The Cyprus-Crisis Culture Clash

The Cyprus-Crisis Culture Clash

The bank fight was influenced by European-Cypriot-Russian worldviews as much as by money.

Thus, the Cyprus crisis was by no means a surprise, as the crunch had been approaching for months. The Troika delayed confronting the problem for two reasons. First, it wanted things to quiet down elsewhere in the Eurozone, especially in Spain. Second, it anticipated a change of government in Nicosia. Suffice to say, the Troika would not have trusted the previous AKEL (Communist Party) administration with a centime. But, with the election of the centrist Nicos Anastasiades as president in February, the Troika was ready to lance the Cypriot financial boil.

The ensuing negotiations exposed two critical conflicts of political culture: European vs. Greek Cypriot and European vs. Russian. The new Greek Cypriot leader was unprepared for the shock of the Troika’s draconian demands, but he negotiated a first “package” that reflected a desire to protect his country’s offshore depositors more than his own citizenry. Whether or not Anastasiades agreed to apply a tax on insured deposits in anticipation that his parliament would reject it, the implication was that protecting large foreign depositors loomed very large in his priorities. (Indeed, his own law practice serviced Russian and Ukrainian interests.)

Even more striking was that the initial package worked out with the Troika would have imposed the deposits tax (a form of confiscation) on all financial institutions, solvent as well as insolvent. If executed, this would have imposed a significant levy on VTB’s institutional and individual depositors on Cyprus despite the fact that Russian Commercial Bank was solvent, with the assets of Russia’s second largest bank behind it. At this point, Moscow screamed “theft,” and Moscow was by no means alone. Both provisions were removed by the Troika from the revised package within days, but Russian authorities and investors understandably experienced a severe loss of confidence both in the Cypriot government and in the probity of European institutions.

The European political culture in this story is, of course, largely German, with its tendency to regard money as inherently evil and debt as immoral. At the same time, Russia and Germany had enjoyed a special relationship in which Moscow looked to Berlin to “take Russian interests into account” on issues such as the Cyprus bailout. Things did not work out that way. German authorities had foreseen the impending Cyprus crisis for months. Indeed, Chancellor Merkel said publicly her biggest single concern within Europe was Cyprus. Once the value of Greek sovereign debt was reduced by more than half in 2011, the aftershock on Cyprus was a question of timing and management. The timing was determined by the collapse of Laiki’s Greek bond valuations and by the Cypriot presidential elections in February.

Unfortunately, the German political class and media chose to portray the Cyprus problem as a morality play with Russia as the villain. While fulminating against the “casino economy” on Cyprus, they portrayed Russian oligarchic money as responsible. In a German election year, political figures across the spectrum postured against bailing out Russian oligarchs as if that were the issue. Few German commentators acknowledged the failures of governance by European institutions in regard to a Eurozone member, or that the decision of Laiki Bank and others to take on so much Greek sovereign debt was their own blunder, or that the Troika’s imposed haircut on Greek bonds in 2011 made a Cyprus crisis inevitable. And there was no acknowledgement that the separate Russian bank on the island remained solvent despite processing large amounts of offshore funds.

The fact is that the core European mistakes dated to 2004 and 2007. First, European governments accepted the Republic of Cyprus as an EU member without resolution of the division of the island, against the advice of everyone knowledgeable on the “Cyprus problem.” Instead, they chose to accept the word of then-President Tassos Papadopoulos—a man known even to his supporters as a congenital liar—that his people would vote in favor of the United Nations unification plan. But, responding to the public plea of their president, the Greek Cypriots then voted “no” by two to one, after the Turkish Cypriots had voted “yes” three to one. Second, Europe took in this “casino economy,” which did not remotely meet the standards of existing European financial law and was by then awash with illicit offshore money. Third, less than four years later, an unreformed Cyprus was taken into the Eurozone. Thus, European governments have none but themselves to blame. Simple application of the “fool me once/fool me twice” principle should have barred entry of Cyprus into the Eurozone.

Given the history of bad faith by Nicosia in its dealings with Brussels and Frankfurt, it is not surprising the Troika felt the need to impose a clear “moral hazard” in the Cyprus case, but there was also an element of punishing Cyprus for excessive fraternization with Russians. Europeans increasingly are uneasy about the presence of Russian money in almost every nook and cranny of the EU, with the specter of Russian oligarchs behind it. Cyprus was used as a convenient object lesson in the dangers of doing too much business with Russia. This image dominated the European—and especially German—portrayal of the crisis.

Not surprisingly, this theme played poorly in Moscow, which believed the banking problems on Cyprus were well within EU capacities to resolve without investor losses. The Russian government had even provided a state loan to Cyprus early in the crisis, which unfortunately simply added to the republic’s already large debt load. When Russia’s leaders learned the terms of the first and even second Troika packages, they reacted with stupefaction followed by a presumption of bad faith on the part of Russia’s supposed European partners. Moscow complained loudly that it should have been consulted and directly involved in the negotiations.

Moscow certainly had grounds to expect better consultation from Nicosia, given the extent to which Russia had given official support to Cyprus. The failure of the Greek Cypriots to communicate with their Russian sponsors during the crisis was both shabby and poorly judged. On the other hand, Russia had no standing in a negotiation between EU institutions and a member state about the use of EU resources. It is difficult to imagine how the Troika could have legitimately involved Russia in the negotiations without accusations of favoring Russian depositors over domestic and other savers. The subsequent Russian proposal for a three-way negotiation of Europe-Russia-Cyprus produced genuine incredulity in Europe.

Unfortunately, the European Commission compounded the problem of misperceptions by proposing to Moscow that Russian financial institutions take over Laiki Bank, absorbing most of its losses while guaranteeing its depositors. In this case, incredulity emerged on the Russian side. The Russian official banking presence on the island was solvent. Why should Moscow buy out an insolvent Eurozone bank, with depositors from all over the world, to protect EU institutions from the consequences of their own policy shortcomings? In addition, only the state-owned banks in Russia have the scale for such a takeover, so in effect the Russian state would have absorbed Laiki. Even by contemporary Russian standards, this would have constituted malfeasance. The Europeans rationalized this high-handed proposal on the presumption that Moscow would be protecting its own national depositors in Laiki and, in essence, cleaning up a mess seen in Brussels as of Russian origin. In contrast, Moscow saw the EU proposal as “neo-colonial” and an attempt to use Russia as a dumping ground for failures of European governance.

As Greek Cypriots now endure currency controls (the first in a Eurozone country), the question is asked, how much Russian money got off the island before the door slammed shut? Several Russian (and non-Russian) oligarchs visited Cyprus in the months and weeks leading up to the crisis, presumably to remove their assets. Media leaks in Nicosia already indicate massive withdrawals from foreign accounts in the final days of Laiki Bank. Still, many Russians in the “high net worth” but not oligarchic category shared the Cypriot illusion that a European bailout was guaranteed. Many had yet to learn the new English expression, “bail in.” For those who trusted to presumed European “solidarity,” the losses will be considerable. However, Laiki was the kind of institution to maintain more than one set of books, so any coherent tabulation of how much was invested and/or lost will have to wait for accountants and lawyers to toil many a billable hour. For the true oligarchs, there will never be transparency. In terms of who will bear the brunt of the losses, the “Titanic” principle is likely to pertain: First Class gets the lifeboats while steerage and crew stay behind.

Cyprus will be in deep economic distress for a considerable time, as its major economic sector is in ruins. This will be a good time for Russian oligarchs to return, to benefit from fire-sale prices and the local hostility toward Europe/Germany. Greek Cypriot public sentiment remains very favorable towards Russia, while the island’s business elite will understand where its self-interest lies. Russian patience, opportunism and a bit of overt “solidarity” should work to Moscow’s long-term advantage on Cyprus. Russia, after all, has often felt more comfortable operating in the Levant than in Europe. If Cyprus chooses to leave the Eurozone (a real option), the Greek side of the island could become more Russocentric in future than it is today, with serious implications for Turkey and for Europe.