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German Chancellor Angela Merkel said, “Right now the banking sector isn’t sustainable and has come under enormous difficulties because of its business model. It’s our obligation, if we want to provide ESM assistance, that we make sure there is a permanent solution.” Photographer: Johannes Eisele/AFP/Getty Images (c) Bloomberg BusinessWeek
The Eurozone insistence on a
Cyprus bank deposit confiscation has almost nothing to do with a desire to
“save” Cyprus, and everything to do with its destruction.
The surprise plan forced through on
Saturday, 16 March called for a 6.75% "levy" on deposits up to EUR 100,000, and
9.99% on deposits over EUR 100,000. Although part of this “levy”, which is more
appropriately called a confiscation, would have
been offset by the issue of bank bonds, the Eurozone finance ministers departed
from all previous best practise and EU law.
Specifically nearly all bank
recapitalisations and restructurings protect depositors and impose losses on
bondholders. Moreover, deposits up to EUR 100,000 in the EU are insured to
their full value. No losses on bondholders were proposed, although these would
not have been sufficient in any case. And the Eurozone tried to twist reality,
explaining that this was a “levy”, or tax, on deposits, not an outright
confiscation.
But at the heart of the issue is a dramatic
refusal by the Eurozone finance ministers to understand basic financial
reality. By embarking on this step, they dramatically undermine faith in the
European banking system. Although they claim that this is a “unique instance”
(the same term used for the Greek government bond haircuts), it is only a
question of time before the hyper-indebted governments of Spain, Italy, Belgium
and perhaps France follow suit.
The Eurozone has had over a year to prepare
for this crisis, but sprang the idea of a levy at the last minute as a fait
accompli. This is where I am led to believe that there is both a deep
misunderstanding of modern finance, as well as a deliberate intent to “make an
example” of a small country.
This latter attempt was already tried in Greece,
but apparently there is no satisfying the appetite of the German political
class for “making examples” of hapless countries, particularly if they are
smaller ones.
How do I come to this conclusion? Through a
very simple assessment of the public statements of German officials, which have
changed so many times in the last week.
The Russian Money Laundering Thesis
The German position building up over the
past year is that Cyprus is a haven for Russian money laundering. WolfgangSchauble led the offensive as quoted by Bloomberg:
“Suspicion arises -- and it’s plain
to see -- because Russian investment in Cyprus is so high and at the same time
Cypriot investment in Russia is high,” Schaeuble said today on Germany’s ARD television 2+Leif program.
“You may ask why Cyprus is the second-largest foreign investor in Russia and we
need clear answers to that.”
In fact, transactions between Russia and
Cyprus are governed by a double tax treaty, which together with the
English-language business culture, Cyprus' 10% tax for non-resident companies, and
the ease of registering and operating companies has made Cyprus an attractive
location for Russian companies.
Cyprus is regulated by European law and by the OECD’s Financial Action Task Force (FATF), and cooperates fully
with the EU MONEYVAL. The latest MONEYVALevaluation report can be seen here.
So the first logical fallacy is that Cyprus
must be punished for a crime it hasn’t committed: being an attractive location
for Russian investments.
Let’s assume that this “crime” is true:
that Cyprus is a hub of Russian money laundering. What is the solution? Is the
solution to destroy the country’s banking system, which is what the current
Eurozone solution is doing?
Or is the solution to tighten EU rules on
money laundering, pricing transfers and tax avoidance schemes, affecting not
only Cyprus, but jurisdictions such as The Netherlands, Luxembourg, Lichtenstein,
London, Jersey, Guernsey, Ireland, Isle of Man, Malta and others?
Germany certainly tried to destroy the
Irish economic model as well: it failed. But in Cyprus, a country of just
860,000 residents, was “non-systemically relevant”, and had no choice.
Holy German Money and Evil Russian Depositors
This fallacy of economic destruction to
avoid money-laundering was actually launched by the SPD. The SPD is in the middle of a failing election campaign, and is casting about for any
straw with which to beat Angela Merkel’s CDU. AsSpiegel reports, the SPD specifically linked a Cyprus bailout to “illegalRussian money”:
Germany's opposition, center-left Social Democratic Party says it will
only accept a rescue package for Cyprus if certain conditions are met.
"Before the SPD can approve loan assistance for Cyprus the country's
business model must be addressed," SPD lawmaker Carsten Schneider told
SPIEGEL. "We can't use German taxpayers' money to guarantee deposits of
illegal Russian money in Cypriot banks."
As seen here, the fallacy is alive and
well: All Russian money in Cyprus is illegal. Therefore, German taxpayer money
will not be used to bail-out Cypriot banks.
Here I have to ask some simple questions:
a. Did the SPD conduct an audit of
depositors in Greek, Irish, Spanish or Portuguese banks before agreeing to
their bailouts?
b. When the European Central Bank
extended EUR 1.1 trillion in lost-cost loans to European banks under LTRO, did
it differentiate between banks with Russian deposits and those without?
c. When US multinationals such as
Google, Yahoo and Starbucks use a “Dutchsandwich” to avoid billions of dollars in EU taxes, did the SPD investigate
whether these companies should operate in Germany or anywhere else in the EU?
The answer to these three questions is, of
course, a resounding “no”. The SPD is making a pathetic election year issue out
of Cyprus. And the fact that Cyprus is the EU’s third-smallest country, while
Germany is the largest, is decisive.
The
Banks are too Large – They Must be Destroyed for their Own Good
Following the Cyprus Parliament’s rejection
of the first Eurozone “offer”, German comments about the deposit confiscation
changed. Realising that they had over-reached in forcing a deposit confiscation,
they attempted to cast the confiscationas being in the best interests of the Cypriot banking system:
"Cyprus has a banking sector
that is way too big and they are insolvent with that model and no one outside
of Cyprus is at fault for that," Schaeuble said. "This business model
is not sustainable, there is no alternative."
This is one of the greatest fallacies of
all, and flies in the face of established EU law and international banking
practise. The EU has adopted the Basle II and III banking regulation and
capital requirements. Basel II and III regulations, which make detailed provisions for the ratio
of bank core capital to deposits and loans.
But nowhere is there a requirement, or even
a definition, that a country’s banking sector must shrink to a certain
proportion of GDP. This is confirmed both by the absence of any such indicator
in EU or international law or standards. It is also confirmed by the fact that
no such condition was raised in the Irish or Spanish bail-outs.
It is, as with so many other decisions, a statement
tossed out with the air of authority, which unfortunately no one has
challenged, and which bears no relation to legal or financial reality.
The
Myth of Debt Sustainability
There was a further attempt to justifya deposit confiscation in order to make Cypriot public debt “sustainable”:
"But investors above 100,000 euros should make a contribution to
the Cypriot banking landscape being stabilized," Merkel said, stressing
that she still believes "the banking sector must make a contribution to
Cypriot debt being sustainable." "Cyprus is our partner in the euro area and so we
are obliged to find a solution together," Merkel said.
If debt sustainability in Cyprus is the key, then
Germany should have recommended three alternative solutions to dealing with the
bank component of the bail-out:
a. Creating
a state-owned “bad bank” and transferring non-performing loans from Bank of
Cyprus and Laiki to this bank. This would remove at least EUR 4-8 billion from
the loan books of these two banks, and made their recapitalization and
restructuring easier.
b. Force
the divestment, over time, of the international banking network of BOC/Laiki,
particularly loss-making Greek, Russian and Ukrainian operations.
c. Use
the European Stability Mechanism funds to lend directly to banks, avoiding the
sovereign. This solution is not yet technically ready, but the two banks could
have maintained operations under an ECB ELA-funded restructuring until ESM is
fully ready.
But there was no attempt to do so. In fact, the
hysteria over the Eurogroup’s decision was reinforced by the typically veiled
threats that Cyprus would collapse and leave the Euro, and by the ECB’sunnecessary decision to stop ELA assistance to BOC and Laiki by Monday.
Cyprus
is Immoral
And finally, we come to the same statement deployed
against Greece: Cyprus deserves to fail, because it is immoral. This was couched in different terms by Wolfgang Schauble on March 19th:
"Whoever
deposits their money in a country because it will be taxed less and controlled
less runs a risks when the banks in
these countries are no longer solvent. That is what happened in Iceland and in Ireland some years ago. European taxpayers should not be made
responsible for this risk," said Schaeuble.
This viewpoint ignores a number of specific issues in
Cyprus:
a. The
2011 Mari explosion damagedCypriot energy generation and cost at least EUR 1 billion (in an economy of
EUR 17 billion)
b. BOC
and Laiki suffered write-downs of EUR 4 billion on the Greek government bond
PSI, with further losses from non-performing loans in Greece and Cyprus. This
has nothing to do with Russian deposits or the “size of the banking sector”.
c. When
Cyprus participated in the bail-outs of Greece, Ireland, Portugal and Spain,
Germany was happy to make Cypriot taxpayers responsible for these risks. Only now has Germany turned against a
country that is “taxed less and controlled less.”
d. There
has been absolutely no agreement on what “taxed less” means: The Netherlands
has a much lower effective tax rate on international transfer pricing
transactions than Cyprus does. And if the issue is “controlled less”, then
there are obviously other solutions for this.
Conclusions
Looking back at this extraordinary week, the most
charitable thing one could say is that the European Union’s crisis management
and decision-making function is perhaps permanently dysfunctional. But this is
obviously not enough.
I find it difficult to understand how a relatively
simple EUR 17.5 billion sovereign and bank bailout can be so badly managed,
particularly by Germany.
The undercurrent of hysteria, logical fallacy,
finger-pointing and false morality one sees resurface time and time again among
German political leadership and press is not a harbinger of good times in the present or the future.
The sight of a country with 82 million inhabitants and
a EUR 2.6 trillion GDP ganging up so obviously on Cyprus, a country of 860,000
and a EUR 18 billion GDP, is deeply unedifying.
The constant and escalating stream of threats,
deliberate misstatements, and omissions from Wolfgang Schauble, Angela Merkel
and others is deeply
worrying.
The refusal to consider a rational bank recap and
restructuring over a period of 3-5 years, and to provide a calm framework for
negotiations without false deadlines and threats, is inconceivable,
particularly if one compares this to how Germany’sgovernment has treated German bank recapitalisations.
The fact that the German Parliament has to approve the
Cypriot bail-out makes this bail-out, and any other one, prey to the lowest
political instinct of the German political class and its accompanying yellow
press. It’s something we have seen before in the case of Greece, but it’s
surprising that nothing has changed.
Absent in this debate is the fact that ESM/EFSF
resources and capital exist: no new capital raising is required, and that
Germany is not the only contributor to ESM/EFSF. Ironically, Cyprus is a
contributor.
Even more worrying is the fact that there was not a
single report of a dissenting voice at the Eurozone summit which led to the
insane bank deposit confiscation in the first place.
Do any of these “finance ministers” understand the
basics of finance?
What will Europe do when confronted by a real crisis,
not a EUR 17.5 billion rounding error?
How many rule-books will they destroy? How many
foreign investors and key suppliers like Russia will they offend and alienate?
How many more Eurozone banks will they destroy?
Forecast
I believe the following scenario will unfold over this
weekend and next week:
a. Cyprus
will accept a face-saving “levy”, which will be 0-1% tax for deposits on EUR
20,000, 5-6% for deposits up to EUR 100,000, and 12-15% on deposits over EUR
100,000. This will allow the Eurogroup and Cyprus the false satisfaction of
having reached a compromise.
b. Capital
flight will commence in Cyprus immediately. Russia multinationals such as
ITERA, Nikoil, Gazprom, Mecel, Rosneft, Sintez and others will lift their
deposits as soon as they are able, most likely to London and Switzerland,
avoiding the Eurozone. Cypriot and British depositors will follow suit.
c. Cyprus
will have to introduce capital controls to avoid deposit flight – thus
worsening the need for Cypriot bank recapitalization that the Eurozone’s
“solution” purported to avoid. A second Cypriot bank recap will be needed.
d. The
Cypriot GDP will fall, probably by 5-6%, and unemployment will rise to 15-18%
by the end of 2013, with a negative track going into 2014. Cyprus will be in
for a 3-4 year depression, the end of which will only be signaled by
hydrocarbon investment. Cypriot emmigration follows.
e. The
Cypriot project to develop hydrocarbons will also be set back. On the one hand,
the Cyprus credit rating will mean years of higher interest rates and a lack of
capital availability. On the other hand, Russia will withdraw its political and
economic cover. On the other hand, it is clear that rather than being the
vaunted engine of geopolitical and economic stability the European Union
claims, it is actually an engine of destruction in the case of Cyprus. This means that Cyprus will meet renewed
Turkish hostility and interference, quite beyond its illegal occupation of
northern Cyprus.
I sincerely doubt we have heard the last of
deposit confiscation. Italy, France, Spain and Belgium are mismanaging their
national budgets and will likely follow the Cypriot example at some point in
the future. Having taxed financial transactions, the inevitable next step is to
tax savings, rather than “only” the interest on savings.
The democratic deficit within the European
Union has been clearly indicated beyond a shadow of a doubt, as has the role of
Germany and its satellite countries. I expect these tendencies of continue in
the future, to the detriment of the people of a continent that are daily
confronted with declining economic competitiveness, adverse demographics,
absurd taxation, an anti-entrepreneurial culture and cut-throat international
competition.
Once can only wonder what Europe will do in
the face of a real crisis.
© Philip Ammerman, 2013
