by Andrew Higgins and Liz Alderman
March 26, 2013
James Kanter contributed
reporting from Brussels, and Dimitrias Bounias from Nicosia.
Thousands of Students Protested Outside The Presidential Palace in Nicosia a
Cyprus Agreed to A Painful
Bailout to Avert Bankruptcy
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
But the path that led to Cyprus’s current crisis - big banks bereft of
money, a government in disarray and citizens filled with angry despair -
leads back, at least in part, to a fateful decision made 17 months ago by
the same guardians of financial discipline that now demand that Cyprus shape
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
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
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
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
Cyprus banks, bloated by billions of dollars
from overseas, particularly from Russia, had many troubles other than Greek
bonds, notably a host of unwise loans in Cyprus at the peak of a property
bubble, now burst, and, critics say, to Greek companies with ties to Laiki’s
former chairman, the Greek tycoon Andreas Vgenopoulos.
Mr. Kazamias, the finance minister at the time of the Greek bond write-down,
said he had little idea of just how badly the move would hurt his country’s
“We worried but we never received any
information that this was a red line” that should not be crossed, he
The Cypriot government, he added, initially calculated that,
were in a position to cover the losses,” and it was only later, after
depositors began to flee and the Cyprus economy stalled, that “we found
out that this was impossible.”
But Charles H. Dallara, the lead
representative for the banking industry who negotiated with European
officials in 2011 in a bid to keep the losses imposed on Greek bonds as low
as possible, said the writing was on the wall.
“very clear that the effect of the Greek
deal on Cypriot banks would be severe,” said Mr. Dallara, the former
managing director of the Institute of International Finance, the banks’
“But there were elections coming up, and the
tendency in Brussels is to let these things drift. So nothing was done.”
Slashing the amount that Greece paid on its
bonds was necessary at the time, he acknowledged, because it helped reduce a
mountain of debt that could have pushed Greece from the Euro.
“But looking back, in reality there was no
way to avoid the eventual adverse effect on Cypriot banks,” said Mr.
Dallara, now the chairman of the Americas for Partners Group, a private
Even before the Greek debt bombshell, Laiki
“was already in a bad way because of bad
lending,” said Kikis Lazarides, a former chairman of the bank.
But, he added, the write-down on Greek bonds,
“was more or less the killer blow.”
Like many Cypriots, Mr. Lazarides is
angry that Europe’s richer countries, particularly Germany, largely dictate
“We have to change some things in Europe in
the way decisions are taken,” he said.
After the Greek write-down, Cyprus compounded
its problems by dithering on whether to seek a bailout from the European
At first, it appealed to Russia, which provided
a 2.5 billion-euro loan in December 2011.
But this money quickly ran out, and when Cyprus
did finally go cap-in-hand to its European partners for a lifeline, it
received a rude shock: Germany, already gearing up for an election this
year, wanted not just budget cuts and other conventional austerity measures
but a complete overhaul of Cyprus’s economic model, built around financial
services for foreigners seeking ways to dodge taxes and, Berlin suspected,
launder dirty money.
“They did not want the Cypriot model to
exist as it did - they wanted Cyprus to stop being a financial center,”
said Pambos Papageorgiou, a former central bank board member who is now
a member of parliament and on its finance committee.
“It was very brutal, like warfare.”
Mr. Papageorgiou complained that the
European Union had shown “the opposite of solidarity” in its dealings with
one of its weakest and most vulnerable members.
In the three years since Europe’s rolling debt crisis first exploded in
Greece, governments and citizens in the hardest-hit nations have fumed that
decisions made in Brussels pay little heed to their interests and are
dictated instead by the economic concerns and election cycles of Germany.
Whether in Athens, Dublin, Rome, Madrid or
Nicosia, people increasingly ask whether the European Union serves their own
aspirations or those of remote institutions dominated by others,
Such questions have grown to a furious pitch in Cyprus, where terms set
early Monday for a 10 billion-Euro bailout will deepen an already painful
recession and send unemployment - now at 15 percent - soaring.
They require the dismantling of
Laiki Bank, with
the loss of around 2,500 jobs, and a significant reduction in the country’s
role as an offshore financial center.
“We are looking at a very grim future for
Cyprus,” said Michael Olympios, chairman of the Cyprus Investor
Association, a lobbying group. “Even firm believers in European project
like myself see now that it was a bad idea and that we should have at
least stayed out of the Euro.”
As jobs disappear and the economy contracts, Mr.
Olympios said, faith in Europe will wither.
“I used to be a believer. Not anymore.”
This article has been revised to reflect the following correction:
Correction: March 28, 2013
An article on Wednesday about the lengthy
path that led to Cyprus’s current financial crisis misidentified the
firm for which Charles H. Dallara is chairman.
Mr. Dallara, the lead negotiator for the
banking industry in 2011 during Greece’s financial crisis, is chairman
of Americas for Partners Group, a private markets firm - not of
Group, a consultancy to banks and governments.
The article also omitted
the byline of a second reporter. Besides Andrew Higgins, the article was by