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Spring 2013 E Ngelen From Deauville to Cyprus B Y K LAUS C. E NGELEN hen the history of the euro area sovereign and bank debt crisis is written, the way the troika of The seeds of another Eurogroup finance ministers, the European Central Bank, and the International Monetary eurozone crisis have Fund managed the rescue of the outsized Cyprus offshore bank - been planted. ing center will be useful as a case study to document the Wextremely fragile state of European monetary union at that point in time. The handling of the crisis puts big question marks around the June 2012 EU summit council resolution to transfer banking supervision to the European Central Bank—to a European institution acting as the euro area’s financier of first resort for banks that lack access to market funding. This huge conflict of interest between supervising and funding large and small eurozone zombie banks and pursuing monetary policies oriented toward price stability is ignored by Europe’s democrati - cally elected leaders. When they talk about “Chinese walls,” it is sheer nonsense—look at Cyprus. On April 18, 2013, Germany’s parliament passed the aid package for troubled Cyprus with a large majority—486 in favor THE MAGAZINE OF INTERNATIONAL ECONOMIC POLICY and 104 against. Under a decision by the German Constitutional 220 I Street, N.E., Suite 200 Court, the German legislature retains the right to vote on any new Washington, D.C. 20002 Phone: 202-861-0791 • Fax: 202-861-0790 www.international-economy.com Klaus C. Engelen is a contributing editor for both Handelsblatt [email protected] and TIE. 50 THE INTERNATIONAL ECONOMY SPRING 2013 E NGELEN THE PRESIDENT’S LETTER BOMB TO DRAGHI support program by the €700 billion European Stability Mechanism. Behind the impressive support of German leg - The fallout from the bitter struggle between the new con - islators for the €10 billion ($13.05 billion) rescue loan pro - servative president of Cyprus, Nicos Anastasiades, and vision was the fact that Eurogroup finance ministers in the ECB President Mario Draghi over removing Central Bank case of Cyprus not only insisted on far-reaching reforms, of Cyprus Governor Panicos Demetriades from office is but also put the reigning bank bail-out doctrine aside and bringing into the open the “smoking gun” of how Cyprus required bank bail-ins by creditors and large depositors. has been misusing the Eurosystem. Leaving a guarantee in the Cyprus bank resolution exercise When the new conservative government’s move to get to insure deposits of up to €100,000 made it easier for rid of the Central Bank of Cyprus head reached the Germany’s left and green opposition parties to back the European Central Bank, Draghi was quick to come to the terms of the revised rescue agreement under which Cyprus defense of Demetriades, who also has a seat on the ECB also must raise €5.8 billion of its own money. Governing Council, the main decision-making body of the For the German government, the Cyprus rescue turned Eurosystem. politically explosive in an election year after an intelli - In a letter to the Cypriot president, Draghi warned that gence report was leaked alleging that the island is a haven the governor could only be dismissed on grounds specified for Russian organized crime. And Sigmar Gabriel, the SPD by EU law and even then the action would have to floor leader, attacked Cyprus in a speech in the Bundestag reviewed by the European Union’s Court of Justice. as having “a business model based on Russian oligarchs, The problem, however, is that the role of both the Serbian mafias, and tax evaders.” Along with other Central Bank of Cyprus and the ECB Governing Council— German politicians, Gabriel dismissed claims that the which can block the use of emergency liquidity assistance Cypriot banking system could set off broader contagion if funds to a financial institution with a two-thirds majority— allowed to fail since it is “systemically undesirable.” reveals a breakdown of governance and the rule of law in Before discussing the complex new burden-sharing the Eurosystem. Emergency liquidity assistance liabilities and rescue approach and its wide implications in detail, were issued by the Central Bank of Cyprus to keep an insol - two developments in the run-up to the Cyprus banking dis - vent Laiki Bank, the country’s second-largest bank, afloat aster have to be explored. after the former Cypriot government presented its applica - tion to the euro area rescue funds in June of 2012. Leadership Failure n his letter to ECB President Mario Draghi, Anastasiades cites the March 28, 2013, confession of Demetriades in a press conference: “I was constantly informing the gov - Iernment about the risk for the banking system to collapse and that is why I proposed that the former government reach an agreement for a bail-out deal in June 2012, as the sit - uation was evident since then. Emergency Liquidity Assistance for Laiki reached 60 per - Nicos Anastasiades cent of the GDP of Cyprus. This was not pleasant, but we had to sustain Laiki in order for the elections to take place, a new government to come to power and take its decision, and to reach agreement with our European partners so as to avoid not only the bankruptcy of Laiki, but also the bankruptcy of the country.” The Cypriot president continued: “I believe that the decision of Governor Demetriades not to annul the ongoing liquidity assistance provided to Laiki Bank by ELA with the aim of holding elections in February 2013, despite the fact that the “situation was evident” since June 2012, demonstrates his failure of effective prudential regulation and supervision of the banking system.” At the same time, “It raises questions related to the independency that the Governor enjoyed with the former Government.” —K. Engelen Panicos Demetriades SPRING 2013 THE INTERNATIONAL ECONOMY 51 E NGELEN The Cypriot president continued: “I believe that the decision of Governor First Test Case Demetriades not to annul the ongoing liquidity assistance provided to Laiki Bank by ELA with eroen Dijsselbloem, the Dutch the aim of holding elections in February 2013, finance minister heading the despite the fact that the ‘situation was evident’ JEurogroup, seemed determined since June 2012, demonstrates his failure of to use the somewhat disreputable and effective prudential regulation and supervision bloated Cyprus offshore banking cen - of the banking system.” At the same time, “It ter as a first test case to end the pre - raises questions related to the independency vailing bank debt bail-out doctrine in that the Governor enjoyed with the former eurozone crisis management. Government.” Jeroen Dijsselbloem —K. Engelen The questions all this raises for the European Central Bank, its Governing Council, and for the troika must be answered if the whole euro area rescue approach is to remain credible and restore market confidence. In the Under the Eurosystem rules, emergency liquidity case of Cyprus emergency liquidity assistance loans— assistance loans should only be provided to solvent which are extended under the sovereign guarantee of a financial institutions. But in the case of Cyprus, emer - European monetary union member country but consti - gency liquidity assistance funds were used—under tute an increase in Eurosystem liability—the Cyprus pressure from the government and in collusion with central bank-issued liabilities were used to bridge a its central bank governor—to delay the bankruptcy of change in government and make elections possible. Laiki Bank for almost a year. As Willem Buiter and Juergen Michels of Citi In a six-page letter, Anastasiades responded to Research note, such liabilities issued by national cen - Draghi by denying any action aimed at sacking the tral banks carry a guarantee from the national central central bank governor, but listing dubious policies and bank’s sovereign but are Eurosystem liabilities. “In decisions that Demetriades was responsible for since the case of an insolvent euro area sovereign, such taking office in May 2012 under the previous left- guarantees would be irrelevant without external sup - wing government of Demetris Christofias. “A system - port for the sovereign, and the credit risk de facto ically important financial institution of Cyprus, Laiki would remain with the Eurosystem. As a conse - Bank, which according to the European Central Bank and the troika partners was already bankrupt, received €9.5 billion in Emergency Liquidity Assistance, an amount that accounts for 60 percent of GDP,” wrote The huge conflict of interest between the Cypriot president. Together with €1. 8 billion in bailout funds from the State of Cyprus, Laiki received €11.3 billion, or 70 percent of GDP. supervising and funding large and In his letter, Anastasiades cites the March 28, 2013, confession of Demetriades in a press confer - ence: “I was constantly informing the government small euro area zombie banks on about the risk for the banking system to collapse and that is why I proposed that the former government reach an agreement for a bail-out deal in June 2012, as questionable collateral is ignored the situation was evident since then. Emergency Liquidity Assistance for Laiki reached 60 percent of the GDP of Cyprus. This was not pleasant, but we had by the power-hungry to sustain Laiki in order for the elections to take place, a new government to come to power and take its deci - sion, and to reach agreement with our European part - Eurosystem central bank kingpins. ners so as to avoid not only the bankruptcy of Laiki, but also the bankruptcy of the country.” 52 THE INTERNATIONAL ECONOMY SPRING 2013 E NGELEN Nicosia for the New York Times on March 28, 2013, document how the European leaders, the International The European Central Bank and Monetary Fund, and the European Central Bank, at the Brussels EU summit in October 2011, decided to force the private sector to share some of the burden of the Eurosystem are securing Greece’s external debt sustainability through haircuts on Greek government bonds of up to 50 per - cent and later up to 75 percent of the bonds’ face losing their independence.
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