So What

The most common question I’ve been asked this week is whether I’ve been watching the new political thriller Scandal – no, though I did get hooked on the Netflix original series House of Cards, starring Kevin Spacey as a ruthless House Majority Whip. The second most popular question I’ve been asked is whether I could give a really quick, non-technocratic explanation of this thing people keep hearing about in someplace called Cyprus. Yes ... or at least I can try.

The Republic of Cyprus is a tiny island in the Mediterranean, that lies between the historically unfriendly neighbors of Greece and Turkey. Like most tiny Mediterranean islands it was sacked by just about every major empire to have trampled through that part of the world, from the Egyptians to the Persians to the Romans, Byzantines and the Ottoman Turks. The Ottomans held it for three centuries until the Brits got their hands on it, eventually awarding its independence in 1960. (I have a giant coffee table book on empires that comes in handy for such columns.)

A lot of fighting between the Greeks and Turks (the two nationalities that make up most of the island’s population) followed. They’re now semi-unified with a U.N. monitored buffer zone called the “green line,” separating the Turks in the north and the Greeks in a larger part of the south. It’s a tiny place, with a very small economy that contains a ridiculously large number of banks. That’s because its minuscule tax rates and penchant for secrecy, along with its relatively-advanced infrastructure, have made it a haven for offshoring money, especially for wealthy Russian interests which are estimated to have around 20 billion Euros parked there.

So why is everyone making such a big deal over the fact that the tentacles of the financial crisis in Europe are reaching the shores of a small island that was otherwise best known for being the supposed birthplace of Aphrodite in Greek mythology? Mostly because in 2008, Cyprus went on the Euro, meaning that whatever happens there can have profound impact on the rest of the crisis and hence, affect world markets.

Though Cyprus is unique in that it’s the first real offshoring haven to go belly up, its problems are somewhat typical of the crisis. To simplify, it had a lot of outside, mostly Russian money parked in its banks. Its banks used their newfound capital to buy a lot of bad debt (including a bunch from Greece), while making bad loans backed by real estate-related assets that are no longer worth nearly the debt load attached to them. The haircut they had to take on Greek debt eventually pulled the economy to its knees and they have been trying to hammer out a bailout plan with the EU since mid-2012.

The questions were who would take the Cyprus haircut (and how much), what sort of austerity would be required by the so-called Troika (the European Commission, the International Monetary Fund, and the European Central Bank), and whether or not Russia would offer an alternative infusion of cash to help the Cypriots recapitalize their insolvent banking system. On Friday morning, the Russians, who were said to have been considering an investment in exchange for the ability to develop the island’s not-insignificant natural gas reserves, broke off talks. Cyprus then had to turn back to the Troika with less leverage, once it was the only show in town.

The Troika has given Cyprus a Monday deadline to either raise the required capital or pare it off account holders. Otherwise, they have threatened to let the banks fail. From the start, Cypriots roundly rejected the idea of taxing account holders, especially when the Troika would not agree to exempt accounts of $100,000 or less. The idea of nationalizing the pension accounts has also been floated, but would likely be met with even greater protest.

If an agreement isn't reached, the likely result will be a departure from the EU and a return to a national currency, which would involve messy controls on withdrawals to avoid a run. Cyprus could then liquidate all insolvent banks, making good on the FDIC-like $100,000 in protected funds the country guarantees its depositors, while letting the much more sizable accounts of foreign companies and depositors go belly up beyond that amount (it's estimated that more than half of total deposits are owned by foreign interests or citizens by name only). Populist thinking says that since such account holders are the ones who took their chances by depositing money in an offshore haven to avoid taxes back home and/or draw higher rates from banks engaged in risky activity, they should pay the price in accordance with the guarantees that were in place when they put their money down. As of this column's deadline, Cypriot officials were indicating they were close to agreeing on a deal they felt the Troika would accept, though details were sketchy.

Asking everyday Cypriots who had little choice as to where to put their ordinary savings or deposits but their local banks – a necessity of participating in their native economy – to pay the price for irresponsible risk taking at much higher levels seems more than a bit unfair. But history has proven that it's rarely the banksters and the schemers who suffer most when the house of cards crumbles. If Americans can learn anything from the mess in the Mediterranean, it might be how foolish we've been not to reinstall the Glass Stegall Act, in order to keep the sort of separation between risky investment banking and the necessary deposit sort firmly partitioned, as history continues to prove necessary.

* update the New York Times is reporting that an 11th-hour bailout deal has been reached between Cyprus and the EU that will allow them to remain in the Eurozone.

Dennis Maley's column appears every Thursday and Sunday in The Bradenton Times. He can be reached at dennis.maley@thebradentontimes.com. Click here to visit his column archive. You can also follow Dennis on Facebook. Sign up for a free email subscription and get The Bradenton Times' Thursday Weekly Recap and Sunday Edition delivered to your email box each week at no cost.