Great Leap Forward

What Went Wrong in Cyprus: an MMT Perspective (updated)

Some readers have encouraged me to provide an MMT perspective on Cyprus. First a caveat: I have no special expertise on that country. However, as all of you know, MMTers have been warning about the fate of Euroland for almost two decades. As you watch one after another of those dominoes fall, you cannot help thinking about the Wild Africa documentaries you watched on TV when you were a kid.

Remember when the pair of lions sneak up on a herd of wildebeest? The lions pounce on the weakest one. The others are startled, watch the lions munching on their brother for a minute or two, and then go right back to grazing. “Better him than me”, they appear to think. And so goes Iceland, Ireland, Spain, Portugal, Italy, Greece and Cyprus. The Dutch and French and Germans just keep grazing that grass.

Ok so what went wrong in Cyprus. Floyd Norris helpfully noted that Cyprus is a bit smaller than the state of Vermont, so let us begin there. Cyprus is a user of the euro; Vermont is a user of the dollar. Neither issues its own sovereign currency. Both have banks that issue deposits denominated in the currency they use—the euro deposits in Cyprus look exactly like euro deposits in any Euroland nation; the dollar deposits in Vermont look just like dollar deposits anywhere in the USA. There are no capital controls among Euronations, nor among USA states. The Eurozone has a central bank—the ECB—and the USAzone has the Fed. These central banks clear accounts for their respective banking systems. So far so good.

There are three fundamental differences, however.

Cyprus is responsible for regulating and rescuing its own banks; Vermont has some supervisory responsibility for its state-chartered banks (I suppose there are some), but the FED, OCC and FDIC oversee that. Further, if the you-know-what hits the fan and Vermont’s banks get in trouble, Uncle Sam (Fed+Treasury) comes to the rescue. If Cypriot banks get in trouble, it is the government of Cyprus that must bail them out. (Good luck with that!) When it cannot, it goes hat-in-hand to the Troika to beg for pennies, offering to sell all the royal jewels to the Germans in return.

Second, while both Vermont and Cyprus are currency users (not issuers), only Vermont has a direct line to Uncle Sam’s national treasury—which spends over 20% of USAzone GDP across Congressional districts to keep the pork flowing. Cyprus has no Uncle Fritz, and in any case the EU Parliament spends well under 1% of Eurozone GDP, mostly to subsidize farmers. In a deep economic downturn, Cyprus is on its own; by contrast, Vermont got a share of President Obama’s Trillion Dollar Deficits.

Third, while Vermont’s electorate has some independence to determine laws that apply to the state, in many areas federal laws trump. Witness the national debate about whether individual states have the right to marry gays or let people partake of particular herbs. Cyprus has much more leeway to decide what goes on within its borders. (I realize that part of the reason to unify has been to harmonize laws—but Eurozone nations are more tolerant, which is precisely why there is so much anger now about what periphery nations have been doing….)

Now why are these differences important? Think back to the days before 2008. Ireland was the Eurozone’s preferred bank haven. It issued euro deposits and paid handsome interest rates. Its banks blew up to gargantuan size. When the crisis came, the banks went bust and the deposits flew out.

Depositors looked for an alternative, and Cyprus was the lucky recipient of hot flows of deposits.

Cyprus marketed itself as a new offshore—but very close and safe—repository for euro deposits. It was European, but with substantial independence to set its own bank operating rules—which were purposely kept loosey-goosey. You see, the 500 Euro note has become the favorite currency for international crime (as Norris points out, the USA only issues the measly $100 bill).

Without casting dispersions, one might note that a lot of the deposit-holders in Cypriot banks happened to be Russians. Coincidence? You decide.

By 2008, Cyprus was gaining $41 billion of deposits per year, over 160 percent of the tiny island’s GDP. Banks and Beaches were the only thing Cyprus had on offer.

Cypriot banks made loans to the Cypriot government. Why not? What could possibly go wrong? Unified currency, access to ECB for clearing, member of the biggest economy in the world.

Then the dominoes start to fall; ratings on government debt fall as tax revenues fall (and, to be sure, some periphery nations were not all that good at collecting taxes in the first place) and interest rate spreads rise—blowing up government budgets.

Cyprus doesn’t look so good any more. Her banks are holding risky government debt, and become insolvent. The Troika demands taxes on deposits to recapitalize the banks. Investors the world-over are shocked, shocked! that deposits in euro banks are not safe.

You know the rest of that story: banks are closed and no one can get deposits. The Troika has to back-off on plans to “tax” (seize) everyone’s deposits, and “compromises” with a haircut of up to 40% on deposits above 100k euros. Capital controls have been imposed for the foreseeable future, restricting the amount of cash allowed to be taken from ATMs, and prohibiting check cashing and electronic transfers.

I think we call that “closing the barn door after the cows got out”. The time for capital controls would have been in 2008—to keep the damned hot money cows out! But the wildebeests in Cyprus just went on grazing while the lions fed on Ireland, then welcomed the lions into Cyprus.

To understand the sheer folly of all this, think again about Vermont.

Suppose Vermont decided to declare itself an offshore banking paradise. Its banks would offer dollar deposit accounts to all drug running, money laundering and terrorist outfits from around the world—encouraging the worst money laundering banks (think HSBC and BofA) to expand their operations in Vermont. No restrictions, perfectly free flowing capital. All tainted dollar-denominated money flows into Vermont from the USA, the Bahamas, and the world beyond.

Lots of new jobs are created in handling the tainted money. The economy grows rapidly. The state government realizes it can afford more pork. Expecting revenues to rise forever, it decides to issue debt against future taxes. Its banks load up on state government debt.

The global financial crisis hits. Hello, Washington, We’ve Got A Problem. Can you spare $20 billion?

And so it goes. The Troika will provide 10 billion in loans, of which 1.4 billion will be used by the government of Cyprus to make a payment in June to hedge funds that have been scooping up government debt for pennies on the euro in expectation that the Troika would eventually blink.

Cypriots lose all their banking jobs. And their life’s savings. They send their kids off to Germany to slave away in permanent peonage.

And the wildebeests in Euroland munch on.

Update: See here:

“It is often said that the best way to rob a bank is to buy one.   During the last few years, Laiki Bank and Bank of Cyprus lent billions to members of their boards and shareholders without receiving the required collateral and guarantees1. A little-understood but important contributing factor to the Cypriot banking crisis was the investment in and exposure to Greek bonds from the secondary market as Cyprus’s banking business model began to feel the strain of reduced investment flows, due to the European financial crisis unfolding around it. Cyprus’s major banks turned to Greek sovereign debts as a desperate strategy to find cheap but profitable investments, despite the obvious risks from exposure to Greece.

Laiki Bank and Bank of Cyprus, Cyprus’ two major banking institutions, in particular bought ‘toxic‘ Greek bonds in the last few years, often at a discounted value as other European banks sought to divest themselves of the increasingly risky debts of Greece. In one prominent example, Greek sovereign bonds were purchased at an 18 per cent discount to their nominal value through the brokerage of Bank of Cyprus, from Germany’s Deutsche Bank. Deutsche was so desperate to sell that it had even offered 5 per cent commission to any agents who succeeded in selling these ‘toxic’ bonds. This catastrophic investment, whose losses were realized once Greek bonds were forcibly devalued by Greece’s latest Troika deal, represented €100 million euros of revenue for Bank of Cyprus’ brokerage company. Greece’s revised bailout conditions that were agreed by the Troika in December imposed a widely expected ‘haircut’ on holders of Greek bonds, forcing the Cypriot banks to accept major losses. This was the death-knell for Cyprus’s irresponsible financial titans. The likely losses on Greek bonds were widely identified in advance both locally and internationally, yet the Cypriot central bank dismissed them. When the haircut was inevitably applied, both banks collapsed.”

And so the Germans had them coming and going!!!




12 Responses to “What Went Wrong in Cyprus: an MMT Perspective (updated)”

Antoine DuvalMarch 29th, 2013 at 2:58 pm

Indeed, you're not an expert…Cyprus is no bloated Government Debt story, it is about some banks making very bad (sentimental?) investments in Greek bonds and being deadly wounded by the haircut on these bonds, forcing then the Cypriot government to bail them out…Moreover, Cyprus' business model is not new (as you seem to point out, linking it with the ailing of Ireland's Banks), it relies on an older banking tradition and it involves mainly Russian money…However, despite the factual inaccuracy, your macro account of the differences between Cyprus and Vermont remains accurate…It is the dilemma of the Eurozone: Integrate (too fast, too deep?) or disappear (in a Maelstrom)…

L. Randall Wray L. Randall WrayMarch 29th, 2013 at 4:17 pm

Relax Antoine. I never said Cyprus had a bloated government or debt. You are reading into this something I never said.

And, yes, Cypriot banks did buy Greek debt (see my update).

As I said long ago, anyone who has deposits in any Euroland bank that is not a German bank is either a philanthropist or a fool. And anyone who buys any Euroland government debt except German government debt is a philanthropist or a fool. You’d never put money in a Vermont bank or in Vermont government debt if that state was responsible for bailing out its banks, and ran up government debt greater than 10% of the state’s GDP.

Antoine DuvalMarch 29th, 2013 at 4:46 pm

Sorry if I sounded a bit aggressive.

As I said I share with you the view that the Eurozone is build on shaky institutional and political grounds. Especially, because of the deadly link between financial and sovereign debt (in the absence of any national monetary policy). However, the interesting thing with the Eurozone is that we are in a grey zone, there is a bit of federal "stuff" building up (see the Banking Union if it materializes, the ECB policy "to do whatever it takes", even to some extent the bailouts which might be a form of financial transfer if as probable they are extended ad vitam aeternam), but will it be enough if at the same time this federalization fuels social despair and unrest?

We are at a crossroad, the longer we stay there the more painful (and dramatic) the choice will be, either we take a right (as seems to be slowly the case) and a federal Eurozone emerges (a many tier EU) or we take a left everybody devaluates and the Euro adventure is over for good (economic short term) and for bad (economic long term?).

Ben JohannsonMarch 29th, 2013 at 5:05 pm

There's no argument here that Cyprus was spending too much. The lesson is the eurozone was destined for trouble once the first major demand shock occurred.

llisa2u2March 30th, 2013 at 5:22 pm

great comments!

It may also be worthwhile for anyone and everyone to read the copy of interview with Dr. Bernd Lucke that's on BI March30, 2013. He clearly and actually specifically, and rather simply refers to the issues of "EU development into a transfer union", issues with the "euro as separate for all nation member of the EU", and specific problems, of course, just for Germany. However, his comments really clarify the specifics of what is going on with EU membership and the EURO. The specifics address the problems that are affecting Cyprus. However, there is still the basic issue of Russians probably laundering money and the great interest rates that was only available in Cyprus. So another real issue is laundering money internationally. Then the other most basic issue, and Lucke points that one out very clearly too, is:
"So, while it currently seems to be the case that we do benefit from the euro crisis, there are tremendous risks in the wings, and we would like to end these policies of disguising fiscal risk, and discharging banks of their risk to the detriment of taxpayers."

For the US, The most basic issue of everything that has occurred from really the 1990's bank fiascos, and of course the more recent 2008 US bank crises is the most basic fact of "disguising fiscal risk, and discharging banks of their risk to the detriment of taxpayers". This one issue has affected the US taxpayers, and will continue to do so to our detriment and our childrens' detriment. Our US educators to a certain extent also try to "disguise" and gloss over the real issue with varying focus on secondary issues, and choice of terminology and phraseology. Our US politicians, both Dems and Republicans definitely try to use terminology, and hyped key-words and repetition of key/buzz-words, that also disguise this basic fact and all of the resulting issues and risks to taxpayers.
Talking heads need to specifically and clearly speak the truth and the facts rather than trying to disguise issues, facts, and divert public attention to sub-issues and non-issues that will not resolve the basic problem and the basic issue. We are beyond the stage of letting Politicians continue to play a no-win game for everyone else, except to get politicians voted in for a short or long tenure that ensures their financial success at the cost of the majority of US taxpayers.

Wray has some guts and so does this other guy from Germany.

Read more:

and of course, ponder, digest and repeat facts to reveal clear messages.

L. Randall Wray L. Randall WrayMarch 31st, 2013 at 1:54 am

Thx Lisa: you are right, that is a very good article; probably the most sensible thing I’ve read coming out of the Eurozone.

ChristianApril 2nd, 2013 at 10:33 am

The problem is, that Mr. Lucke and his fellows are expressing "right wing" solutions not only for the Eurozone but also for most of the ordinary people in Germany. Instead of fixing real problems like the rising mass unemployment, the tax injustice or the declining real wages througout Europe they prefer to kick all "lazy states" out and give them "the chance" to introduce their own currency. Nice trick: first you make an economic arrangement which definitly will not work in times of crisis and after the massive social and economic problems occur you give them the opportunity to leave or to take the medicine which will kill not cure. And so the most benefiting country from the whole arrangement (Germany) will not be bothered and most politicans and the economic experts in our country could live happily ever after…Maybe some arguments from Mr. Lucke are correct and maybe they are sometimes similar to some positions of MMT. He and his bunch of jerks will never come up with rational and fair solutions to fix the mess we are in – not only in the Eurozone but also here in Germany.

Christian/Berlin (Germany)

jerryApril 2nd, 2013 at 6:03 pm

Very informative, thanks for the article. I've heard Yanis and Marshall Auerback make reference to the "competitive devaluation" and the labor struggle in Germany more generally. I don't see much information related to this on the internet.. obviously Germany is able to thrive in the Eurozone due to its large trade surplus, does anyone have more information on the German labor situation? Have wages stagnated similar to here in the US? Worse?

L. Randall Wray L. Randall WrayApril 2nd, 2013 at 10:58 pm

yes. i’ve actually presented the data, as have others. germany held wages essentially constant since east germany joined up; while all other countries had rising wages. that is what increased german competitiveness

jssApril 2nd, 2013 at 11:10 pm

Greek government bonds? This seems to be thing that many bloggers are running with (as in it was enforced writedowns of Greek Sovereigns that took these "unsuspecting" bankers down in turn). However, browsing an IMF piece released at the end of 2011 reviewing the Cypriot banking system, I see that its non-government credit exposure to Greece was quite a few multiples its then exposure to Greek Government Bonds. I suppose the loans in that book must be doing just fine! I wonder, do other "International Banking Centres" like Luxembourg and the Caymans take in deposits from all over and then invest those in local car parks and fishing boats – or are they actually conduits (as in international deposits in, international loans/assets out)? "International" didn't quite seem to be the case on the asset side of Cypriot banking. Guess they'll get it right next time.

John DurhamApril 4th, 2013 at 11:15 pm

This is an important article which also quotes an even more important article by Petros Kosmas who shows a way out by citing Iceland's public controlled banking model and the public taking back first rights to natural resources. The banks are eating us alive, nothing less. We need to kill these banks, like Deutsche Bank, Goldman, HSBC, B of A, etc. (hedge funds or banks?) before they kill us all. Again, nothing less will do.

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