From Deauville to Cyprus: The Seeds of Another Eurozone Crisis Have Been Planted
Engelen, Klaus C., The International Economy
When the history of the euro area sovereign and bank debt crisis is written, the way the troika of Eurogroup finance ministers, the European Central Bank, and the International Monetary Fund managed the rescue of the outsized Cyprus offshore banking center will be useful as a case study to document the extremely fragile state of European monetary union at that point in time. The handling of the crisis puts big question marks around the June 2012 EU summit council resolution to transfer banking supervision to the European Central Bank--to a European institution acting as the euro area's financier of first resort for banks that lack access to market funding. This huge conflict of interest between supervising and funding large and small eurozone zombie banks and pursuing monetary policies oriented toward price stability is ignored by Europe's democratically elected leaders. When they talk about "Chinese walls," it is sheer nonsense--look at Cyprus.
On April 18, 2013, Germany's parliament passed the aid package for troubled Cyprus with a large majority--486 in favor and 104 against. Under a decision by the German Constitutional Court, the German legislature retains the right to vote on any new support program by the 700 billion[euro] European Stability Mechanism. Behind the impressive support of German legislators for the 10 billion [pounds sterling] ($13.05 billion) rescue loan provision was the fact that Eurogroup finance ministers in the case of Cyprus not only insisted on far-reaching reforms, but also put the reigning bank bail-out doctrine aside and required bank bail-ins by creditors and large depositors. Leaving a guarantee in the Cyprus bank resolution exercise to insure deposits of up to 100,000[euro] made it easier for Germany's left and green opposition parties to back the terms of the revised rescue agreement under which Cyprus also must raise 5.8 billion[euro] of its own money.
For the German government, the Cyprus rescue turned politically explosive in an election year after an intelligence report was leaked alleging that the island is a haven for Russian organized crime. And Sigmar Gabriel, the SPD floor leader, attacked Cyprus in a speech in the Bundestag as having "a business model based on Russian oligarchs, Serbian mafias, and tax evaders." Along with other German politicians, Gabriel dismissed claims that the Cypriot banking system could set off broader contagion if allowed to fail since it is "systemically undesirable."
Before discussing the complex new burden-sharing and rescue approach and its wide implications in detail, two developments in the run-up to the Cyprus banking disaster have to be explored.
THE PRESIDENT'S LETTER BOMB TO DRAGHI
The fallout from the bitter struggle between the new conservative president of Cyprus, Nicos Anastasiades, and ECB President Mario Draghi over removing Central Bank of Cyprus Governor Panicos Demetriades from office is bringing into the open the "smoking gun" of how Cyprus has been misusing the Eurosystem.
When the new conservative government's move to get rid of the Central Bank of Cyprus head reached the European Central Bank, Draghi was quick to come to the defense of Demetriades, who also has a seat on the ECB Governing Council, the main decision-making body of the Eurosystem.
In a letter to the Cypriot president, Draghi warned that the governor could only be dismissed on grounds specified by EU law and even then the action would have to reviewed by the European Union's Court of Justice.
The problem, however, is that the role of both the Central Bank of Cyprus and the ECB Governing Council--which can block the use of emergency liquidity assistance funds to a financial institution with a two-thirds majority--reveals a breakdown of governance and the rule of law in the Eurosystem. Emergency liquidity assistance liabilities were issued by the Central Bank of Cyprus to keep an insolvent Laiki Bank, the country's second-largest bank, afloat after the former Cypriot government presented its application to the euro area rescue funds in June of 2012. …