Cyprus: repeating history’s mistakes


The parents of Cyprus Central Bank Governor Demetriades did their son no favours when they christened him Panicos. If, as seems likely, he loses the job he took up less than a year ago and returns to UK academic life it is not hard to guess what his nickname will be. 


If you want a textbook illustration of the fact that knowledge in finance is cyclical (see my last posting), the Cypriot banking crisis is a prime example. The book deserves a place in the Library of Mistakes – and Panicos may be the man to write it.

To be fair to him, by the time he left the University of Leicester, where he was Professor of Financial Economics, the die had already been cast. There was little he could do besides describe the problem. Cyprus did not have enough money to save its banks and Europe and the IMF were playing hardball. That hasn’t stopped the local press from blaming him.

The Bank of Cyprus crisis is the mirror image of those which brought down most western banks (notably HBOS), but had its parallel in the sovereign debt crisis of the 1980s. Whereas most failed banks fatally over-extended themselves by lending too much, BoC had the opposite problem – it took too much in deposits, mostly hot money from Russian oligarchs.


Cyprus a haven for investors?
Investors’ paradise?


It ended up with total liabilities (banks call deposits “liabilities” because – in theory – they have to be paid back one day) of €120 billion – six times the size of the Cypriot economy. The problem was how to invest this money so that it would earn enough to pay the interest. The tiny island economy clearly was not going to find a productive home for this wall of cash, so the Cypriot banks turned to their near neighbours in Athens.

Greek banks, lending like mad into a larger bubble economy, were funding themselves by issuing bonds paying highly attractive “coupons” (interest). The Cypriots weren’t alone in taking up this seemingly too-good-to-be-true opportunity. All over the Eurozone other banks were piling in, probably betting that the IMF and the European Central bank would always be there to pick up the pieces if the Greek banks failed.

But last year the IMF, the ECB and the European Commission, egged on by the Germans, decided that Greek bondholders should reap part of what they had sowed and imposed a “haircut” of upwards of 50%. Bank of Cyprus suddenly found that it was holding “assets” which were worth half the value of the “liabilities” they were supposed to balance. It was insolvent and the Cypriot Government couldn’t raise the cash to recapitalise it.

We have been here before.  In the 1980s the wall of money came not from Russia, but from the Gulf States, where OPEC members were wondering what to do with the vast mountains of money they had extracted from oil-dependent Western economies. US and European banks took it gleefully and lent it to Third World governments in Latin and Central America and Africa.

The interest rates they demanded were sky-high, but the risk, they reasoned, was negligible because the IMF would never allow a country to go bankrupt and default. They were wrong and had to write off huge sums.

This was all, of course, endlessly documented. But you know what they say: if you are ignorant of history, you are bound to repeat its mistakes.