Why the EU is right on Cyprus

By Peter Gumbel
March 18, 2013

The reaction to this weekend’s European Union bailout deal for Cyprus has gone from initial shock to rather predictable condemnation. “Europe botches another rescue,” ran the headline on an editorial in the Financial Times. “It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying ‘time to stage a run on your banks,’ ” Paul Krugman, the economist and New York Times columnist wrote on his blog.

As widely reported, the deal has an important claw-back component: a one-time tax on the deposits of everyone who has a bank account in Cyprus ‑ Cypriots and foreigners alike ‑ aimed at raising 5.8 billion euros of the total rescue package of 17 billion euros. It’s always possible that the hyper-alarmist scenario of a pan-European bank run actually takes place, although by Monday afternoon, even jittery stock markets across Europe were starting to grow calmer, as EU officials insisted that the Cyprus deal was exceptional.

In fact, there are two compelling reasons why the EU actually has gotten this one right. The first is that Cyprus for years ranked highly on international lists of opaque tax havens, as it reinvented itself in the 1990s as the offshore banking center of choice for Russians. Under growing international pressure, and in order to join the EU in 2004, Cyprus eventually abolished its offshore tax regime and put in place a residence-based one with some clear oversight.

Still, the suspicions about Cypriot banks linger on. Last November, the German foreign-intelligence agency reportedly warned that any EU bailout funds for Cyprus could simply end up in the pockets of Russian oligarchs, according to the newsweekly Der Spiegel. The German agency estimated the amount of Russian money in Cypriot banks at $26 billion – substantially more than the total EU bailout package. Indeed, one Russian businessman, Dmitry Rybolovlev, owns almost 10 percent of Bank of Cyprus, the island’s biggest. (The Bank of Cyprus is also one of the two banks whose soured loans to Greece sparked the crisis in the first place.) Cyprus remains on an Organization for Economic Cooperation and Development “gray” list of countries that have made progress to meeting international standards but have not yet been judged squeaky-clean. (So, too, does Luxembourg, which was the one country supporting Cyprus’s objections in the weekend negotiations).

Under these circumstances, simply cutting Cyprus a check for the equivalent of more than half its annual gross domestic product with no strings attached would be politically incoherent. France and Germany for years have railed about the dangers of offshore tax centers, and have pushed their colleagues around the world at G8, G20 and other meetings to clamp down on abuses and harmful tax competition. The notion of “moral hazard” was much bandied about during the 2007-08 financial crisis, although in the end few were punished. But not to ask for a contribution from the Cypriots themselves would undermine their tough line on tax havens and what the French and German leaders have called the need for a “moralization” of finance.

Indeed, by suddenly showing that even preferred tax havens aren’t 100 percent safe, the EU may have done a great service to international finance as a whole.

The second reason to support the EU bailout is more about economic pain than moral obligation. If you asked the Irish, the Spanish or the Greeks in 2008 whether they would have preferred a very sharp, one-time hit to their pocketbooks to deal with their national banking crises, or, as in fact happened, five years of intense economic pain, with soaring unemployment, rising taxes, cutbacks in social welfare and general impoverishment, the answer may be ambiguous.

It’s not a choice anyone likes making, and the Cypriots, of course, aren’t being given a choice. But there is one interesting precedent for the short, sharp shock approach: Iceland. It was left for dead by the rest of Europe after its banks blew up in 2008, wiping out the deposits of many British and Dutch citizens who had put their money in Icelandic online accounts. However, unlike Ireland or Greece, the Icelanders didn’t bail out their banks with government money that they then sought to recoup by raising taxes or cutting social spending; they let them go bust. Iceland’s president, Ólafur Ragnar Grímsson, in a fascinating interview with the French website Rue89, draws another distinction to the euro zone’s austerity strategy. “We realized that this crisis wasn’t just an economic and financial one, but a profound political, democratic and legal crisis.” The upshot: Bankers and politicians are under criminal investigation, and Iceland has put in place a raft of legislation, including the creation of a special prosecutor investigating why the country got itself into such a mess in the first place.

Cyprus’s population is about three times that of Iceland. But once the panic about their bank deposits subsides, Cypriots might take a closer look at what actually caused the crisis, just as the Icelanders have been doing. For the big question that Cypriots still need to ask themselves is why, despite attracting tens of billions of euros from Russians and others, an amount that easily exceeds the GDP of the island, Cyprus banks are in such a mess that they have almost brought down the whole country. Maybe the lesson is that being an offshore banking haven just isn’t worth it. And if that’s indeed the case, the EU policy that led to that realization will have been more than salutary.

PHOTO: Protesters take part in an anti-bailout rally outside the parliament in Nicosia March 18, 2013. REUTERS/Yorgos Karahalis

28 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

A complete distortion. The EU is PRECISELY the reason these
measures came about. The institutions lending know full well they may never get paid back with the economic climate these countries foster. So their asking for collateral. Just like a secured loan. If this thing goes south, it’ll be cold day in hades before another banking group risks capitol this way. There are plenty of places left on the planet to risk investment without this kind of rancor. These banks would do better buying Chinese factorys.

Posted by frek149kie | Report as abusive

Seriously? You argue that it is ok to steal a percentage of every single depositor’s savings because some of the banks hold large sums of money deposited by wealthy Russians who may have deposited the funds there to hide from Russian authorities. Then you note that one such wealthy Russian businessman owns a 10% equity stake in the bank. I don’t think there is anything wrong with wealthy Russians moving their assets out of Russia to escape Russian taxation (and the possible confiscation by a corrupt Putin led government), but even if you do believe these people are doing something wrong this plan makes no sense. The first people that should get wiped out when a company fails is the equity holders (including the wealthy Russian you name), then in the case of banks unsecured creditors and bond holders, then maybe depositors. This plan gets it backwards, and allows the equity holders who were ultimately responsible for selecting the failed management to stay in place and punishes the innocent savers instead. If you think Mr. Rybolovlev did something wrong to move his money to Cyprus and invest in a bank, why are you rewarding him for his conduct and excusing his inept stewardship?

Posted by seriouslyzzzzz | Report as abusive

Why the shock? Our government took the Social Security funds and spent them then told us that SS is an entitlement which is bogus because I’ve been paying into the SS all my life. The reason the SS is broke is because the government spent the money.

Posted by judester | Report as abusive

No way!

- The proposed 6% on small depositors was outrageous! The EU-required guarantee on up to 100,000 EUR has to be sustained, not tossed overboard; or else the whole concept of banking becomes suspect, not only in Cyprus, but also in Spain and Italy. For the little people who live in Cyprus, it would be better if the banks were just shut down than to accept this deal: At least they would get their money back.

- For deposits of more than 100,000 EUR: They can be taxed to the necessary amount. There was NEVER any guarantee for accounts bigger than that anyway, so the “moral hazard” issue is fully applicable. And if you want to get the money from the rich Russian oligarchs, this is where it will be.

Posted by nealjking | Report as abusive

To put it simply, the EU has decided to bail out itself and Cyprus by using someone else money. It’s like putting your hand in someone’s wallet.

That’s some rotten policy covered with long speeches, great phrases that don’t make sense and are aimed at defending itself from negative reactions of the general public.

Posted by Kovalyonok | Report as abusive

Yeah, this is classic. Search for the guilty, punishment of the innocent, reward of the uninvolved. Precisely how were the small savers in Cyprus involved in the financial shenanigans of the banks? And why should they be the ones to pay for it? The author offers up a lot of dreck but doesn’t answer either of those two questions.

Posted by majkmushrm | Report as abusive

The root of this problem is private ownership of central banks. We (in the US)have gotten rid of private ownership of central banks before, however, our banksters have repeatedly weaseled their way back in with bribes to politicians. Private ownership is a workable system only combined with strict regulation and oversight. It is also helpful to have bankers fearful of breaking the rules. This is presently lacking. When I see the phony posturing of Euro power brokers protecting the banking elite at the expense of their populations is disgusts me. If this power imbalance is politically required to keep the Euro together, it is not worth the cost. Europe’s population can pull the plug on these schemes by withdrawing their savings from the banks. Put savings in gold or open a non-Euro bank account. Eventually this house of cards is doomed.

Posted by MediocreFred | Report as abusive

The criminal pickpocketing of the U.S. saver by the scum at the Fed to line the pockets of the well off in an effort at trickle-down economics is beyond immoral. The commies and other dictators love picking winners and losers and the Fed is no different. Not a lot was said about this in the media but I have started to see more of it. Only by putting those involved in the destruction of the financial well-being of U.S. and world citizens in jail will you see real change.

Posted by keebo | Report as abusive