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An abominable legacy

IN 2008, after failing to get its presidential candidate into round two of the Presidential elections, DIKO has done the unthinkable and backed Demetris Christofias a die-hard communist of limited ability to become the President of the Republic of Cyprus. Christofias’ five year reign has given Cyprus two explosions.

The first, a physical explosion, at Mari where thirteen people lost their lives and the main power station of the country at Vassilikos has been partially destroyed.

The second was at the very foundations of the country’s economy which came about from the worst economic management of public sector finances and a near total lack of regulation and control of the banking system.

The banking crisis was blamed on Christofias and his lack of ability and unwillingness to take advice, although in truth, the banking bubble was brewing for some years even before Christofias came to power. As Bloomberg Businessweek wrote in a report on 21 March 2013, the problem was that “Cyprus’ two biggest banks couldn’t manage the flood of deposits [and] Cypriot regulators fell short as well”.

Nevertheless, in polls conducted shortly before the end of his presidential term, Christofias was voted as the worst president to have held office since the foundation of the Republic. Moreover, when Cyprus finally asked for a financial bailout in June 2012, President Christofias was guilty of stalling the negotiations as he was unwilling to accept measures such as privatization, thereby accentuating the economic problem and leaving a real mess to his successor to clean up.

Soon after being installed in power, taking over from the Christofias’ Government, the newly elected Anastasiades Government, found itself in dire straits regarding the state of the economy and the painful options that were laid out before it in the iniquitous Eurogroup of March 2013.

The new president, in his beloved method of “charm them and win them over” has tried his utmost to persuade our European partners and the World Bank representatives that no bail-in was necessary and that if we had to do something, we should be content to “tax” all the deposit holders (including those accounts with balances of under €100,000 which as the head of the State he was obliged to be the guarantor and protector of) with an across the board bail-in of 9.9%. A curious number indeed, by the way. It is as if some bigger force has mandated that a bail-in of higher than 10% would not be acceptable.

It was a taste of things to come for a Government and President that makes up policy by public relations. The problem with such President of course is that he soon becomes vulnerable to organised interests who happen to have or can somehow secure access to the Presidential Palace.

Unfortunately, an over-confident president with a dominant and overwhelming personality but one who, as it seems, is also superficial and conniving in his approach, is liable to drive the country into new and bigger dangers and risks. And this, I am afraid, is what may be happening right now.

The latest piece of presidential political mastery may have come about in the role the President may have played in the recent takeover of our systemic banks by hedge funds. For about six months, when I was a member of the Interim Board of the Bank of Cyprus, we rebuffed hundreds of hedge funds who were trying every which way to enter through the back door and take over at greatly discounted prices the loan portfolio of the bank. We slammed the door because we very well knew that the bank (and the country) could not sustain such losses. We also had a fairly good idea of how hedge funds operate. They basically suck the blood out of governments and financial institutions in distress making themselves a quick huge profit and move on. This is the last thing the after bail-in Cyprus needed.

A financial expert has characteristically recently commented, “We need hedge funds taking over our banks like we need the Ebola virus in Cyprus”. Of course, when one is at the edge of the cliff and about to fall down to a certain death he is perhaps willing and is wise to accept a parachute that is full of holes. At least this way, he stands a chance to survive, be it at the cost of sustaining very serious injuries. The question we should be asking, however, is why we have allowed ourselves to come to this point? Why indeed a whole year has passed without taking any reconstructive measures both at the Government and Bank level? The proposal to create a Development Bank to take the lead in the restructuring of major projects in the economy for example was quickly thrown in the recycle bin.

Typically, the current debacle has unfolded following reports of private meetings at the Presidential Palace with Mr Hourican and some “prospective investors”. Seemingly, as if the stage was set, soon enough we witnessed the parameters of the passing of control of ownership of the Bank to hedge funds rather clearly spelled out and mandated by the Central Bank and strongly supported by the Minister of Finance. The end result is that the hedge funds are now triumphantly, and as saviours, entering the Bank of Cyprus through the front door, but very suspiciously, via and courtesy of the Presidential Palace.

Our president, and in truth, most of our politicians who are now criticizing the new and totally necessary law for a legal framework that allows for a quick resolution in liquidating mortgaged assets that secure non-performing loans have once again failed to understand how hedge funds operate and what is really at risk.

As Mr Hourican and the new boss at Bank of Cyprus Wilbur Ross were so quick to point out in articles in the local press, almost as if they were already prepared for it, it is not their intention to engage in an immediate selling off of mortgages. I believe them. In fact, the real threat is from selling the loan portfolio of the bank which will subsequently be packaged and sold to investors. Indeed, if it was possible for investment banks to do this in the United States with packages of sub-prime loans, how easier would that be with well collateralised loans that are likely to appreciate in value in the next three to five years? Moreover, this is not likely to take place until after the bank passes the stress tests and becomes a member of the new European Central Bank network of banks. This way, it will be possible to sustain the losses the bank will inevitably incur from selling off their loan portfolio at hugely discounted prices as ECB and the Government of Cyprus will have to pick up the bill of recapitalising the bank once again. Soon, after the selling off of the loans I expect the Hedge Funds will also sell off their shares in the bank and move on to “save” other distressed countries and financial institutions in the world.

The auctioning of the acquired mortgages will happen gradually in order to cover the interest due to bond holders with a major sell off happening perhaps in 3-5 years when, as they expect, the property prices in Cyprus will recover and will thus generate a huge profit for them.

What is really at stake is that this wealth transfer will go outside Cyprus. Even in the case where the Bank takes over the properties or of creating an Asset Management Company in Cyprus, value would be preserved and remain to a large extent within the country. This is the major risk our politicians must be aware of and should be thinking of ways to contain.

In my opinion, instead of asking for many changes to the new bill which are not even feasible let alone desirable, such as to compel the bank to settle the whole loan when it auctions a mortgaged property, our political leaders should try to understand what is likely to happen and think of ways to guard against or at the very least mitigate its impact on the people of Cyprus. For example, a simple condition in the new law to be drafted making it illegal to sell off loan assets outside the Cyprus Banking system (a very reasonable condition based on the lender-borrower contract) will go a long way towards achieving this objective.

The bottom line is that a president who cannot judge the character and true intentions of people around him or assess the real situation of the country, and I may add, one that is evidently more concerned with his image rather than substance, is the worst that could have followed the “egocentric and incompetent” style of the previous president. The country cannot survive consecutively two such presidents. In fact, I don’t think any country can.

About the author

 Savvakis C. Savvides Savvakis C. Savvides is an economist, specialising in economic development and project financing. He is a former senior manager at the Cyprus Development Bank and has been a regular visiting lecturer at Harvard University and more recently at Queen’s University, Canada. Visit the author’s page.