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Costas Lapavitsas: Cyprus should let the private banks fail and create a public bank that focuses on strengthening the real economy  

Costas Lapavitsas is a professor in economics at the University of London School of Oriental and African Studies. He teaches the political economy of finance, and he's a regular columnist for The Guardian.

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Baltimore.

The latest case of global financial craziness is taking place in Cyprus. Now joining us to talk about the situation there is Costas Lapavitsas. He's a professor of economics at the School of Oriental and African Studies at the University of London. He's a member of Research on Money and Finance. And he's a regular columnist for The Guardian.

Thanks for joining us again, Costas.

So before we get into the specifics of the back-and-forth between the European Central Bank and Cyprus and all of this, just to give us some context of the Cypriot economy, am I missing something or is a big piece of the Cypriot economy parking money for Russian billionaires--some people say laundering money for Russian billionaires? I mean, is this at the heart of what the crisis is about?

COSTAS LAPAVITSAS, PROF. ECONOMICS, UNIV. OF LONDON: In part. Basically, Cyprus has followed a development path that was unsustainable and quite simply mad. It's gone for becoming an international financial center, which in the context of Cyprus has meant attracting deposits from across the world and very few questions asked. And therefore some of these deposits are of very shady provenance. So Cyprus has done all that.

And on the basis of this collecting of money, the banks in Cyprus have become simply enormous relative to the economy. The banks have invested heavily in Greece and elsewhere, and they've engaged in property lending on the island, which has created a local bubble of quite some size. That's the banking side.

The real economy, meanwhile, in Cyprus has gone from bad to worse. It's been losing competitiveness within the euro, and it's not been functioning very well at all, creating huge deficits--generally, inability to compete internationally. [crosstalk]

JAY: Okay. Let me just ask one question. So why--apparently the Russian billionaires have a third to half of the deposits in the Cypriot banks, according to the BBC. I mean, why are they parking their money there? 'Cause it gets them inside the EU?

LAPAVITSAS: Very low tax. No questions asked. So it's essentially, you know, the place where operators--you know, is a center for legalizing money or moving money away from the eyes of the authorities elsewhere.

JAY: But it's not like the Russian authorities are so rigorous, are they?

LAPAVITSAS: It's true. But some of the money that ends up in Cyprus is perhaps not of a provenance that they would like to admit in Russia itself. Russia, in any case, has been leaking money left, right, and center for a long time, and one of the places where it's been leaking money to is Cyprus. Cyprus in that respect is not that unusual to other places in Europe, such as Luxembourg, such as the City of London, incidentally, which is one of the places of choice for Russian oligarchs to move their money, although very--far fewer questions are asked about the City of London compared to Cyprus. Cyprus has moved into this game and chose to structure its economy on this basis. It was a terrible decision, it's obvious, a terrible decision.

JAY: Okay. So the banks are now in this financial crisis, which you'll explain to us why they're in it, and the European Central Bank and the IMF have given them what? Till this coming Monday to raise a certain amount of capital or they won't get the big bailout. So explain all this to us.

LAPAVITSAS: The crisis in Cyprus is fundamentally a banking crisis. Let's start with that. Okay, the economy's doing very badly, but it's fundamentally a banking crisis, and it's a banking crisis similar to the crisis in Iceland. Icelandic banks six years ago, or five, six years ago were in a similar position. They were huge, they had overexpanded, they were much larger than the economy, and they go bankrupt. The crisis in Cyprus is also similar to the Irish crisis, where the Irish banks were, again, huge, and they had overexpanded, and they go bankrupt. So this is a banking crisis, but it is within the Eurozone.

So Cyprus was presented with a so-called solution last week, which was no solution at all. It was told that it had to do two things. It was told that the state had to borrow an enormous amount of money relative to the economy in order to refinance the banks. It was also told that some more money had to be found through taxing the deposits--in other words, by imposing a levy on the deposits.

The combination of these two measures that Cyprus had to take would be simply--would destroy the economy. Taking on the debt to rescue the banks would make public debt in Cyprus unsustainable, or very large, in any case, and it would impose austerity and everything else on the economy to deal with the public debt. It would basically transform the private debt of the banks into a public debt of the state, and it would ruin the economy in the process. The other part of the equation, which is finding the money by imposing a levy on bank accounts, would also destroy the banking system, because, of course, depositors would take their money and run, and they would object to having their money taxed in spite of guarantees. The combination of the two was simply deadly. Cyprus couldn't accept it, and it said no.

Now, where are we at the moment? Where we are at the moment is a terribly difficult position, because--and that's something that those who are under European banking system ought to know--bank runs are very dangerous situations that, once they begin, once they start, they become almost impossible to reverse. And I'm afraid that Cyprus has reached the stage where a bank run, when the banks reopen, if they reopen, is almost inevitable. That's where we are. And we're there because, as I said to you previously, the guarantees on deposits have been challenged, have been broken, and everybody now knows that Cypriot banks are bankrupt. Well, the first thing that everyone will do whenever the banks open would be to rush to the banks to get their money out. If that happens, the banks are finished.

Now, for that not to happen, some new plan has to be put on the table very, very quickly, very quickly. I don't know what this plan would be.

JAY: Well, one of the plans being talked about is the Russian billionaires, that if they really have half the deposits, are going to have a lot to say in whether there's a big bank run or not. Apparently, one of the things being put on the table is they're going to have some privileged access to the energy fields off of Cyprus in exchange for not, you know, having this bank run, which will be--it's like picking the bones of what's going to be left of Cyprus.

LAPAVITSAS: This is what is being mooted, and I believe that some version of that is being negotiated by the Cypriot government or Cypriot representatives in Moscow and elsewhere even as we speak.

Now, I want to point out that this is not a very good path to follow, first of all because it essentially leaves the basic structure of a deal that was offered to Cyprus last week unchanged. It hasn't changed as an economic policy. The state would still have to take upon itself a huge debt to rescue the banks. And then the rest of the money would come from Russian investors of some sort who will obviously want their pound of flesh. Cyprus would be selling its natural resources at a very low price if that would happen.

If I were the Cypriot government, I wouldn't want to find myself at the mercy of Russian oligarchs right now. Those who've had the links of this nature know very well that this isn't a very good master or a very good friend. That is not to say that you shouldn't, you know, liaise or have business with them necessarily. If you're a state, you must. But relying on them isn't a brilliant idea.

Be that as it may, the point I'm making is more serious than that. I think we're beginning to get past this point. Already there is talk--the latest I've seen in the news right now is that the Cypriot government has decided to shut down one of the banks, one of the weakest banks. It's just too far gone to be able to bring back. The bank--Popular Bank of Cyprus, it's called--the bank is basically bankrupt. The money isn't on the table to rescue it. The depositors know that this is the case. It's nearly impossible to prevent a run on it if it reopens. And I believe that the Cypriot government has already--seems to have decided to close it.

To my mind, this points at the way that the whole problem must be resolved. And I'm happy to tell you about this if you ask me.

JAY: Yeah, go ahead.

LAPAVITSAS: Cyprus needs to take drastic action and radical action immediately if it wishes to put its economy--to turn its economy around and solve this problem. And it needs to take a leaf from the book of Iceland right now. Iceland confronted a similar problem a few years back, and what it decided to do was to solve it without allowing the bank crisis to ruin the economy. In other words, it isolated the problem by allowing the banks to go bankrupt, fundamentally, and not taking on public debts to rescue the banks.

This means that Cyprus must acknowledge the bankers of its banks. It must shut them down. It must protect the depositors who put their savings in the banks. And it must allow large bondholders, shareholders, and large deposit holders, Russians or whoever else it is, to take a hit. They must carry the can for what has happened. They must receive most of the shock. And the domestic economy must be protected.

It's very, very important that the domestic economy's protected--small deposit holders and businesses. This means, as I said before, allowing the banks to go bankrupt and re-creating, quickly, new banks under public ownership from the ruins of the old banks. That is, it seems to me, the only way in which this issue can be resolved without causing wholescale destruction of the economy. Of course it'll be a shock for the economy, but that's the only way.

Now, what it means at the macro level is, of course, that Cyprus must not have austerity, it must not go for austerity. It must go for a different strategy of boosting the local economy to, at the very least, counterbalance the shock of contracting the banks. So it must boost the local economy and it must take whatever action it can to reenergize the productive sector, which is very weak, as I mentioned to you previously.

Now, can all this happen within the Eurozone? Probably not, but that must be the least concern of the Cypriot government right now. It's concern must be not to ruin the economy in order to rescue the banks.

JAY: Is there any political voice in Cyprus articulating this, at least one with any influence?

LAPAVITSAS: Unfortunately not, not that I know, because, again, the left one more time is failing to live up to its historic responsibilities. I believe that the left in Cyprus and in Greece is actually arguing very strongly that Cyprus must not accept the policy of the European Union. And that is correct. That is right. But it's not really articulating a different set of steps that the Cypriot government should take, and not in the way that I would like them to do it, which I've outlined to you. But I think--I can't see any other way of doing it.

Now, it's possible that actually the right-wing government of Cyprus will go down a path of this type. As I mentioned to you previously, they seem to be closing down one of the banks already, because quite simply there is no plausible alternative if they wish to avoid destroying the economy altogether. We shall see how it pans out in the next 48 hours.

JAY: Now, the European Central Bank and the IMF and the German finance ministry and such, they're all playing kind of a high and mighty, oh, Cyprus, you got yourself into this, now you're going to have to pay to get yourself out of it. But they all knew this was going on. And have they ever said that Cyprus shouldn't be doing that, playing this kind of game?

LAPAVITSAS: I wish to state in the strongest possible terms that the way the troika of the European Central Bank, the European Union and the IMF have behaved over this is amateurish and absolutely arrogant, and how to describe the content of it, because of course they knew what was happening.

And Cyprus isn't the only country which engages in practices of this type. As I mentioned to you previously, Luxembourg isn't a million miles away. The City of London isn't exactly spotless when it comes to these things. These are well-known instances and occasions of, you know, shady dealings with banks and bank deposits.

They chose to make an example of Cyprus, and they chose to teach it a lesson, for whatever reason they had in their heads. They offered it a deal last week which was manifestly unmanageable, and they're insisting on it. They're taking a very hard line. In other words, they seem to be destroying the economy, and they seem to be giving Cyprus a choice which it cannot have. They're treating it like an insignificant little member of this monetary union. In other words, they're telling us and telling the Cypriots this isn't a monetary union at all; this is a hierarchical alliance.

JAY: And of course it's going to force Cyprus into a situation of selling off publicly owned assets, which is another nice little privatization piece.

LAPAVITSAS: Of course. Of course.

But if I may say something on the European Central Bank, it is hard to think of a central bank that has behaved more irresponsibly. And I say this because they pride themselves in conservatism and being sensible and so on.

First of all, they agreed, they accepted a deal last week which basically told the Cypriots that they had to tax deposits in spite of the guarantee. Now, it's hard to believe that the central bank has agreed to a deal like that, because, of course, this was very likely to create a bank run, and yes, it has created a bank run. So this is a bank run created by the ECB. It is hard to believe that the central bank has done that.

On top of it, the ECB came out today and basically gave to the Cypriots a complete ultimatum. It told them that they've got liquidity for their banks until next Monday. Therefore they've got to find a solution by Tuesday morning. Now, this was guaranteed to compound the pressure of a bank run, because, of course, depositors will not believe that banks are secure, will not believe that banks are okay. When the banks reopen on Tuesday, if they reopen on Tuesday, you're likely to see chaotic scenes. And that would have been created by and aided and abetted by the central bank of Europe.

JAY: Well, we'll see whether this in the end winds up giving these Russian billionaires big pieces of Cypriot energy or perhaps some of the Russian billionaires get screwed in the course of all this. That's also possible.

LAPAVITSAS: It is indeed possible. This is hanging in the balance at the moment. We don't know which way it's going to go. If the Russian billionaires get pieces of Cypriot real estate, Cypriot resources, and they force the Cypriot population to undertake austerity and placate the Russians in order to stay in this monetary union, that would be a terrible act. If on the other hand the situation has gone too far for that, we might well see events unfolding such that the Russian billionaires will take a significant hit and Cyprus will go down a different path.

Whichever way it goes, it's clear that the people who run the Monetary Union and who run Europe are beginning to lose sense of what's happening. They live in their own bubble in Brussels. They don't quite understand what this crisis is doing to the peoples of the periphery, peoples of the south. And they're behaving like emperors, basically, cut off from the population. These are typical signs that we see of political regimes before a fall. This is not a monetary union that is going anywhere. This is--if you look at it historically, this clearly is the endgame.

JAY: Alright. Thanks for joining us, Costas.

LAPAVITSAS: Thank you.

JAY: And thank you for joining us on The Real News Network.


Gerald Epstein: EU tries to force Cyprus to tax bank deposits to pay for bailout

Gerald Epstein is codirector of the Political Economy Research Institute (PERI) and Professor of Economics. He received his Ph.D. in economics from Princeton University. He has published widely on a variety of progressive economic policy issues, especially in the areas of central banking and international finance, and is the editor or co-editor of six volumes.

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Baltimore. And welcome to this week's episode of the PERI report with Gerry Epstein, who now joins us from Amherst, Massachusetts, where he is codirector of the Political Economy Research Institute, or PERI.

Thanks very much for joining us again, Gerry.


JAY: So what do you got for us this week?

EPSTEIN: Well, this is another week of financial follies of capitalism. I've been looking at what's going on in Cyprus, and it's really quite amazing. So Cyprus, part of the European Union, part of the Eurozone, needed another bailout, because its financial system, which they were trying to portray--they were trying to build up, like the financial system in Iceland or Ireland, as this great financial center. It of course went bust as a result of the financial crisis.

And the European Union has had to give it some loans in the past, and now it's time for another bailout. But the Germans were balking at giving the full $17 billion that the Cyprus government had needed, and so at the last minute they decided to, well, we'll just give you $10 billion, and then we'll put a tax on bank deposits. Well, guess what? When you threaten to put a tax on bank deposits, what do you think depositors do? They line up and try to take their money and run. And this has led to financial chaos not only in Cyprus, but also has now spread to other parts of Europe.

JAY: And they had some phone call on Monday, today, I guess. Has that happened yet?

EPSTEIN: Well, the parliament in Cyprus has to approve of this, has to approve it, and they were going to have a vote today. But now they've postponed the vote till tomorrow. There's a bank holiday--they've called a bank holiday so people can't actually go into the banks to get their money out, but they can go line up at the ATM machines and take their money out until the cash runs out, which it's doing.

But stock markets are now tanking, or did tank this morning in Japan, and lost 2 percent in Japan and lost 1 percent in Europe, and I don't know what's happening on Wall Street at the moment. But this has just shown once again how precarious the whole Eurozone is and how contradictory and, I think, in some ways asinine the policies are of the European Union and others in the so-called troika, including the IMF and the European Central Bank, as they're trying to deal with this crisis. That is, the more they push on austerity, the more contradictions they create. And this is threatening to spread contagion around Europe again.

JAY: Now, if I understand it correctly, the Russian depositors have something like--what is it?--EUR 30 billion of deposits by Russians in Cypriot banks, and now they're, as you said, heading for the hills. They want to pull out the EUR 30 billion. On the other hand, the Eurozone wants Cyprus to start paying--what is it?--some kind of fees to the Eurozone to deal with the bank bailout. As you say, it's complete chaos.

EPSTEIN: That's right. I mean, one of the first rules when you're trying to protect a financial system is you don't want to create bank runs. This has been known for decades, if not centuries. And the thing is, that's right, one of the ways in which the Cypriot banking system was trying to make a lot of money was by letting it be kind of a laundry for Russian money of all kinds. And so there's many millions of billions of euros of Russian money in there.

And so one of the excuses for levying this bank tax--this deposit tax, excuse me, is to try to make the Russian money launderers or money depositors pay some of the tax. The problem is, there was a proposal to limit this tax on deposits above EUR 100,000, so to get to the--to tax big depositors.

But president of Cyprus, the new president of Cyprus didn't want there to be high enough of a tax rate to just limit it to deposits over EUR 100,000. I guess he was trying to protect his rich friends. So they decided that in order to generate the $6-7 billion they needed to satisfy the Germans and the Dutch and the Fins, they'd have to put some of the tax on small depositors. So there's a 6.5 percent tax on deposits below EUR 100,000 and a 9.9 percent tax on deposits above EUR 100,000. So it's a very--honestly, it's a very regressive tax, relatively regressive.

But the main problem is it's not a tax you can really implement without destroying the banking system. And so now if you're sitting there in Spain thinking, well, Spain's in trouble financially with the European Union, or Italy or Portugal, you're thinking, are they going to start coming after our bank deposits next? And so the fear is that this is going to generate bank runs in the southern parts of Europe as well.

JAY: Alright. What else have you been looking at this week?

EPSTEIN: Well, I think the point I wanted to make about this example is that there's no good way, there's no safe way to implement this austerity program. And the only way that you can deal with a situation like this is to impose the costs on those actors that have really created the problems.

And in the case of the United States, this past week there was a Senate committee hearing on JPMorgan and the famous London Whale trades, where Bruno Iksil, the London Whale, a trader, lost over $6 billion and maybe more in trades last year, and the bank tried to cover up these trades. And this information about how they tried to cover up the losses in the trades has--really came out in a Senate report that was revealed by Carl Levin's committee last week.

And it's pretty astonishing what happened. As they were making these losses, they tried to change all of the formulas to try to hide the losses. They tried to change their formulas for risk management to try to make it seem like they were less risky than they were.

When the regulators came to try to get some information, JPMorgan, Jamie Dimon and the others basically said, you don't have any right to this information. And the Comptroller of the Currency that let all the problems in 2006, 2007 to go by without trying to do anything about it just said, okay, if you won't give us the information, that's fine, not to worry.

So we see that the follies, the financial follies of financial deregulation and austerity are still with us on both sides of the Atlantic.

JAY: Alright. Thanks for joining us, Gerry.

EPSTEIN: Thank you.

JAY: And thank you for joining us on The Real News Network.