Cyprus is really screwed

At this point the Cyprus situation is pretty clear — and clarity does not bring reassurance. In fact, it looks as if Cyprus has managed to combine in one place everything that has gone wrong elsewhere.

1. Runaway banking. Cyprus has a huge banking system — assets around 8 times GDP — based on a business model of attracting offshore money with high rates and good opportunities for tax avoidance/evasion.

I’ve done some asking around, and cleared up something that was puzzling me. Officially, only about 40 percent of the deposits in Cypriot banks are from nonresidents, which would imply resident deposits of almost 500 percent of GDP, which is crazy. But the answer is that I do not think that word “resident” means what you think it means. Some of the money is from wealthy expats living in Cyprus; much of it is from rich people who have resident status without, you know, actually living there. So we should think of Cypriot deposits as mainly coming from non-Cypriots, attracted by that business model.

And the business model only works until there’s a big loss somewhere; since Cypriot banks were investing in Greece and in their own domestic real estate bubble, doom was inevitable. Which brings me to:

2. Big domestic real estate bubble, Spain or Ireland-sized. Not yet fully deflated, which means lots more losses to come. And the combination of the real estate bubble and the income from dodgy banking also led to:

3. Massive overvaluation, with Cypriot prices and costs having risen much more than in the rest of the euro area. In 2008 the current account deficit was more than 15 percent of GDP!

What can be done? First off, Cypriot banks cannot honor their debts, which unfortunately overwhelmingly take the form of deposits. So a default on deposits is inevitable.

As I now understand it, the initial screwup was a joint error of the Europeans and the Cypriots. Europe didn’t want an explicit bank resolution, which would among other things have given clear seniority to small insured deposits; instead, it wanted this essentially fictitious tax scheme. Meanwhile, the Cypriot government still has the illusion that its banking model can survive, and wanted to limit the hit to the big overseas depositors. Hence the debacle of the small-deposit tax.

In the end this probably comes, in some version, to what it should have been from the start — a big haircut on deposits over 100,000.

But even then the situation is by no means under control. There’s still a real estate bubble to implode, there’s still a huge problem of competitiveness (made worse because one major export industry, banking, has just gone to meet its maker), and the bailout will leave Cyprus with Greek-level sovereign debt.

So then what? As a number of people have pointed out, Cyprus is arguably better positioned than Iceland to do an Iceland, because devaluing a reintroduced Cypriot currency could bring in a lot of tourism. But will the Cypriots — who haven’t even reconciled themselves to the end of their round-tripping business — be willing to go there?

Truly awesome stuff.

11 Comments on "Cyprus is really screwed"

Beery on Thu, 21st Mar 2013 11:00 pm 



Plus, what no one seems to be mentioning is that there is still a lot of Greek vs. Turkish Cypriot friction that stems from what was effectively a civil war on the island in the 1950s. My uncle was killed there in 1956 while serving with the British peacekeeping force. The country is still very much divided. I think this could easily turn into a bloodbath.

Plantagenet on Thu, 21st Mar 2013 11:26 pm 



There wasn’t a “civil war” on Cyprus—-the Turkish Army invaded Cyprus and still occupy half the island.

Arthur on Thu, 21st Mar 2013 11:49 pm 



Yes, diversity always has genocide looming just around the corner, fortunately in this case the diversity is totally segregated, with a nice fence in the middle, so accidents are not very likely. In fact the most logical next step would be for Russia to step in. After all, they soon might need a new Mediterranian marine base, now that the Syrian pied-a-terre in Tarsus might soon become vacant.

BillT on Fri, 22nd Mar 2013 12:21 am 



Arthur, I think you have the solution. I have read that same answer in other articles. Russia needs to be in the Med and Syria is either going to need their help or be abandoned as a base. Plus, Russia would like to get rights to the oil and gas and will make some kind of deal.

Beery on Fri, 22nd Mar 2013 12:57 am 



Planty, the Turkish army invaded in the ’70s. I’m talking about the 1950s. And I said it was ‘effectively a civil war’.

Violence flared up in 1956. In 1957 the Turkish Resistance Organization (TMT) came into existence. Although infrequent, EOKA and TMT targeted each other’s members with ferocity. In 1958, EOKA killed 55 Turkish Cypriots whilst TMT killed 60 Greeks.

GregT on Fri, 22nd Mar 2013 7:11 am 



Don’t worry guys, once we get beyond all of the small looming problems that the world is facing, and we return back to BAU, everything will be fine. Honest.

Arthur on Fri, 22nd Mar 2013 8:09 am 



Today Eric Margolis (Lebanese-Jewish) chimes in, sensible as always, draws the same conclusion, Russia could step in:

http://lewrockwell.com/margolis/margolis333.html

They are emerging as the worlds number one energy giant, they have the know-how to extract the resources, they have cultural ties with orthodox Greece and have been a moderating force since they abandoned their abstruse bolshevism. To be fair, currently the Russians are too weak to behave differently.

I am not too impressed by the financial woes of Cyprus, just another Iceland, of which nobody talks anymore either and 18 billion is not the end of the world. Far more explosive are the huge gas finds, disputed by Greece/Cyprus, Turkey and Israel. Turkey has a booming economy and developments in the ME are all pointing towards the formation of a uniform Sunny block, of which Turkey is volunteering to play the role of the Germany of the ME, filling the void of a receding Pax Americana.

Arthur on Fri, 22nd Mar 2013 9:01 am 



http://www.elsevier.nl/Europese-Unie/nieuws/2013/3/Rusland-stopt-gesprekken-met-Cyprus-over-financiele-steun-1208419W/

Meanwhile Russia is not impressed by the free advice offered from either this page or Eric Margolis and has declined to step in. Maybe Cyprus will go broke as the EU is tired of bailing out every sucker.

News that came out yesterday that in fact, surprise, surprise, Germans are poorer than the so-called mediterranian losers, will not help much either for the northern Europeans willingness to foot the bill… again.

http://www.manager-magazin.de/finanzen/artikel/0,2828,890276,00.html

Financial assets average household in euro (=1.3$):
Germany: 51k
France: 113k
Italy: 164k
Spain: 178k

Reason: real estate. Southerners prefare to pay off their mortgage rather than taxes. Call them libertarians or crooks or both.

It could very well be that they will let Cyprus go broke, I hope they do, because it will mean the end of the scourge of bailouts. Message: you screw up, you suffer, not us.

BillT on Fri, 22nd Mar 2013 11:33 am 



But Arthur, it will mean the end of the EU and the Euro. I know that die hard EU fans don’t want to see the writing on the wall, but no country is little in this domino world. Any intelligent European (or American) should see that the ECB has tipped it’s hand as to how it will come down in the future for ALL indebted countries. Confiscation of wealth. The bank runs will be all over Europe if it happen in Cyprus. Wait and see. They cannot allow Cyprus to leave the EU as it will only be the first of many and the end of the Euro.

Arthur on Fri, 22nd Mar 2013 2:59 pm 



Cyprus will possibly go broke, so what? People lose savings and have to start all over again. Happened in Russia in, I believe, 1998, in Argentina, in Iceland. I do not see the link between the crisis in Cyprus or Greece and the continuity of the EU. The Greeks are free to go, yet they are desperate to stay in the EU. Membership of the EU means membership of one of the most potent economic blocks of the world. Greece outside the EU would place Greece in the ‘club’ of Turkey, Egypt, Russia, Lybia, what have you. Greece owes the crisis to itself and they know it. There is no incentive to leave the EU, because the EU would find means to make this move felt. Like tariffs or hindered access to EU markets. The only country that could potentially leave the EU is Britain, for geostrategic reasons, as they have tied their fate to Anglosphere, but even Britain leaving the EU is not likely, certainly not as long as the EU is in a subservient position to the US and Britain will be happy to function as a bridge between the US and EU, a role for Britain even preferred btw more by the US than by the UK itself. But the clock of the timebomb under the Atlantic alliance is ticking and as the US is moving into third world status, ahead of Europe, which is moving in the same direction, there will come a time when the relationship will have outlived itself and nationalist forces in Europe will gain the upperhand, something that is brewing here in Europe for decades. Since the Fortuyn and van Gogh murders political the power of political correctness has vanished completely and relationsship between the Dutch and muslims is tense and openly discredited by the Dutch. France is even further in this respect and so is Belgium (Flanders). Greece already is hyper-nationalist, as a direct consequence of the crisis, showing what is going to happen in the EU (and US) when a economic/financial crisis erupts.

The EU/united Europe is not very controversial. Controversial is the tendency of Brussels to grab ever more power and direct taxation. Most Europeans are content with the institutions as they are and do not want to hand over more power to Brussels. And it looks as if this is not going to happen indeed. The EU is a very thing institutional layer over European nations: a euro, 30,000 civil servants, budget 1% EU GDP, a euro-songfestival, euro-soccer tournaments, aviation industry, space program, europol. No army, no fleet, no nukes. This is ok with most and that attitude will not likely change.

BillT on Sat, 23rd Mar 2013 11:53 am 



The EU’s glory days are over. Peak energy is going to make sure of that. So, argue all you want that the EU is strong and going to last. It isn’t.