Cyprus, levies, loans and human nature

More often than not, humans behave in a psychologically and socially understandable way which, alas, turns out to be quite irrational. As behavioral economists, based on the ground-breaking research of D. Kahneman and A. Tversky, have demonstrated, economic decisions do not always make sense. Widespread reactions to the Cypriot combined bail-in and bail-out are a prime example thereof.

Last Friday, right before a long weekend in Cyprus, the Eurogroup decided, on behalf of the so-called Troika – including the European Commission, the European Central Bank and the International Monetary Fund – and in conjunction with Cyprus' new centre-right president Nicos Anastasiades, to apply a one-time "stability levy" to all Cypriot deposits to complement the €10 billion bailout loan its European partners were offering to stabilize the dramatic financial situation of this divided Mediterranean island.

What started as an atrocious injustice for small savers – with initial plans asking for a 6.75% levy on all deposits under €100,000 (theoretically fully guaranteed by the Cypriot government and Europe's planned Deposit Guarantee Scheme) and just a 9.99% levy on deposits over €100,000 – now looks like a one-time wealth tax for richer Cypriots and non-Cypriots alike, which will have to foot the bill to the tune of €5.8 billion via a levy that will surely shave at least 10% off the balance of all deposits below €500,000 and up to 15% of those of the wealthiest.

A 12.5% levy was precisely what Germany was asking for from the start, in order to punish speculators and money launderers that had found a home in the poorly regulated and overly generous Cypriot banking system, with interest rates for ordinary deposits averaging over 4.5% (or even more for much-favored Russian customers). It now appears that it was Cypriot president Anastasiades the one insisting on spreading the levy to ordinary savers to "lower the burden on the wealthy" and try to prevent them from fleeing Cyprus as a low-tax banking haven.

Be it as it may, everybody is talking only about the injustice of this planned "lab experiment" with the Cypriot people, that unduly punished honest working-class people (and the rich) in a way no other previously rescued European country had faced. Further from that, the Eurogroup showed undue toughness in not offering a more generous direct bailout and forcing the Cypriot people to pay for it heads on. In other words, our economic short-sightedness made most people, including the press and many pundits (with some honorable exceptions), forget that a bailout package is no more than a loan that needs to be returned with interest, not a donation.

Cyprus’ GDP hovers around €18 billion. It has just received an €10 billion bailout. In other words, they will have to eventually repay a loan amounting to 55% of GDP, or around €13,000 per capita – plus the corresponding yearly interest. Please note that this amount (minus interest) equals a one-time levy of 13% on a deposit of €100,000 (or 10% over €130,000), of course assuming that each and every Cypriot had such savings.

As economists have extensively and reliably proved, debt-to-GDP ratios of over 90% severely reduce growth prospects. Public debt already stood at 81% of GDP in 2012: add a further 55% and the number turns into a scary 136% of GDP, not even counting the projected deficit for 2013, which should amount to a further 4-5% of GDP. What if the EU had been really generous and offered an all-encompassing rescue package of €16-17 billion? Well, in that case, public debt at the end of 2013 might reach a nightmarish 180% of GDP, or €43,000 (plus interest) per capita. Plus, unsustainable debt means austerity measures and budget cuts, and most Europeans know what this recipe entails: rising unemployment, more poverty and the loss of the sadly unappreciated multiplier and accelerator effects of government and public sector investment.

Let's just spend a few lines comparing it with the "standard bailout" of the Spanish banking sector, agreed in June 2012, to the tune of a €60 billion rescue package (or 6% of Spanish GDP). Being a loan and not a donation and coming before the actual implementation of the Eurozone banking union, this hefty amount was debited into the public debt accounts. Spain is currently paying a yield of around 5% for standard 10-year notes and between 3 and 4% for shorter-maturity bonds, so interest payments for this extra debt would amount roughly €2 billion per year during up to 10 years, thus raising the actual bill to almost €80 billion.

Under the current dramatic economic situation, the total number of active taxpayers among the Spanish working population stands at barely over 16 million (and decreasing). If we divide these 80 billion among the tax-paying, active population, we get that each non-retired taxpayer should foot a bill of €5,000. Even if we divide it across the entire population, the projected bill stands at €1,700 per person.

This would equal applying the initially-planned Cypriot levy of 6.75% to someone with a deposit of €75,000, or to anyone with savings of just over €27,000 in case we artificially divide the bill among all Spaniards, including children, the retired and the 26% of unemployed working population. If we use the first number, however, working Spaniards are already paying more than what an ordinary Cypriot, with less than €100,000 in savings, would have paid under the unfair and harsh levy scheme proposed last Friday. Of course, this is not to say that their current situation is enviable: on the contrary. Cypriots will also have to foot the bill for the additional €10 billion that the Troika is lending the nation in order to save its banks and this is, by far, the heaviest burden on the Cypriots – for the rich and the poor alike.

Pointing out the irrationality of the exclusive focus on the levy for depositors, outrageous as it might be, is not to say that we should consider the solution to be optimal. Far from it: curing illnesses that could have been prevented is never the best possible option, and the medicine employed always has undesirable side effects. The first and more obvious is that the image of the European Union, led by the seemingly omnipotent German government, has been badly tainted by an improvised, half-baked rescue that highlighted a worrying lack of internal solidarity and cohesion. The unhealthy exercise of finger pointing carried out by the Cypriot president and the German finance minister, now also including the Eurogroup itself, has only helped create further discomfort with the initial decision and hurt even more the feelings of those who still dare to feel European. Mending the initial abusive levy for small savers at the eleventh hour in face of parliamentary pressure will definitely not mend their image overnight in front of millions of scared Southern European taxpayers.

The second is the lack of justice and punishment for the ones who could have prevented this malaise but did nothing else than feeding it: the greedy bankers and politicians of this small and divided Mediterranean island. If the size of your financial system is 8 times that of your GDP, there must be something wrong. If your guaranteed deposit interest rates are almost double those of other Eurozone countries, there must be something wrong. If you bet over 60% of the GDP of your country on Greek bonds, there is definitely something wrong with you. If you lure Russian (and Israeli) undeclared income on a massive scale and spice it up with the lowest corporate tax rate in the EU (currently at just 10% and set to rise to Ireland’s much-maligned 12.5% if this clause of the March 16 deal if finally approved), you have all the ingredients for a massive crash fueled by offshore funds flushed into a banking casino economy. One has to wonder why a Russian company, Gazprom, allegedly offered Cyprus a debt restructuring deal to avoid the EU bailout. Companies operate out of self-interest, not for the public good. Of course, this offer had an even darker side, aside from helping fellow Russians whose savings in Cyprus might take a nice haircut: the private bailout would have been in exchange for the island’s gas rights. In other words, it all just looks way too shady.

However, nobody cared to regulate this casino until it was way too late, and a few people sure made hefty profits with this business. Will they pay for it? Or is are the EU, the IMF, the Eurogroup and everyone involved in the issue forgetting about them… either because they also feel the shame of culpability or, worse still, because these very clever people are above and beyond the law? Sadly enough, the only answer we can now give to this doubt of ours is the one given by the Financial Times’ Martin Wolf in reviewing a newly published book: bankers are intellectually naked (and, we might add, most politicians look rather naked to us, too).