Europeans Planted Seeds of Crisis in Cyprus

NICOSIA, Cyprus — When European finance chiefs explained their harsh terms for rescuing Cyprus this week, many blamed the tiny Mediterranean nation’s wayward banking practices for bringing ruin on itself.

Yannis Behrakis/Reuters

Thousands of students protested Tuesday outside the presidential palace in Nicosia, the capital, a day after Cyprus agreed to a painful bailout to avert bankruptcy.

By ANDREW HIGGINS and LIZ ALDERMAN

That decision, like the onerous bailout package for Cyprus announced early Monday, was sealed in Brussels in secretive emergency sessions in the dead of night in late October 2011. That was when the European Union, then struggling to contain a debt crisis in Greece, effectively planted a time bomb that would blow a big hole in Cyprus’s banking system — and set off a chain reaction of unintended and ever escalating ugly consequences.

“It was 3 o’clock in the morning,” recalled Kikis Kazamias, Cyprus’s finance minister at the time. “I was not happy. Nobody was happy, but what could we do?”

He was in Brussels as European leaders and the International Monetary Fund engineered a 50 percent write-down of Greek government bonds. This meant that those holding the bonds — notably the then-cash-rich banks of the Greek-speaking Republic of Cyprus — would lose at least half the money they thought they had. Eventual losses came close to 75 percent of the bonds’ face value.

The action had an anodyne name — private-sector involvement, or P.S.I. — and, it seemed at the time, a worthy goal: forcing private investors to share some of the burden of shoring up Greece’s crumbling finances. “We Europeans showed tonight that we reached the right conclusions,” Chancellor Angela Merkelof Germany announced at the time.

For Cypriot banks, particularly Laiki Bank, at the center of the current storm, however, these conclusions foretold a disaster: Altogether, they lost more than four billion euros, a huge amount in a country with a gross domestic product of just 18 billion euros. Laiki, also known as Cyprus Popular Bank, alone took a hit of 2.3 billion euros, according to its 2011 annual report.

What happened between the overnight session in 2011 and the one that ended early Monday morning is a study of how decisions made in closed conference rooms in Brussels — often in the middle of the night and invariably couched in impenetrable jargon — help explain why the so-called European project keeps getting blindsided by a cascade of crises.

“I cannot remember that European policy makers have seen anything coming throughout the euro crisis,” said Paul de Grauwe, a professor at the London School of Economics and a former adviser at the European Commission. “The general rule is that they do not see problems coming.”

Simon O’Connor, the spokesman for the union’s economic and monetary affairs commissioner, Olli Rehn, declined to comment on whether Mr. Rehn had taken a position on the possible impact of the Greek debt write-down on Cypriot banks.

As well as hitting Cyprus over its banks’ holdings of Greek bonds, the European Union also abruptly raised the amount of capital all European banks needed to hold in order to be considered solvent. This move, too, had good intentions — making sure that banks had a cushion to fall back on. But it helped drain confidence, the most important asset in banking.

“The bar suddenly got higher,” said Fiona Mullen, director of Sapienta Economics, a Nicosia-based consulting firm. “It was a sign of how the E.U. keeps moving the goal posts.”

Cyprus, she added, “created plenty of its own problems” and was not aided by the fact that the country’s last president, a communist who left office in February, and his central bank chief were barely on speaking terms. But decisions and perceptions formed more than 1,500 miles away in Brussels and Berlin “didn’t help and often hurt,” Ms. Mullen said.

http://www.nytimes.com/2013/03/27/world/europe/europeans-planted-seeds-of-crisis-in-cyprus.html?emc=eta1&_r=1&