Cyprus: Risking The European Ship For Ten Euros Of Tar

andrew wattI come from a nautical family. One expression I learnt as a child was: “Don’t sink the ship for a ha’penny worth of tar”.

The weekend agreement on a rescue of the Cypriot banking system flagrantly disregards this sound advice. The ship in question is not the banking system of that Mediterranean island, which is to be ‘saved’ with the provision of about EUR 10 billion in EU and IMF funding. It is the entire euro area economy. Accordingly the missing tar – a thick resin used to seal the hull of wooden ships in olden times – in this case costs a bit more than half a penny: EUR 5.8 billion to be precise. That is the sum that holders of Cypriot bank accounts will be forced to stump up in the form of a one-off levy: 6.75% on all deposits up to EUR 100,000 and 9.9% above that.

That may sound a lot. Well, it is a touch over ten euros for every EU citizen. More relevantly, it represents less than 0.05% (one two-thousandth) of euro area annual GDP. And it is a safe bet indeed that the knock-on damage on economic output of this deal will be far higher, with a substantial tail-risk of a renewed lurch into crisis. Why is that?

All advanced capitalist economies provide state-run deposit insurance, up to a certain limit. It is the single most important element in preventing devastating bank-runs. (Banks only ever hold a relatively small proportion of the money deposited with them. The rest is lent out. If doubts arise about the safety of those deposits, customers will seek to withdraw them. Once they start to do so the risk becomes a self-fulfilling prophecy.)

In the wake of the 2007/2008 financial crisis all European Union countries committed to a common ceiling of EUR 100,000. Account-holders with less were never to suffer losses. This is key to underpinning confidence in the banking system and thus the normal flow of credit in the economy. (If you are wondering why the the deposit insurance will not be paying out in this case, the answer is that such insurance covers actual financial losses by the bank. The levy is a form of tax on account holders that any government with a majority in Parliament can impose on its population. This explanation will satisfy lawyers, but there is no real economic difference given that the levy is being used to stem bank losses, and there is no reason to expect that such a distinction will placate irate account holders.)

For the sake of a paltry EUR 5.8 billion, then, this crucial principle of sound economic management has been effectively scrapped. At the very most a levy on accounts above EUR 100,000 should have been imposed. (Although given the orders of magnitude involved, even this I would consider an unnecessary risk to take.) Depositors, particularly in countries with shaky banking systems such as Spain and Italy, but very likely in other countries as well, are certainly asking themselves this morning whether their money is safe. If they start making substantial withdrawals, a shadow will be cast once again over the whole European banking system and thus over the prospects of emerging from the crisis. Of course, policymakers have assured voters that Cyprus is a special case requiring special measures. But we have heard this before, when holders of Greek sovereign bonds suffered a haircut – of which more in a minute.

In recent weeks the Cypriot banking sector has been subjected to a barrage of criticism which will go a long way to placating all those Europeans who do not hold accounts there, and are tired and suspicious of taxpayers having to stump up for the failings – so the perception – of undeserving others. Indeed, reporting seemed to have an element of a concerted campaign to soften up public opinion. At the very least it pandered, in an uninformed way, to popular restments and clouded the issues at hand. For many of the arguments made are very largely either specious or irrelevant or both.

The island’s banking system is supposedly awash with Russian money that the Cypriot banks have been happily washing for a handsome profit. It seems that in fact only around 15 out of EUR 68 billion is held by non-residents, mostly Russians and Britons. So domestic account-holders will take by far the biggest hit. In any case: so what? Cyprus is a Mediterranean island. It is not the Ruhr area or the Emilia Romana. It is no surprise that it seeks to pay its way in the world with tourism and financial services. It has a large number of ex-patriat residents, not coincidentally including many Russians and Brits with whom there are cultural and linguistic/historical ties.

It may well be that some of the money brought in by wealthy Russians has a nasty smell about it. But the origin of such money is primarily an issue for Russian lawmakers. If it was legally brought into an EU country then it offers no ground for retribution. It certainly cannot be laundered simply by paying it into a Cypriot (or any other) bank account and taking it out again. To the extent that any fraudulent activities have taken place, this is a matter for the financial authorities and individuals guilty of wrongdoing should receive appropriate punishment: this is no justification for an across-the-board levy, particularly one that hits the very smallest savers.

More fundamentally, I have seen not a scrap of evidence that the inflow of Russian capital has been the Achilles’ Heel of the island’s banks. In fact it is very obvious what critically weakened the Cypriot banking system: the haircut on Greek bonds which was decided by, yes, the same European governments and EU and international institutions that are now imposing a haircut, this time called a levy, that is once again sending shockwaves through the financial system. The Greek haircut was a bad idea for slightly different reasons (for the prediction see here, for the impacts here), but it was inevitable that the value losses (around half) on such bonds would cause massive problems for banks holding large amounts of Greek public debt. It is quite understandable and normal that the banks in (Greek-speaking) Cyprus have relatively large holdings of Greek government bonds. This is not speculation: holding the bonds of your own government – or if you are a small island those of a government with which you have close relations – is a hum-drum, essentially risk-free affair: or rather, it is supposed to be.

Greek bond-holders last time (unique!), Cypriot deposit-holders this time (also unique!). Who’s next? That is the question reverberating around Europe this morning. Even if a major renewed crisis is avoided, this agreement will cost growth and jobs, and not just in Cyprus. Once again the weaknesses of a primarily intergovernmental approach to running the monetary union have been exposed. (From what I have garnered from the media about the negotiations, this is one case where the EU Commission is entirely blameless.) The urgent need is to press ahead with banking union and to back up the fine words on “doing what it takes to save the euro area” (Draghi) with equally firm action. Instead, onec again policymakers will be manning the pumps.

The ship, in other words, needs new steering gear and a new set of sails. The risk is that the ship might sink while those are being put into place – for a ha’penny worth of tar.


  1. George Kalis says

    Well said. Indeed in retrospect it is clear that this was cooked in the media (mostly German) via a negative campaign about Cyprus banks for at least the couple of months.

  2. vdbjean-pierre says

    change especially the very bad captains of the EU ship who are overpaid and don’t even realise what they are doing to simple people. they just wanted to save their own face or the face of a cracking euro.bad management But worse no interest what happens to european people.Its if they want to build an organisation only for themselves.

  3. vdbranden jp says

    this is david against goliath,we know how it ended…………its stupid ,its power abuse,its dangerous because it can happen again.i don’t think it was done with with the idea not to touch people,maybe the idea behind is just the contrary.that the stupid guys who decided this speak out. basta.

  4. says

    Really, the more I hear about crises in the Eurozone, the more I get the impression that many of those responsible must be actively trying to create economic meltdown in Southern Europe. They think they have enough control that they will always be able to hose the South and break its workforce without ever quite breaking the Eurozone or creating a broader depression or inviting a broad enough backlash to lose control of southern economies. I think they are mistaken.

  5. Marios Sofianos says

    Well said Mr Watt. Your analysis is fair and accurate, and i agree completely. As the measures imposed by the IMF and Mrs Merkel really make no economic sense at all, one is compelled to examine whether there are other (non economic) ulterior motives involved in this nonsense decision. And if yes, then those responsible should not only be accused of bad judgment,(i am being polite), but also of criminal intent!

  6. nick tesla says

    I came from french Aerosace industry, Euro is being kiling us. Airbus plan to fight the strong exch rate (called POWER8) forced the supplier to product in dollars zone. French, as a lot of european people are now understanding that euro zone is not to protect them against china neither USA. Its exactly the contrary, everyone who has made the research find the verity, its a US technique of vassalisation (theorized by Z.Bresinski with all its friend of CFR, Trilateral and other discretes group), a loss of competitivity through exchange rate driven by Goldman Sachs intruder (JC TRichet, Draghi, Monti, Papademos etc etc). A complete deregulation of food market (80% of europeean don’t want GMO, f beef cloned and bleach chicken). How they will understand we don’t want free trade agreement with US.

      • Adolfo says

        There is not an valid and logic reason why € should be 30% over US Dollar, specially when Americans are using their currency (which has been used as world currency for 50 years) in such responsibleness way.

        A 1:1 FX rate of € vs.$ could do wonders in European employment and level of life, but nobody ask their local politicians why this is not happening.

    • Adolfo says

      If the GMO food or bleach chicken are rated 1:1 one dollar= 1 €uro, you should no worry…be sure that most European fellows will consume natural chicken, problem is that FX is out of any comparison.

  7. Global says

    Rightly said, and I wonder if the policymakers of the Eurogroup that created all this mess to the whole banking system in the Euro zone will ever pay any damages! To me it sounds like a well orchestrated 4th Reich by Germany and their friends.

    • says

      a week ago I would have felt sorry for the Germans for bearing the burden of rescuing the Euro. after the Cyprus incident I am inclined to believe what you say ; They are following a mitigating strategy ,consolidating control and resources , to what end ? I dont believe that our German friends have got the best interest of the Euro at heart !

    • superjamespond says

      well deducted,they are screwing us for which sake???is germany better than the others or are they more militarised and more submissive than other europeans or is this the price to pay for the euro???

  8. Yannis C says

    Well said! Unfortunately yet again, the average person will have to carry the burden of mistakes that led to this situation. Will those responsible ever pay for their incompetence? Worst of all, we call on these same people to find solutions to the problem and bestow on them our futures!

  9. says

    very well said ! it seems that ‘zee’ Germans are either a)incompetent or b)have a more sinister agenda ; given the fact that Greeks said yes to all demands to the axis of evil (Troika, Germany, IMF) they thought that the small island state of Cyprus would succumb to the same scaremongering and journalistic terrorism as we did in the mainland ; ohh boy they were so wrong !!! and they are still barking up the wrong tree !

  10. superjamespond says

    Another Cypriot, Nobel prize winning economist Christopher Pissarides opposes the confiscation. He claims that Germany is blackmailing the smaller members of the Eurozone and that Germany wants all of the Eurozone members to behave like Germany. These claims are somewhere true .The problem with the euro is that smaller members unwittingly accept a monetary policy fit for the eurozone’s largest member.!!!!!!!

  11. superjamespond says

    the fourth REICH is a REALITY without gunshots but with a lot of misery in europe to favour their own economy.the EU commissioners are the slaves of germany

  12. Anoop says

    “At the very most a levy on accounts above EUR 100,000 should have been imposed”

    Why is no commentator or politician intelligent enough to figure out that taking 5bn euros from any depositors would result in the other 90% of deposits leaving the country ASAP?

    Raising 5b at the cost of 40bn+ is idiotic. No journalist or politician seems to have the necessary mental capacity to see this.

  13. says

    ECB buys back 200 billion euros a day to keep euro afloat but cannot spare some change. R I D I C U L O U S …

  14. Kees Bruin says

    Of course 5,8 billion is a relatively small amount in the whole Eurocrisis. But one has to remember that citizens in the nortern countries are getting fed up with bailing out other countries. In Holland, where I live, 3 of the 4 larger banks in the country had to be ‘saved’ by Dutch taxpayers, and on top of that these same people are also saving other countries via the EMU. How many more countries will need a bailout? If Spain or Italy is next, the Euro will be toast. This bailout circus simply cannot go on forever. It may not sound nice, but is very realistic: there is a limit to solidarity between countries when it comes to shoveling money out of one’s own country. In the end you have to admit that the whole Euroconcept was fataly flawed from the very start. It cannot work, which should be Obvious to everyone by now.

  15. says

    Cyprus is sunk.
    Depositors will lose every penny.
    There is no way those banks can reopen without ‘capital controls’. What are capital controls? Depriving people of access to their money. If you cannot have your money, well, you don’t have your money.

    Who cares if you have bank statement that says you have $10million in a bank if you are not allowed to withdraw it and likely never will be.

    It’s over. The government will steal – oh, ‘tax’ – 20-25%, the market will do the rest. Depositors will end up with close to nothing in the end.

    Cyprus’s days as a financial center are over forever.
    At least they still have nice beaches.

  16. Frank Roels says

    Finally a paper that clarfies a few things about the Cyprus panic. I always wonder: who profits? Perhaps Andrew Watt has an idea?

    • superjamespond says

      i love the hypocritical news about the deal made. cyprus is saved but the people will sUFFER for long years. what for a blody deal is that??they will go the same way as greece. OUT of europe is the best solution. this 4TH reich europe is bringing everything down we don’t need the germans. kick the germans out and let the others in peace.

  17. Bert N says

    I can only assume the writer knows nothing at all about the financial situation in Cyprus and is therefore talking in general terms.
    This country (I am in Cyprus) is so currupt and full of nepotism that a banking collapse was inevitable. Banks are continuing to lend money to ‘developers’ who are building more and more houses and apartments all over the island. The value of these buildings is less than half of the money lent against them. Houses and land are mortgaged even though they have been ‘sold’ to unsuspecting buyers – the checks and legal system here is chaotic.
    Nobody is buying, in general. But building – and lending for building – continues. The assets held by the banks are worthless. Check the CPO website based in Paphos for details of the scams operated by the banks and builders.
    Why should the taxpayers of a successful country like Germany continue to fund the reckless greed of a country such as this?

  18. Kitty Konialis says

    The bottom line-“To the extent that any fraudulent activities have taken place, this is a matter for the financial authorities and individuals guilty of wrongdoing should receive appropriate punishment: this is no justification for an across-the-board levy, particularly one that hits the very smallest savers.”

  19. Adolfo says

    The ship has been in trouble because a significant amount of sailors start acting as passengers so, instead of doing their duties spent the time in the jacuzzi drinking beer, at he same time the people in the engine room and the kitchen started to take control of the ship, otherwise the whole unit could be compromised.

    Now the rest of the crew is divided between those who support that engineers and chefs takes control of the ship and the others who are not clearly against that…..they are not able to sail the ship, but still claims their right for being in the Jacuzzi/Bar area.

    • says

      Not sure who’s who in this metaphor. For my money it looks an awful lot like the ship’s accountant is trying to take over, and what he’s not telling the crew is that he recently signed a lucrative insurance deal which will pay him more than he thinks the ship is worth if he runs the thing onto the rocks.

      • vdbranden jp says

        europe the new land of poverty,unemployment increases ,the dream is over. the euro has killed us.the lyers of the commission who decided to take on board countries not ready for it should be juged in court,this is purely criminal what these unresponsable people have been doing.the rsult is there and still they stand laughing at the berlaymont. it makes me think of other dangerous huy who took over europe not so long ago.

      • Bert says

        Typical: Everybody at fault except the real culprits. Cyprus (and Greece) lied about their country’s wealth and value when they joined the Euro. It is the fault of the politicians of those country’s not the fault of the Europeans who believed them. Cyprus needed a kick in the a*** to bring back it into the real world, not the fantasy land that the bankers, solicitors and politicians of that country inhabit.

      • superjamespond says

        there is no sentiment in europe. politicians like van rompuy with ZERO international experience joined this organisation at age 63 .he should have better retired .he,s applying blody belgian politics to europe. with such guys we will be soon belonging to a big poverty region.
        blow him out and that he takes his pension this weird functionair who never spent a dime of his own pocket to undertake something.