The Last Europeans? Answer to the Troika*
1. Agency Problem. The Troika has power to impose measures that correct mistakes made both by the debtors and the creditors. Therefore, it can impose measuresto correct mistakes made by Troika members. Not surprising then the rescue programs load all burdens to the debtors. In Cyprus we can give two examples of such situations
a. The Greek PSI, imposed by the Troika to address Greek sovereign debt problems, had an impact on the national economies of some EU countries as shown in Table 1. However, when it was time to address the 23.03% of GDP losses suffered by the Cypriot economy from a Troika decision, Troika dictated that Cypriot depositors alone should cover all losses. Thus, the «Cyprus solution» was born that had all the negative effects of a bail-in without any of the deterrent power ofa bail-in option.
Table 1. Losses to the banking sector of some EU member states from the Greek PSI
b. There is evidence that Cyprus Popular Bank(Laiki) was receiving ELA while it was insolvent and without posting sufficient collateral. However, when it was time to address the €9 billion ELA obligation of the failed Laiki –and suffer an estimated loss of about €2 billion to the eurosystem- Troika dictated that this obligation should go to a solvent Bank of Cyprus that is now staying afloat only through capital controls
2. Signaling. As a result of agency problems the Troika may be giving inconsistent signals as to the problem it is trying to solve and the solutions it offers. This has been twice the case in Cyprus:
a. Even after Cyprus banks were re-capitalized with depositors’ money the ECB refused to extend unlimited liquidity and capital controls became necessary. The signal from Troika seems to be: «we do not really believe that our own solution will work; For otherwise we would have trusted the banks and extend unlimited liquidity». In reality what they are doing is to refuse to assume any risks for their own decision. And even if the solution could work, the capital controls exacerbate the problems for the local economy.
b. Similarly, the correct signal regarding ELA would be to convert it into long-term liability, as happened in the case of Ireland. This would give the local banking sector time to unwind ELA and avoid fire sales of the posted collateral.
3. Transparency and accountability. Policy decisions are driven by «experts» whose opinion at the given time carries great weight, but they are not accountable if their opinion turns out to be flawed.
Such has been the case in Cyprus with the due diligence carried out under Troika supervision by PIMCO to establish Cyprus banking sector recapitalization needs. The PIMCO estimate (about €5.8 billion) appears to have been grossly overestimated and is more than double the estimate provided by the stress test of EBA for the Cyprus banks a few months earlier. Nevertheless, the need to bail-in depositors and the magnitude of the rescue package were determined by the PIMCO study. This report is Strictly Confidential -it has leaked though and is available on FT Alphaville - and so are other studies that allow us to assess the validity of the PIMCO estimate. As a result my own analysis for the Investigation Commission was also characterized as Strictly Confidential, which mocks the meaning of «public hearings» and «shedding light» on the causes of the Cyprus crisis.
My report Mismanaging the Cyprus crisis 2012-2013: Delays, ELA, PIMCO and all thatanalyzes publicly available information. However, without complete transparency we can not fully comprehend the flaws in the Troika approach to dealing with the Eurozone debt crisis.
In conclusion: We should not criticize lightly the «man in the arena» – the politician or technocrat who is fighting to solve real problems with real money in real time. The men and women of Troika are trying to make the best of a bad situation. However, the advise of Cypriot Nobel Laureate Chris Pissarides concerning the euro should be carefully headed: «fix it, or abandon it». The work of Troika is neither fixing the euro nor abandoning it. In the case of Cyprus it is creating an economic disaster worse than the 1974 war with Turkey.
Certainly this is not what the people of Cyprus – and Portugal, Ireland and Greece- had in mind when they joined the EU. But then, what Benjamin Franklin experienced in the Cockpit in 1774 is not what he had in mind either. I hope the European Parliament Committee does better than the Lords of the Privy Council.
*Το άρθρο ετοιμάστηκε για παρουσίαση στην Επιτροπή Οικονομικών και Νομισματικών Υποθέσεων του Ευρωπαϊκού Κοινοβουλίου αναφορικά με το ρόλο και τη λειτουργία της Τρόικας στις χώρες του ευρώ που βρίσκονται σε πρόγραμμα στήριξης. Λευκωσία, 10 Ιανουαρίου 2014.
*Αναρτήθηκε στο μπλογκ zenios.wordpress.com .
Under preparation for the proceedings of the T. Papadopoulos Center Conference on “Five years euro in Cyprus”.