Island Nightmares – NYTimes.com


 

What is it about islands around Europe’s periphery? Is there some peculiar psychological thing about proximity plus the illusion of isolation that makes them turn themselves into havens for runaway banks? Inquiring minds want to know.

Anyway, the Cyprus story has obvious parallels with both Iceland and Ireland, with RMML — Russian mobster money laundering — as an extra ingredient. All three island nations had a run of rapid growth as banking havens that left them with banking systems that were too big to save. Iceland, at peak, had banks with assets that were 980 percent of GDP, more than 10 times the US number; Ireland was at 440 percent. Cyprus, at around 800 percent, was closer to Iceland in this respect. For a good summary, read this.

In all three, runaway banking was the source of the crisis — although not everyone seems to get this, even now. Joe Weisenthal finds the most clueless remark so far about Cyprus, and it comes, you guessed it, from George Osborne, who seems to think it has something to do with lack of fiscal discipline. Actually, as the IMF (pdf) points out,

Before the 2008 crisis, Cyprus enjoyed a long period of high growth, low unemployment, and sound public finances.

Oh well. In any case, the question is what to do now.

Iceland got through the crisis with less damage than Ireland, for two reasons. First, it let the banks default on liabilities to overseas creditors, including deposits in offshore accounts. Second, it had the flexibility that comes from having your own currency.

The own-currency advantage helped the real adjustment of the economy; it also allowed some fairly undisruptive financial repression, because the depreciation of the krona (coupled with temporary capital controls) led to a brief burst of inflation that eroded the real value of deposits. Savers were hurt — but with banks having grown to 10 times GDP, that was going to happen one way or another.

Cyprus, unfortunately, seems to be making a hash of it. To be fair, the proposed levy on depositors is actually smaller than the real losses Icelandic depositors took (and they lost on their currency holdings too). But this is just the beginning! Even with the effective default on deposits, Cyprus will need a huge loan from the troika, and the condition for this loan will be harsh austerity. This looks like the beginning of endless, inconceivable pain.

And while it looks as if the terms of the deposit tax are being revised, overseas creditors are still getting a much better deal than in Iceland. I’m still trying to figure out the technical aspects here, but it seems clear that one big problem is that Cyprus, unlike Iceland, isn’t willing to put its banking excesses behind it; they’re still trying to hold on to the RMML business, which means less taxation of the RMs and more taxation of locals.

I am, as I’ve already admitted, somewhat behind the curve here; I should have been tracking Cyprus, but I wasn’t. Still, even on a cursory look it’s really hard to see how any of this is going to work.

Island Nightmares – NYTimes.com

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