Having run out of options to solve its bigger problems, European Union commissioners, in the spirit of famed bank robber Willy Sutton, have decided to go after depositors’ money on Cyprus for a simple reason: “That’s where the money is.” Will the current shake down of bank depositors on Cyprus save or sink the Euro? It stretches the imagination to fathom how putting bank depositors in play will comfort European Union bondholders or other EU banks.
In exchange for $13 billion in bailout money for the Cyprus government, the EU has demanded that the local banking system, bloated with offshore deposits including many from Russia and Eastern Europe, pony up in the interests of Euro harmony.
An island divided into Greek and Turkish spheres of influence, Cyprus was allowed into the EU, and later the Euro, as an early attempt to gloss over European ethnic fault lines and pump hot money into the sovereign debts of Greece and East European countries. Greek Cyprus is the tax haven of choice for Russian companies and oligarchs, many of whom register their worldwide assets under Cypriot holding companies and maintain huge deposits in the local banking system.
Before the recent crisis, the Cypriot banking system held assets in its banks and fiduciary companies that amounted to more than five times the country’s gross domestic product.
Business as usual in Cyprus meant that, with few questions asked locally, an overseas investor — including many from Serbia, Romania, and the Ukraine, as well as Russia—could set up a front company, open a bank account, and run his or her financial empire away from the long arm of any government accountants.
The problem for the Cypriot banks wasn’t attracting deposits, it was finding a place to put them once they arrived by SWIFT (the international transfer system), the Fed Wire, or suitcases.
Confusing their swelling balance sheets with the genius of J.P. Morgan, local bankers made several fatal mistakes. They lent their newfound money to the Greek government by buying its bonds, they invested in now-failing real estate deals, and they funded these long-term bets with deposits that could be withdrawn in less than ninety days.
In justifying these strategies to clients, the Cyprus banks claimed that their long positions in Greek government bonds, denominated in Euros, came with an implicit EU guarantee, which also served as a reason to pay minimum rates on short-term deposits, and to bet the ranch on long-term Euro bonds. The Euro gave Cyprus cover for punting.
In the era of the Greek drachma, German leader Angela Merkel would not have delayed a hair appointment to keep Greece solvent, let alone to save its lovechild in Nicosia, a Balkan money-changing city hard up against the border of the Turkish mercenary state in northern Cyprus. Still, even today, the Cypriot pyramid might have withstood the lazy stress test of a buoyant market.
The first Cyprus rescue plan called for the island’s bank depositors (whose deposits totaled $82 billion at the peak) to cough up 10% of their wealth into the stabilization fund. That financial haircut, however, called also for a 7% trim from local clients, not just a shave for Russian oligarchs. Local Cypriots voted with their middle fingers.
Although the inspiration to drain local bank accounts to offset subsidies from Brussels was attributed to EU bureaucrats, if not Merkel and French President François Hollande, the impulse for an open season on passbook savings comes from the worldwide assault on tax havens, led by the United States.
In its search for money to balance it own mismatched accounts, the US has taken the position that the dollar, instead of an international commodity or method of exchange, is a national loyalty oath, and is imposing tax obligations on those that have some in their wallets. Even though the EU is more a tariff union than a functioning government, Brussels has warmed to the idea that bank depositors within its fragile borders are fair game for a fleecing.
The revised Cyprus plan walked back from skimming all bank deposits, and shook down the depositors only of the two largest banks, the Bank of Cyprus and Laiki (Cyprus Popular) Bank. It demanded the sale of $500 million in the central bank's gold, unsettling financial markets.
While the heist was in the planning stage, all Cypriot banks were closed, to keep the hot money from turning into flight capital, once removed.
The Bank of Cyprus will survive, barely, although Laiki is going belly up, which through the magic of bankruptcy laws will put its €24 billion in deposits at the disposal not just of local liquidators but also of EU “structural reformists,” who have more in common with Butch Cassidy and the Sundance Kid than with International Monetary Fund economists.
The biggest losers are the Cyprus banks’ shareholders, bondholders, and depositors, who are being bled dry so that the Euro might live. Think of these write-downs as a pan-European tax, assessed mostly on shady front companies that don’t vote in German regional elections. Russian President Vladimir Putin isn’t thrilled that his offshore economy was chosen to make the world safe for par-value Spanish bonds.
As a consequence, bank depositors will flee not just failing Mediterranean banks, but those in Milan, London, and Frankfurt. They will seek safety in gold, real estate, art, stock markets, and hedge funds, leaving money-center banks down the road to scramble for their liabilities (in the accounting world, deposits are something you owe).
The bigger problem with the Cypriot financial collapse of 2013, though, is that it threatens to turn the EU into a divided nation — not unlike Cyprus itself — that may need to balance its books with offshore money and lax accounting.
More than the crises of Italian elections or French unemployment, the Cyprus bank run threatens to pull apart the rickety architecture of a union that can no longer roll over its Eurobonds on what Willy Loman used: “a smile and a shoeshine.” Because of bad balance sheets in Cyprus, as well as in Spain, Italy, Ireland, and Greece, bondholders are no longer “smiling back” at the EU.
German Chancellor Otto von Bismarck said in the late nineteenth century that “some damn thing in the Balkans” might drag Russia into war with Austria-Hungary, or with his Prussian confederation. In that instance, the murder of an Austrian archduke in Sarajevo shattered Europe into fragments that lasted for most of the twentieth century, a division that the EU and its Euro were designed to glue together.
When the dust settles on Cyprus, the losers will be the local economy — headed for a double-digit recession — and Europe’s bank depositors, who in theory should be the backbone of a successful economic union.
Matthew Stevenson, a contributing editor of Harper's Magazine, is the author of Remembering the Twentieth Century Limited, a collection of historical travel essays. His next book is Whistle-Stopping America.
Flickr photo by Leonid Mamchenkov taken in Limassol, Cyprus.