­ing sys­tem. That needed to be re­formed. Bail­ing in cred­i­tors (in­clud­ing unin­sured de­pos­i­tors) of fail­ing banks is de­sir­able -- so long as it doesn't cause sys­temic in­sta­bil­ity. But some­body in author­ity should have been ask­ing two ques­tions. First, is the in­stant de­struc­tion of the Cypriot bank­ing sys­tem the best way to re­form it? Sec­ond, what will be the wider im­pli­ca­tions of this ac­tion for the rest of the EU?

One such im­pli­ca­tion is im­me­di­ately ap­par­ent: the in­tro­duc­tion of cap­i­tal con­trols, which Cyprus will have to keep in place for who knows how long. Note in pass­ing that, as a re­sult, the euro area is no longer the mon­e­tary union it pur­ports to be: A euro in a bank in Cyprus is now worth less than a euro in a bank in France. This vi­o­lates at least the spirit (and ar­guably the let­ter) of the treaty that cre­ated the sin­gle cur­rency in the first place.

I thought the ECB and its pres­i­dent, Mario Draghi, were go­ing to do what­ever it takes to pre­serve the in­tegrity of the euro sys­tem.

Be­cause Cyprus is so small, the cost of a more mea­sured re­struc­tur­ing of its banks would have been mod­est.

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