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When politicians meddle with economics

Posted by (Guest Contributor) on March 23rd, 2013 - 10 Comments

Where is common sense? The madness of ignoring basic market economics

The Cyprus government, under pressure from the Eurogroup and the IMF to de-leverage its relatively oversized banking sector, sold the interests of the Greek branches of the two main Cypriot banks to Pireaus Bank of Greece “with the most beneficial terms under the circumstances and with an important benefit for the Cypriot side.” Euro zone finance ministers had excluded the Greek branches of Cypriot banks from the deposit levy they intended to impose on Cyprus, on condition that those units would be transferred to Greek banks. The sale included 300 branches and their portfolio of about 15 Billion Euro of deposits (8% of Greek banking deposits) and about €20 Billion of loans (10% of loans in Greece) –exceeding Cyprus’ annual GDP of €18 billion. The sale follows moves that sunk in €1.8 Billion of Cypriot tax payers money last year and another €8 Billion of European liquidity funds since then.

Piraeus shares closed up 20% over the day, rising from €0.193 to €0.233 per share. At 1.143 million shares and a market cap of €265 Million (Bloomberg, 23 March) the 20% one day increase amounts to more than €50 Million one-day bonus to shareholders of Pireaus Bank. Actually, this is a lower bound. Just 2 days earlier, on March 20, Piraeus shares stood at a one-year low of € 0.17 per share, representing a 37% increase in 2 days or over a €100 Million bonus. The annualized return might make the Guiness records. All this in the name of “saving” the Cyprus economy by having to close a trivial (really!) €6 Billion gap. As an incentive to “accept” this bonus, Cyprus is supposed to pay Piraeus Bank €717 Million. The €817 Million amount could have been used to help close the gap.

The madness is not limited to the perspective of the Cyprus economy and its inept political leadership. It goes all the way to the EU political level. Yesterday, more wealth was lost in Europe and the global financial markets than the trivial €6 Billion needed to rescue Cyprus from economic collapse. Multiples would have been lost each day if a solution is not found over the weekend. According to Bloomberg, stocks were heading for their biggest weekly decline in four months. The Stoxx Europe 600 Index fell to its worst level since November. The Emerging markets index reached a three-month low. A gauge of European bank credit risk climbed. The cost of insuring against a default of European bank debt rose to a highest level since mid-November. German business confidence also declined. UK gas prices jumped to a seven-year high. The world could have shifted into a panic state with unimaginable consequences for a mere €6 Billion!!!

In Cyprus Parliament last night harsh measures were passed to satisfy the European lenders and end the crisis. But at moments, despite reassurances by all politicians to the contrary that at this crucial moment, when the nation walked at the edge of the precipice, the nation’s interest would be put above all, political egos rose again above national interest.The leaders of the two main opposing parties disagreed over phrasing of words (even though the arguments were repeated four times in front of a national TV audience) concerning an amendment the communist party wanted to attach about the fund benefits affected by the restructuring of Laiki bank. And even though all agreed that parliament would handle this issue in the near future, the amendment was taken off and then put back on, risking the future of the nation (by a few votes if the communist party had chosen to oppose rather than abstain) as a result of a peacock-type fight of words among the two political leaders while the nation was hanging in the balance.

On another level, the Russians would have lost €2 Billion if the initial bank deposit haircut proposed in the Eurogroup had gone through (finally opposed unanimously in the Cyprus parliament), but were unwilling to contribute even that amount during week-long talks with the Cyprus Finance Minister (when his presence would have been more useful in Cyprus during these hectic days of agony whether the nation would come up with an economically acceptable solution or face collapse). Greece, following its traditional solidarity to Cyprus, was happy to ensure that the proposed Cyprus bank deposit haircut would not apply to the branches in Greece. And that the Greek branches of the Cypriot banks would be taken over by Greek interests  to “shield Greece and safeguard all deposits held in Cypriot-owned banks”.

This is happening despite the fact that the cause of the near-collapse of the Cyprus economy can be traced back to Eurozone politicians’ earlier decision to enforce the Greek-debt haircut to Cypriot banks without any compensation or safeguard, forcing €4.5 Billion in losses and triggering the series of events that came to nearly threaten the global financial system. In that case as well, EU politicians were negotiating among themselves (having the interest of the German or French banks at heart) whether the size of the Greek haircut should have been 20% or something else and constantly revising the size of the haircut causing confusion and instability in the financial markets –when the precise size of the proper haircut (at 40 or 50%) could already be read in the marketplace. Another foolish and futile attempt at the highest level of the EU political hierarchy to impose politics on market economics.

The latest repeat of EU political elite ignoring basic market economics, was the incomprehensible decision by the group of EU Finance ministers to force a haircut on insured bank deposits in Cyprus, that shook the confidence in the EU banking system and the entire Euro project. That was followed by an unprecedented series of denials and finger-pointing at everyone else. Regardless of who conceived or initiated such an economically unsound and catastrophic idea, the mere fact that over a dozen ministers of Finance approved this and were ready to force it on a small Eurozone country is sheer madness!

And this circus of politicians masked as grand economists in both Cyprus and the EU flirts with the absurd. While the heroic Cypriot parliamentarians voted unanimously (and properly so, given the absurdity of the EU politicians) against the bank deposit haircut, in the last days they were happy to impose even more severe haircuts with a sight of relief. At the same time, the EU politicians, in another reversal, were giving signals that that would not be now acceptable. Hence the winding down of Laiki Bank and more extreme haircuts imposed on Bank of Cyprus deposits.

If national governments or EU politicians are intent to impose confiscation measures in the name of the national (or supernational) interest, at least they should attempt to provide fair compensation in exchange. Fair compensation is set in the market place, not via some arbitrary exchange with near-worthless paper certificates.

Coincidentally, Natanyahu apologizes to Turkey … and a gas pipeline will likely run through Turkey. Some do get the economics right!

 Lenos Trigeorgis holds a PhD (DBA) from Harvard University and is the Bank of Cyprus Chair Professor of Finance at the University of Cyprus and President of the Real Options Group. He has been a Visiting Professor of Finance at the London Business School. He is the author of Real Options (MIT Press, 1996), Strategic Investment (Princeton University Press, 2004) and Competitive Strategy (MIT Press, 2011).


Categories → Οικονομία

  1. avatar
    Logical Person on March 23, 2013 - (permalink)

    Professor, you are absolutely right regarding your analysis, what is most puzzling is the naivety of the Cypriot negotiating teams in not ensuring that the Greek deposits where part of the haircut as well. As you very correctly note part of the problem arose from the Greek PSI and the Greek non performing loans. The deposits in Greece were part of the same legal entity that is facing the haircut in Cyprus so I do not understand the reason for the preferential treatment of the Greek depositors?
    Maybe after all the Cypriot generosity has no limits even when faced with national bankruptcy.

  2. avatar
    Savvakis Savvides on March 23, 2013 - (permalink)

    Well said Lenos. I hate to admit this, but how true! Although it reads like our epitaph and paints the picture of stupidity by which we handle crucial economic and political issues.

    I should add that the Greek arrangement was very convenient for Brussels and enabled them to go through with this outrageous plan without fear of contagion (leaving aside the rip-off and the let off for Greek depositors).

    This seems like a well executed plan which needed our co-operation that reached a climax enabling the taking of the decision at the Eurogroup last week. It seems that the only ones who could not get the signals were our politicians! All in all, this confirms what I have suspected. That we are totally unprofessional and unprepared and think that we can solve problems at this level just by being “charming” and by doing public relations. We totally lack substance.

    Last but not least, it is incredible how bad we are getting the clear messages and understanding the issues and motives of our partners, be it Europeans, the World Bank or as we were reminded by the rushing of our Ministers to that wild goose chase in Moscow this week, the Russians.

    Bottom line: Do we learn anything from our mistakes? Absolutely not.

    It is the same people time and again, like playing a game of musical chairs. The same people who destroy through their incompetence and get away it every time. They just take turns on the chair in the middle.

  3. avatar
    Επιλήσμων on March 24, 2013 - (permalink)

    My dear Professor,

    You ask: “Where is common sense?”

    Coming from Harvard I would have expected you to know that COMMON SENSE IS NOT AS COMMON AS THE WORD IMPLIES.

    PS. We have been “sold” and let down by EU/Eurozone, Greece and our own politicians.
    If you ask me which hurts most: Greece, is my answer.

  4. avatar
    Raskolinikof on March 24, 2013 - (permalink)

    Να και κάποιος που λέει κάποιες αλήθειες για την Ελλάδα που δήθεν μας έσωσε και στην οποία ο πρόεδρος εκφράζει ευγνωμοσύνη. με ποια λογική να μην επηρεαστούν η εργασίες στην Ελλάδα; Θα ήταν και δίκαιο και ωφέλιμο προς την Κύπρο ισχύσουν οι ίδιοι κανόνες (καλή – κακή τράπεζα) και για την Ελλάδα. Έτσι διαγράφεται το έλλειμμα και υπάρχει το ενδεχόμενο να εκβιάσουμε και εμείς τους Ευρωπαίους για πιθανές επιπτώσεις στην Ελλάδα.

  5. avatar
    A Cypriot Citizen on March 24, 2013 - (permalink)

    Professor, your very correct article, raises the following two questions:

    1. Did the Cypriot negotiating team understand the implications of their actions?
    If yes then they should be able to explain to the nation their reasoning.
    If not then should future negotiations be conducted by relevant
    “experts” rather than by appointed politicians, and

    2. what should the future role of the government be? Should government be making strategy or should they be implementing the long term strategy, as defined by relevant “experts” who should have specific and measurable targets?

    Any views would be most welcome.

  6. avatar
    A on March 24, 2013 - (permalink)

    Maybe the “good” vs “bad” bank separation should happen along national borders first.

    The idea that the headquarters (and hence the CBC and government) are held liable for the losses of the foreign branches of Cypriot banks but the depositors of those foreign branches somehow become “untouchables” during the bail-in process is simply absurd. For crying out loud, we are paying hundreds of millions of euros to shield Greece from losses that were generated in/by Greece. And if the jump in the stock price of the absorbing bank is any indication, the markets are treating us for the fools we really seem to be.

    Admittedly, emotion clouds my judgement these days, but this sense of ethnic solidarity seems to be running only in one direction for a while now. I, as have many others, expressed concerns about the deal with the Greek branches and at some point in time the details need to come out.

    And I mean ALL the details, the recapitalization needs and their breakdown, the debt refinancing needs, deficit needs, schedule of sovereign bonds reaching maturity (that’s when we are most vulnerable), breakdown of the funding structure of banks, etc…

    I am not sure what’s going on behind closed doors, but the public opinions expressed on this board, even the ones I strongly disagree with, seem a lot better thought out than what the decision-makers have been coming up with since this mess started…

    • avatar
      A on March 24, 2013 - (permalink)

      One more thing regarding the bank run. With Laiki funded to the tune of €9 bil with emergency liquidity, it is safe to assume that the real bank run happened long ago and it happened under our government’s watch.

  7. avatar
    Petros Christodoulou on March 27, 2013 - (permalink)

    The fiasco of Cyprus could had been easily avoided if in IMF and Eurogroup there where some competent people . Post mordem events and actions indicate clearly that all these officials from top to bottom are enaquate and should be removed immediately.
    The 2 Cyprus banks were the problem to solve firstly. Their biggest weaknes last week was their exposure to the Greek market . Remember that Greece is under IMF supervision too. What happened here? They enforced their innovative measure of bail-in for the Cyprus banks and simultaniously they ‘arranged ” for the banks’ greek exposure to be taken over by a Greek bank and Greece.
    If this arrangement with Greece had preceded the events, Cyprus banks could had easily and adequately capitalised their ownselves from the private sector and there would had been no need for the stupid and destructive measure of bail-in for which Cyprus is counting its losses and Europe will do so in the near future.
    IMF officials including Mrs Lagard should be sent to their homes without compensations. They are not only inadequate but they must be held responsible for the effects of their actions and decisions.

  8. avatar
    Fergus Murray on March 31, 2013 - (permalink)

    Very interesting. I wasn’t sure if your comment about Greek solidarity was tongue in cheek or not. I assume it was.

    I still wonder why the Cyprus Central Bank was happy for Laiki to transfer the liability for its Greek branch network in early 2011 from Greece – as a subsidiary – to Cyprus – as a branch. This analysis by Gabriel Sterne at Exotic is interesting on this.

    Also ironic, if nothing more, that Piraeus Bank – which took over the 312 Cyprus ban Greek branches – was a direct beneficiary of €4.7bn bonds from EFSF in recap in May 2012.

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