The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (55 page)

Pavlou was vice president of Laiki Bank, Cyprus’s second biggest, which when we spoke was only days from liquidation. He said he had witnessed the worst two or three days that he’d ever had to experience. ‘And I’ve seen through crises in many, many countries,’ he continued. ‘This one – it was devastating, because you can see your own people, your own country going into the abyss without any end… It’s traumatic and scary.’

Over the long bank holiday weekend, the bankers kept the cash machines supplied with money. There had been an immediate run on the savings banks that had tried to open on the Saturday morning. Cash was being rationed through the cash machines. ‘I even went around and spoke to people in the queues,’ Pavlou told me, ‘and fortunately or unfortunately I convinced a few people to turn around and go home. Some machines ran out and we needed another half an hour, people were very patient, they were waiting, and the money, it came.’ Pavlou was there on one of the occasions that the money was delivered. He warned the people waiting by the cash machine that the money could run out in the next hour, because the banks were only covered by their insurance to transport so much money in one go. ‘People, actually I admire them,’ Pavlou continued. ‘They were patient, they were standing. Clearly you could see there was a lot of anxiety. And fear, if you like – a little bit. But there was no trouble.’

In the coastal city of Limassol, a roundabout had been decked for Carnival by a slightly sinister circus merry-go-round. It is also the site of ten cash machines. Methodically, cars would slowly whirr around the roundabout, as passengers checked out cash levels at each machine. Some alerted their friends via text or Twitter if they found a working cash machine. Others kept the information close to their chests. ‘Maybe the savings that will be cut will be returned to us,’ one wondered. ‘We are not happy, but what can we do? We don’t have a choice. We thought the EU would be better friends to us.’ Another shrugged his shoulders at an empty ATM and vowed to find a working one. One woman queuing outside a savings bank told Reuters that she had drawn a €12,000 loan to support her daughter’s studies, deposited the money back in the bank – and so would lose nearly 7 per cent of it. British nationals were warned by diplomats to bring different currencies and forms of payment if visiting Cyprus. The RAF flew in €1 million in notes for British military personnel at the island’s two UK bases. In Nicosia an angry Cypriot left a bulldozer outside an empty cash machine. Most Cypriots, oblivious to what was about to hit, had disappeared to the mountains, as is traditional for the Green Day bank holiday. There was general incredulity that Cyprus, not at all the most ‘badly behaved’ of the crisis countries, was clearly being treated as the very worst.

In Nicosia, officials from the European Central Bank arrived immediately after the Eurogroup decision and sought meetings with the country’s president and the president of the Cypriot parliament. The Cypriots had become somewhat standoffish. The feeling on the Cypriot side was that the ECB was attempting to ram through changes in parliament in the hours before the markets reopened on the Sunday night, or at the very least by Monday night. For their part, the Cypriots were looking to buy more time for their parliament and government officials to reconsider the drastic ‘bail in’. Cyprus was trying to wriggle free – or, from the northern European perspective, to renege on commitments made only hours before. Cypriot MPs were rebelling against the deal, trading stories about how, at the crucial Brussels meeting, northern European delegates high-fived each other when Cyprus caved in. The Central Bank of Cyprus summarily announced two unplanned bank holidays. This was in itself a remarkable development. Not since the Great Depression of the 1930s had any Western nation declared a bank holiday for the sole reason of propping up its own financial stability. And it was to get much worse.

Some backstory is worthwhile at this point. Although the Cypriots themselves were largely taken by surprise, anybody moving in government circles in Berlin in the previous months could not have failed to notice that, as far as Cyprus was concerned, a new type of solution was being considered. Chancellor Merkel was, it was reported, much more concerned about Cyprus than Greece. Germany’s intelligence service, the BND, had written a report for parliamentarians picturing the island as a cesspit of money laundering. The clear message was that any bailout of Cyprus – which would largely be paid for by the German taxpayer – would in the end be of much less net benefit to the Eurozone than to a bunch of wealthy Russian gangsters.

Senior MPs from Chancellor Merkel’s own CDU party, thus briefed by the BND, toured the capitals of Europe, warning that Cyprus was ‘a very special case’ because of enormous money laundering, ‘especially of course by Russians’. For Germany to help Cyprus, the MPs stated, certain preconditions had to be met concerning banking transparency. Above all, the ‘criminal structures’ woven into the Cypriot economy had to be unthreaded.

A low-level propaganda war broke out between Berlin and Nicosia over these issues. Cyprus issued independent research showing it was even more compliant with anti-money-laundering legislation than Germany itself. The message was pushed by a London-based consultancy made up of economists who used to work for the UK government. For its part, the Troika commissioned the bond trader PIMCO to research the funding requirements of the Cypriot banks. Nicosia in turn employed BlackRock to research PIMCO’s research.

The motivation for the German approach was partly economic, but also hugely political. Germany’s official opposition had chosen to pick an election fight with Chancellor Merkel over ‘a bailout of the Russian mafia’. The reality was that the opposition SPD (Social Democratic Party) had been broadly supportive of Chancellor Merkel’s approach to the euro crisis at the time of crucial votes on bailout funds. But when it came to Cyprus, the SPD – which wielded considerable influence in the upper house, the Bundesrat – saw an opportunity to make political capital. So it was abundantly clear to observers of the political scene in Berlin that Germany was going to play hardball with Cyprus, and that the Russian connection was going to loom large.

The huge new marina at Limassol was built to accommodate Russia’s de facto Sixth Fleet. Massive berths had been constructed to service an armada of super-yachts owned by Russian oligarchs. ‘Limagrad’, as it had become known, offered all the home comforts favoured by the Russian elite, alongside almost permanent sunshine. The city hosted Russian restaurants, Russian radio stations, and even a Russian strip club. The Cyrillic alphabet was everywhere. And the city also sheltered a large chunk – around €24 billion – of Russia’s offshore money. Russian money accounted for half of all foreign deposits in Cypriot banks, and up to a quarter of total deposits. There is no doubt that a proportion of that money was dubiously made in the ‘Wild West’ era that followed the collapse of the Soviet Union.

But the full story was more nuanced than the suggestion made in Berlin that Cyprus was being kept afloat by laundering Russian mafia money. When international audits were conducted on compliance with anti-money laundering rules, Cyprus
did
actually come out cleaner than either Austria or Germany. That said, even a former Cypriot finance minister admitted to me that ‘on balance, while we do have rules and regulations against money laundering, the way they are implemented may be more relaxed than [in] other countries’. But the Russia–Cyprus nexus was not just about sheltering money. For a start, the country’s rate of corporation tax was only 10 per cent. Cyprus also had a system of international treaties designed to make the island a channel for investment into Russia and other countries. On top of that, a stable legal system, a shared Orthodox Christianity, and longstanding ties dating from the Soviet era cemented Cyprus’s position. The Cypriots had done the opposite of the banking systems of countries such as Ireland, the UK and the USA. Lending was almost fully funded by deposits, rather than hotter flows of bondholder money. In theory this should have been a strength: deposits are the most stable form of funding. But the reliance on Russian deposits – while partly a consequence of tax competition, and largely perfectly legal – did become a systemic fragility.

Pavlou, chairman of the audit committee, said that while he was there Laiki Bank was clean. ‘I saw no signs anywhere that money laundering was part of any business at all,’ he told me. ‘In Cyprus we are paying 4.5 per cent interest rate. Nowhere in Europe can you get a 4.5 per cent interest rate in euros. We have a tax treaty, we have very good weather, we have the same religion, do I need to give you any more? And the people from Russia, with very cold winters, they come to lovely Cyprus for their holiday and they happen to buy a house in Limassol or Larnaca as well.’

But the dependence on Russian deposits, and their deployment in long-term lending, turned out to be a core problem. ‘Looking back,’ Pavlou admitted, ‘looking back, maybe we should have been more careful in taking so many deposits. What was happening was one of the cardinal sins of the bank. We were lending for one year, two years, three years, in some cases in Greece fifteen years, and we were funding it with funds that were very hot. At some stage the central bank had actually conditions that only 30 per cent of those funds were allowed to lend to the market. And suddenly I came in and saw that that regulation was blown out of the window. And nobody went to say to them “Listen, you broke the rule.”’

So why the emphasis on Cypriot banking dodginess? Cypriot leaders describe how they have long been aware of a negative feeling from other EU finance ministers ‘on principle’ regarding the low corporate tax rate in Cyprus. They also report the distaste expressed by those ministers regarding the ‘disproportionate presence of Russian money’ in the Cypriot economy. The problem for Europe’s bigger nations was that all these features were signed off as acceptable when Cyprus joined the European Union in 2004, and again when it joined the Eurozone in 2008. It was certainly odd that these features were highlighted as reasons for treating Cyprus more harshly than all other Eurozone nations, given no objections had been raised during the accessions, and not much had changed since.

During the island’s initial hour of need in late 2011, the then-president, Demetris Christofias – a Communist who had been educated in Moscow – turned to Russia for a €2.5 billion loan on friendly terms. Cyprus had run a big 6 per cent deficit in the first two years of his presidency. Reaching out to Moscow had been an early effort to avoid the indignity of EU bailouts and the tuttings of those thirty-somethings from the Troika.

A senior G7 official had been in Moscow as the Cypriot crisis of March 2013 erupted with the ‘bail-in’ of depositors. He flew from Moscow to Larnaca on a plane that was full to the brim with passengers, even though it was not yet the holiday season. On the plane there were several strangely shaped metal briefcases stuffed into the overhead lockers. On the tarmac at Larnaca Airport, in addition to a number of other packed commercial flights, there were a dozen or so private jets. Some were chartered, others were registered to Russia. Taxi drivers at Larnaca reported that during those hectic days their clientele were almost exclusively Russian. Limousines ferried Russians from Limassol to long meetings with their lawyers in Nicosia. The Muscovites had come to get their money.

The really shocking thing about that moment in mid-March 2013 was that it wasn’t just the money of the Russians that was threatened. Cypriot depositors themselves were also at considerable risk. The banks were still officially shut pending the passage into law of the EU deposit-raid agreement. In central Nicosia the first victims were the elderly, many of whom had never had to use a cash machine before. The mood on the island was febrile, if not yet panicked. Ordinary Cypriots queued at ATMs for money replenished once a day by the nation’s new emergency service: security vans full of euros run by British contractor G4S.

On the streets, Cypriots were broadly consistent in their view as to who was to blame: Germany. Germany, they insisted, was trying to drive Russian deposits off the island, with the intention of gaining primacy in the race for Cyprus’s abundant gas reserves. Before the parliamentary vote, protestors surrounded the German embassy and tore down the German flag. Credit and debit card payments were working only fitfully, as merchants feared having to pay the deposit tax on such transactions. Cyprus was starting to turn into a cash economy, albeit one that was running out of cash. Outside a branch of Laiki I met an elderly man called Andreas. He had no luck in getting money out of the ATM. I then watched as he rang the bell on the door of the branch to complain. A bank clerk briefly opened the door, only for another clerk to stick a handwritten sign on the outside. The sign said ‘Closed’. It was a scene which, in nearly two decades of studying and reporting economics, I never thought I would actually witness. Andreas was furious, ‘Angela Merkel has taken my money,’ he shouted, before entering into an angry debate with a fellow ATM victim. This other man told me he was willing to accept the deposit levy of 7 per cent if it meant keeping Cyprus out of the crisis. Half an hour later I found Andreas clutching five €50 notes. He had in fact been putting his debit card in the machine the wrong way around, because he had never used it before, always choosing to get his money from the branch instead. Now, clutching his notes, he told me it was his money, neither Merkel’s nor Schäuble’s. When I challenged another protesting Cypriot about the presence of Russian money, he was indignant. ‘What about the City?’ he shot back. ‘What about London? What about Chelsea?’ Everybody knew that Chelsea Football Club was owned by Roman Abramovich, one of the richest men in Russia, who made billions selling his Siberian oil company in 2006. This man’s indignation was shared by many of his fellow-countrymen.

In parliament it was becoming clear that Cypriot politicians were not going to push the deposit tax through against the wishes of their citizens. Perhaps in a small country, the political elite were too close to their electors to impose the proposed deposit grab
– after all, they would personally know dozens of friends and relatives who would be affected. It was touch and go. As in Greece, those politicians who believed there was no alternative to swallowing the bitter pill conjured visions of Armageddon if the country refused to take its medicine. President Anastasiades himself said the country faced a choice of ‘catastrophic disorderly bankruptcy’ or ‘painful but controlled crisis management’. The former would lead to the failure of Laiki and eventually of the Bank of Cyprus (BoC), the country’s largest bank, along with the complete collapse of Cyprus’s service sector and a possible exit from the euro. These were the big guns. This was the imperfect economic union at play. The brinkmanship went as far as a threat to withdraw provision of lender-of-last-resort liquidity from the European Central Bank (known as Emergency Liquidity Assistance or ELA). When other nations needing a bailout had been subjected to this threat, their parliaments had tended to vote the ‘right’ way. President Anastasiades phoned Chancellor Merkel in her limousine, pleading ‘I need more solidarity,’ reported the
Wall Street Journal
. Her reply was brief and to the point. ‘I won’t negotiate with you,’ she said. ‘You need to talk to the Troika.’