01 May 2013

Financial World: Oh, island under the gun (Graham Bishop article)

For some time, tiny Cyprus has been on the road to creating huge precedents. This has now happened–regrettably by way of a fiasco rather than thoughtful policy-making. Nonetheless, the events of March 2013 will probably be seen as another milestone on the route to the new financial and political landscape of the euro area.

The political error of the Eurogroup lay in allowing the inexperienced Cypriot government to choose how to raise the money to bail out its banks. The solutions applied have both regulatory and political importance. The government initially opted for a measure – a haircut on all deposits – that seemed bound to create the maximum opposition. Was this a deliberate game? The final decision to bail in uninsured deposits was only slightly less hated.

History will tell what the thought processes were. What we do know now is that buying massive quantities of Greek government bonds – under the EU’s ludicrously favourable capital adequacy regime – is a gamble that backfired on the two key Cypriot banks on a historic scale. It not only “broke the bank”. It also broke the country. The consequences of the destruction of the island’s major industry will play out over many years. It may be very difficult for the euro area to avoid an eventual, second private-sector involvement.

To read the full article, please click on the link below.

© Financial World