Sunday, March 17, 2013

Cyprus and the future of the EU

The island nation of Cyprus joined the EU in 2004 and in 2008 it was accepted as a member of the Eurozone, proper. Since achieving independence--more or less--in 1974, Cyprus has progressively become more prosperous via increased tourism and acting as an international banking center. In this latter role, Cyprus has served as a major conduit for investment activity between nations previously under the banner of the Soviet Union--along with China and other Asian nations in more recent times--and Western Europe. Cyprus banks thus represent offshore accounts (or havens) for people in other nations. These banks have been so successful in this regard that their total holdings dwarf the remainder of the Cypriot economy, being as much as ten times larger than the yearly GDP for the nation.

But unfortunately, these banks bet big on Greece and in 2012 it became apparent that their potential losses put them all in danger of collapse, causing Fitch (along with Moody's and S&P) to lower Cyprus's credit rating to junk status in the middle of last year:
Cyprus's credit rating has been cut to junk status by Fitch, reflecting fears the country could require a eurozone bailout to shore up its banks.  
Cyprus, whose banks are heavily exposed to Greece, will need 4bn euros (£3.2bn) to support its banks, said Fitch.  
This is on top of 1.8bn euros Cyprus said it needs by Friday to recapitalise its lender Cyprus Popular Bank.
Since then, the situation for the Cypriot banks has only gotten worse. On Saturday, EU officials formally announced a €10 billion plan to rescue the nation's banks, more than double the amount projected as needed last year. And one of the terms of this deal requires something new and unheard of--to this point in time--from a member-nation of the EU:
In a radical departure from previous aid packages, euro zone finance ministers want Cyprus savers to forfeit up to 9.9 percent of their deposits in return for a 10 billion euro ($13 billion) bailout for the island, which has been financially crippled by its exposure to neighboring Greece.

The decision, announced on Saturday morning, stunned Cypriots and caused a run on cashpoints, most of which were depleted within hours. Electronic transfers were stopped.
Let's be clear on this: the EU is basically going to fine all account holders in the afflicted Cyprus banks up to almost 10% of their holdings (it's actually 6.75% for accounts with balances less than €100,000, meaning there a bunch of people now trying to reach that plateau by withdrawing cash).

But there's also some other stipulations to the deal that need to be pointed out:
In addition to the levy, [Cyprus Finance Minister] Sarris said, a 20 to 25 per cent tax will be imposed on the interest on deposits.  
And in return for emergency loans, Cyprus additionally agreed to increase its corporate tax rate by 2.5 per cent to 12.5 per cent.
All of these taxes are intended to help pay for the huge loan from the EU and to make sure the government can lower its own deficits in the future, so as not to be in a position where it needs to rely on the EU to bail out banks who make poor decisions. And let's be clear about this, too: just like the now-defunct MF Global, the Cypriot banks made bets on sovereign EU debt, particularly that of Greece, bets that were incredibly risky.

Is it a smart plan? Is it even a workable plan? Is it a fair plan? Many bank customers who did nothing more than establish simple banks accounts where they were living (which includes not only native Cypriots, but also ex-pat Brits and other Europeans) are going to get the shaft here, are going to lose possibly as much as 10% of possibly everything they have. And why? Well, as Megan McArdle points out, the real targets of these taxes are those accounts filled with serious money:
And just to bring it full circle, the banking system had grown to such grotesque, hypertrophied proportions because Cypriot bank accounts seem to be a favorite of tax-dodging Russian oligarchs . . . which is why it was politically necessary to give depositors such a large haircut.
The only way to get at those accounts largely filled with ill-gotten gains is to institute an across the board tax that impacts everyone. Now, EU officials are claiming this is a one-time thing, that it's a unique incident and will not be repeated when it comes to other potential bailouts (like in Spain or Italy). But one has to wonder: why not? Why should anyone in any other EU nation not be worried about a similar tax?

But even more worrying is the targeting of a distinct group for a punitive measure, i.e. the "Russian oligarchs," simple because it can be done. No doubt, there are some who imagine a measure of justice or the like in this measure, but that's a fantasy, since whatever ill-gotten gains this group has made has been largely at the expense of people far removed from Cyprus, the EU leadership, and likely the EU in general. Indeed, these monies have been used as the basis of the banking boom in Cyprus, a boom which others from the EU proper were more than happy to participate in when it was going strong. Now that things look bad, the same source of growth is being targeted simply because it can be targeted, no other reason.

While there is an obvious parallel here to the United States, with regard to the targeting of the "rich" for additional taxation measures and the attempts to derive moral justifications for the same via nebulous and flawed reasoning like the above, there is another issue, a rather large elephant in the room: what about the banks in various other EU nations--including England and Germany--who have been more than happy to take money from pretty much any source? Indeed, banks in other parts of the EU deal with--and profit from--the banks in Cyprus as a matter of course. They're very much partners, with regard to EU financial structures. Yet, it's only in Cyprus that this special one-time tax is being assessed.

There is speculation that this action could cause panic outside of Cyprus proper, once it actually goes into effect. This may or may not happen, but even if it doesn't EU citizens still have cause to worry. Because despite the assurances of EU officials on the uniqueness of the Cyprus situation, it does set a precedent. There's no getting around it. Perhaps these measures won't be repeated, with respect to current EU turmoils, but what about the less-immediate future?

Apparently, EU officials believe their authority to address problems is so great as to allow arbitrary actions like this one that punish some EU citizens for, well, nothing. It's not a good sign. It's a very troubling one.

Cheers, all.

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