Mitchell Thomas, The Daily Record Newswire
Often times in economic history we introspectively reminisce about the beginning of a dramatic perception change that alters the course of earlier intended directions. For example, a succession of rate hikes ultimately thwarted the housing boom in 2007. The first few rate hikes were clearly considered inconsequential, meanwhile, the path to the destiny of our housing implosion was being created.
Geographically, Cyprus is an inconspicuous island located in the Mediterranean, north of Lebanon and south of Turkey. Cyprus is inhabited by approximately one million people with the majority being Greek living in the southern portion and a minority of Turkish citizens residing to the north.
Cyprus had been headline bound when it became an obstacle for Turkey to be a full member of the European Union in 2010. A condition established for acceptance by the Union was for Turkey to resolve their differences with the Greeks on the island.
Historically, the citizens of Cyprus have endured hardships in their past. The Turkish military invasion in 1974 disenfranchised the Greek population in their settled northern portion of the island, forcing a migration to the south. A highly contentious issue filled with harsh memories of economic distress and emotional turmoil has not softened with time.
Unsuccessful with a compromise, this issue still lingers, obstructing Turkey’s full acceptance into the union and restricting their growth potential. However, never be totally led by the vociferous actions of those in control when ulterior motives are being masked with another issue. Ponder the possibility that the apprehension by the European Union is that Turkey would be the only Muslim nation allowed to join.
Cyprus, the third smallest member of the European Union, made headline news most recently when requesting a bailout for their banking sector from the ECB. The Troika’s bellicose response was unprecedented from previous sovereign bailouts by requiring depositors to take a 60 percent haircut after the first 100,000 Euros were exempt.
The confiscation of depositor’s assets was sending a message to the remaining members that your deposit is in jeopardy if your country seeks a bailout. The judge’s gavel fell, the decision was made and regardless of their reasoning, a violation of the covenants to the union membership occurred. In reality this was a test balloon frequently used by politicians for a public response and a testimony to their power and intentions.
The banking system in Cyprus expanded with deposits to 343 percent of their GDP of 23 billion Euros, exponentially creating risk. Unsustainable, the Cypriot banking system became too large for the state to honor its deposit guarantee without external assistance.
Accusations lodged by the ECB were directed at the banking sector conducting a money laundering center for Russian citizens. Capital movements were suspicious and 60 percent of the deposits coming from outside the citizenship were contentious in the negotiating process with the Troika, thus the penalty.
However, if these deposits were from ill-gotten gains by avoiding taxes and reporting procedures, then why have many large banks domiciled in the major European countries vying for these funds? If the charges lodged were authentic, then a transfer to another bank doesn’t change the source.
In June 2012, Greece required a second bailout causing holders of their sovereign debt to take a 75 percent loss to the face value of their bonds. Cyprus purchased these bonds before this event and were assured that the ECB would do whatever was necessary to maintain a semblance of order and value. This event was the tipping point for the Cyprus’ banking sector, unable to maintain liquid capital
reserves from losses incurred from the Greece scenario.
Complex decisions on sovereign debt have far reaching repercussions. Could Cyprus be the template the Troika implements in the future? Could this be the beginning of countries voluntarily leaving the European Central Bank’s autonomy? Could forcing austerity without a growth plan impose disastrous implications that will prolong the anguish citizens will have to endure?
These questions will only be answered with time. Investors are not naive enough to believe that the temporary submerging of a problem by the central bank will simply allow the issue to vanish. Ultimately, the inference as the issue resurfaces creates a contagion situation. Investors are reluctant to wait for an ominous inevitable scenario and are moving capital to other globally solid central banks. Credibility becomes questionable for the Troika going forward.
Speaking personally with citizens of Cyprus, they distrust the Troika, their own sovereign bank and their private banks. However, they are optimistic that after a few years of a severe struggle, they will have a revitalized economy. Logistically, the potential of a large natural gas and oil discovery off their shores is currently being drilled by Noble Energy, offering the realized economic hope.
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Mitchell Thomas is an international equity analyst/portfolio manager/head trader for Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534, (585) 586-4680.
