Recent negotiations over Cyprus’ bailout plan tested the hard wrought stability of a union which seemed finally to have solved a few of its core problems.
Few imagined that the Mediterranean country’s financial problems, well known in advance, could rattle the European Union anew. Yet an economy approximately one tenth the size of Greece’s, where the estimated sum of a bailout package would reach a maximum of €18 billion, in relative terms a paltry sum, raised more existential problems for the euro.
Cyprus’ rescue could have been the culmination of two years of negotiations and institution building. It could have shown the world and indeed the European Union itself that it was finally able to handle these situations with little ado.
Yet old superstitions arose and instead of following on recent developments, the European Union and the International Monetary Fund decided to break assurances and introduce new contingencies, the consequences of which will only be fully known once a bigger euro country enters a period of instability.
Northern European countries believe that Cyprus’ economic policy structure has two undesirable elements to it.
First, it has an oversized financial sector. Cypriot bank assets are worth roughly seven times the island’s gross domestic product. Financial institutions choose to settle in Cyprus because it is part of the single currency union but has a lower corporate tax rate than most member states.
Second, it is a hub for Russian investors who wish to deposit their funds in the eurozone. This has created the perception of European taxpayers having to bail out a tax haven of the Russian oligarchy.
Even in ordinary times, saving Cyprus from the possibility of sovereign default would therefore have been difficult. With German elections scheduled for later this year, the bailout was all the more politically toxic.
The Cypriot bailout was preceded by half a year of negotiations about how to decouple the problem of indebted states from banks that might need financial aid to survive. One of the pieces missing from the framework is a European deposit guarantee that should alleviate the fears of savers in especially the south of Europe. If a bank there collapses, states, coping with high debts of their own, might not be able to compensate savers. A deposit guarantee scheme spanning the whole of the euro area if not the whole European Union would remove such uncertainty.
Instead of building on this framework, however, Cyprus was presented with something else entirely.
The first proposal from the European Union would have required all depositors to contribute to the refinancing of the banking industry. This meant a 9.9 percent tax on big savers and a 6.75 percent levy on deposits under €100,000.
Uproar ensued and capital controls were imposed to stave off a bank run. Parliament rejected the rescue plan unanimously. Only later did it emerge that the scheme had been suggested by Cyprus’ president Nicos Anastasiades who feared that if regular depositors were not included, big depositors would take a hit that could destabilize his country’s economic model.
The revised rescue plan safeguarded deposits under €100,000 in accordance with a 2009 guarantee pledge. The damage, however, was already done.
Even if the deposit guarantee was honored, the situation left many wondering what would happen if a similar situation occurred in a systematically more important member of the eurozone. If Cyprus, small enough to be bailed out, could consider a deposit tax, are savings in Italy and Spain safe? Just how solid is Europe’s deposit insurance promise anyway?
European leaders insisted in July 2011 that private sector involvement in the restructuring of Greece’s debt was “exceptional” and “unique.”
"All other euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms."
The situation in Cyprus was different. Private investors were not directly involved in a sovereign debt restructuring. Yet given the context of the Cypriot bailout, the question for businesses and savers across Europe must be—how different?
A relatively short distance of road leading in to the city centre of Tallinn has been a good reflection of the state of the country during these last few years. Just in the outskirts of town, before buildings start to consecutively become more and more frequent until they form the urban tunnel all big city roads are identified by, there is a housing / business development under the name of Black Swan (Must Luik). To my knowledge it had been bought from its previous owner – the complex had a café and other non-descript tenants - and the aim was to build apartments on the top floor with smaller businesses covering the ground floor. One of the conditions for the development was that the owner needed to renovate old Tsar-era houses that were adjacent to the lot.
Well, the ‘black swan’ event of 2008 occurred and the debt-fuelled housing bubble burst, leaving a derelict building site whose façade slowly lost any serious appearance. The old house was languishing and in terrible disrepair; that part of the roadside served to remind one of the difficult situation many Estonians were facing.
In 2012, the Black Swan development is finished. Just before I left Tallinn a new shop and café had been opened on the premise. The black façade looked new and the window-covered exterior reflected the park on the opposite side. The older house is renovated from the outside and its peak stands majestically over the buildings.
This is but one building that has seen its completion in a short time. Equally so has a new retail / office space opened up further down the sea-side road leading to the city centre. What does the nearby billboard advertise? “Having trouble selling your property? Contact us and we’ll get it sold.”
The oscillations of the European debt crises have become quite familiar to those observing it. A country or national bank suffers from a negative spiral of debt and fading confidence. This is followed by a new nudge in the direction of deeper integration, or a bailout package is announced. A northern country which is fiscally sound then makes a controversial statement of refusing to cooperate on the terms proposed. This process muddles on until a new country or institution is in a dire situation. Like last year, summer holiday season generates the greatest divide between the political process and the factors that affect the crisis.
Quite apart from this has been the European Central Bank. For this reason, Mario Draghi, its president, recently caused a stir that reverberated far from the usual central bank watchers.
In a speech at an investment conference in London, Draghi went against two developments. First, central banks have historically been excruciatingly vague in their announcements regarding future action. Draghi’s speech was quite blunt. Second, the announcement can be interpreted as a commitment by the central bank to safeguard government bond yields from rising too high. This could in effect generate the expectation of future interventions in the bond markets, which may permanently lower yields. Of particular interest are the following passages.
"Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough."
"Then there’s another dimension to this that has to do with the premia that are being charged on sovereign states borrowings. These premia have to do, as I said, with default, with liquidity but they also have to do more and more with convertibility, with the risk of convertibility. Now to the extent that these premia do not have to do with factors inherent to my counterparty—they come into our mandate. They come within our remit."
The last paragraph especially seems to indicate that the European Central Bank will intervene when it expects yield increases to have little do with governments’ solvency rather other factors affecting the borrowing costs of eurozone states. Whether this is the central bank backing that many have been hoping to see remains unknown. Future interventions will not only indicate the extent of support but also show through what institutional setup it will come through.
Markets were quick to react nevertheless. Bond yields for both Italy and Spain have come down somewhat, despite news of rising unemployment in Spain and further complications in Greece. This is perhaps becoming the familiar role played by the bank: like the tremendous liquidity provision during 2012 December holidays, it may have once again taken a step toward saving the single currency.