James Henry: Bailout deal includes capital controls and punishing big Russian depositors to pay off European banks — leaves Cyprus looking for a “new way to make a living”
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. And welcome to this week’s edition of The Henry Report with James Henry. He now joins us.
James is a economist, attorney, investigative journalist who’s written extensively about global issues. He used to be a chief economist at the international consultancy firm McKinsey & Company. And he’s written in Forbes, The Nation, New York Times. And he’s a regular here.
Thanks for joining us, James.
JAMES S. HENRY, ECONOMIST, LAWYER, AND INVESTIGATIVE JOURNALIST: Quite welcome.
JAY: So when I was a kid, I used to read these Superman Bizarro version of the comic books where there was this other planet and there was, like, Bizarro everything, Bizarro Superman. I mean, it’s like this whole Cyprus financial meltdown–and while it’s not a joke to the people of Cyprus, who I’m sure are going to get screwed by all of this, it’s a completely bizarre, weird situation.
HENRY: Yeah. I mean, Cyprus is a country that is about half the size of Connecticut. It’s very close to Turkey, closer to Turkey than anywhere else. It has had a history of division between the Turkish minority and the Greek Cypriots, who’ve always had this idea of unifying with Greece. And that produced a terrible war back in 1974, ’76. The Greek military junta tried to take over the island, and the Turks intervened. And so they’ve been trying to solve that situation, you know, ever since. And they still have a divided country there. So that’s kind of one important backdrop.
The other interesting angle here is that Cyprus and Greece in general are, like Russia, largely Greek Orthodox, part of the Orthodox Church, and they have that common tradition. And as far back as the 1850s, you know, Russia and Greece and what was then Cyprus aligned in the Crimean war against Britain and Turkey.
So, you know, there’s a long history here of relationships that come to play, and it all comes out in this latest episode, which is, you know, basically due to the fact that in 2004, on the insistence of Greece, Cyprus, this tiny island with 860,000 Greek Cypriots, was admitted to the E.U., the European Union. This is a country that basically, except for banking, has only beaches and, you know, has become a kind of raging tax haven, has not only a banking haven but also very low tax rates, 10 percent corporate tax rates for nonresident companies. And it also has notoriously loose controls on money laundering. So it was really, like, you know, the place to be if you had dodgy business and you wanted to be in the E.U.
JAY: And they were reporting that maybe a third to half of the deposits in the Cypriot banks were Russian oligarchs’, Russian billionaire money.
HENRY: Yeah. Well, German intelligence BND did a report that just kind of oddly enough turned up last year in December, about the time that Cyprus was asking for aid from the E.U., and that argued that there was about $26 billion of Russian deposits that were from dubious sources in Cypriot banks. You know, the Russians disputed that, and certainly anyone who had the ability to anticipate this crisis would have been taking money out since then.
But, you know, I think that colored this whole debate. It made it a kind of a bit of theater with Angela Merkel putting her hands on her hips and saying, we’re not going to tax European taxpayers to bail out Russian oligarchs.
JAY: Why is there any need for bailout? The Cypriot banks are sitting on all this cash. So why are they in trouble?
HENRY: Well, they’re in trouble because they invested heavily–some of them, not all of them–invested heavily in Greek bonds–again, kind of the Greek relationship here. And last year, the Greek bonds were subject to a EUR 100 billion haircut in addition to the EUR 240 billion of additional borrowing that the Greeks got from the European Central Bank to bail them out. So Cypriot banks, especially the number two bank, Laiki–which no one really knows who owns, so some mention Qatar–anyway, they especially, for whatever reason, invested heavily in these Greek bonds, which became worthless. And that, you know, started the whole crisis in the banking industry.
This is really unlike the Greek crisis, which was what we call a sovereign debt crisis, you know, involving the state sector. Here we had private banks that basically made bad investment decisions, and suddenly their whole credibility to investors became dubious and their own liquidity became dubious because of these bad investments.
JAY: So on Monday they make a deal, they being the Cypriot government and the European Central Bank and the financial authorities in Europe, which includes capital controls, they say, which will be temporary. Tell us about this deal and who wins and who loses out of this.
HENRY: Well, this is the second deal they tried. You know, the first one was to tax all of the depositors in these banks, and that one fell through.
The deal that they ended up this weekend finally adopting is actually worse for the large depositors. They’re going to lose at least 20 percent of their deposits that are still there. So that’s one clear burden.
The banks are being consolidated as we speak. One of them’s–Laiki is probably going to be put out of business and its depositors are going to go to the others. But I think–you know, so one impact of this you’ve mentioned, which is capital controls, this effectively makes Cypriot euros a different currency. So, you know, we were talking about maybe Cyprus leaving the euro. Well, they effectively already have, ’cause capital controls are not allowed anywhere else in Europe.
Another impact of this thing is going to be on the tax system in Cyprus.
JAY: James, just to make it clear for people, what that means is you may have your euros in Cyprus, but you can’t take them out of the country. So in other words the whole point of the euro is it’s supposed to be throughout Europe, and you can’t take it anywhere now. And this is obviously to stop a bank run, because what’s the point of taking your money out of the bank if you can’t take it anywhere I guess is the logic.
HENRY: Yeah, they’re talking about reopening the–. I mean, they have this dilemma. They have a sizable tourist industry, especially with people from the U.K. and Russia, of course, and they all want to get euros at the ATM machine. So right now the euro restriction on withdrawals is EUR 100, which if you’ve been to these nightclubs in Cyprus you know doesn’t go very far. But, you know, they have a healthy underground economy, and there’s all kinds of currencies circulating there.
So the most important impact of the capital controls will be on bank-to-bank transfers. And then there’s a lot of loopholes there, say, for what they call systematically important payments. So under that guise about EUR 1 billion left just last week. You know. So this is a permeable system, like any capital controls situation, but it’s an important deviation from the E.U. hope to have a common currency.
JAY: Now, it seems like in the debate of who’s going to get screwed most here, initially it was going to be the small Cypriot depositors. And now, after they said no way, it looks like it’s going to be the big depositors. And what does that mean? That the Russian billionaires are going to pay off the European banks?
HENRY: Well, I think to some extent that’s true, but the real losers here are going to be the people who are, first of all, working in the banking sector. I mean, you have an economy that had at least 20 percent of its entire economic activity based on banking, what we call the finance curse, which often occurs for these small haven countries–become heavily dependent on banking. And the kind of banking they do is very limited. It’s–doesn’t–you know, these are not sophisticated banking skills that are required to launder money and, you know, help tax dodging. So at the end of the day, they’re going to be losing thousands of employees in their banking sector, which now employs, you know, more than 20,000 people. I think they are the first ones who will feel the impact of this. And then Cyprus basically has to figure out, you know, what to do for a living going forward.
This is not going to be–.
JAY: [crosstalk] going to put money back in Cypriot banks if you want a tax haven or a launderer, it ain’t going to be a place that had to put temporary capital controls and made you take more than a haircut–it sounds like a scalping.
HENRY: Yeah. I mean, you know, Time magazine declared that this had basically–today that this was the end of a tax haven. In fact, you know, there are several different dimensions to being tax havens, and they’ve only really attacked one of them directly, which is the banking haven role.
You still can benefit if you structure a Cyprus holding company. They only have a 10 percent maximum corporate income tax. So a lot of Russian inbound investment is channeled through Cypriot companies to avoid corporate taxes, and that’s going to maintain itself in place. There’s about 2,000 lawyers in Cyprus and more than 1,200 accountants, and, you know, they’re going to be continuing doing these kind of deals, these trusts and offshore companies, and that are still going to be in place even after the banking haven goes away.
And then they’ve also made it quite easy to get residency in Cyprus. You know, one headline story is that more than 80 Russian oligarchs were given citizenship in the E.U. by way of Cyprus. So there’s a residential haven business here. There’s about 50,000 Russian-speaking residents in Cyprus now.
And, you know, much of–I mean, and Russians have invested more than $10 billion in Cyprus real estate in the last decade. So there’s still a lot of activities going on there that are related to haven, the business. But I do think the banking haven aspect of it is over.
JAY: How is Putin and the Russians going to respond to the deal today?
HENRY: Well, some stories said that he was upset, and that, you know, Medvedev, the prime minister, was denouncing the deal. Part of it was that they didn’t feel that they were appropriately consulted. But Russia had already lent $2.5 billion to Cyprus last year and sort of didn’t really feel disposed to put any more money in.
And Russia’s been talking about trying to attract a lot of this offshore money back into Russia, so the so-called de-offshore-ization of Russian money. They have by our calculations more than $800 billion of offshore flight wealth that belongs to Russian residents, much of it to the tiny elite, that’s flown the coop in the last–you know, since the collapse of communism in 1990. So, you know, there’s a kind of a complicated side to this Russian story as well.
Russia also has some very important gas companies, like Gazprom, which would love to get their hands on the 7 trillion cubic feet reservoir that has just been discovered in Cypriot territorial waters.
JAY: That was once talked about as could be part of this deal, that the Russians would help bail out the banks in exchange for energy rights. But that doesn’t–at least it’s certainly not public–that doesn’t seem to be part of the deal.
HENRY: No. I think the Russian national game is chess, and Putin is looking here at kind of three or four moves down the road. You know, he’s in the driver’s seat. I mean, the Cypriots are going to at some point want to come to the table with some opportunities for Russian investors to come back to Cyprus. And that probably means that Gazprom will be looking at getting those drilling licences, which were, incidentally, exploited at first by a U.S. company called Noble, which found the gas [crosstalk]
JAY: Well, the Americans are not going to like Gazprom getting hold of the energy resources off Cyprus. We know from WikiLeaks they hated the idea that Gazprom and the Italian energy company had such a dominant position in Libya. In fact, a lot of people think that has a lot to do with why there was a war in Libya. And one of the WikiLeaks cables from an American ambassador said that Russia is tightening its noose around European energy supplies.
HENRY: Yeah. I think that, you know, there’s–as natural gas supplies have increased in the last year or so, some of those concerns have been–and, you know, Russia is concerned about driving the Europeans to using alternative pipelines. But it is a concern, you know, that Russia would perhaps get their hands on this gas. It’s also certainly of concern to Turkey, which has disputed the rights to the gas. But, you know, we just have to see how that plays out.
I think another interesting fact about Gazprom, [incompr.] we hear it with respect to Cyprus, is that one of the key partner organizations was a company called Itera, which is a Cypriot-based company. And I’m told that all the trust documents are in Cyprus. You know, they became a major gas player. They have their headquarters in Geneva, but their holding company is in Cyprus. And, you know, there are all these stories about Yeltsin’s daughter being one of the original investors in that company.
So this has many ramifications, and not every one is going to be pleased with, you know, a fundamental change in the Cyprus role in the world.
JAY: Alright. Just quickly, is this–in terms of any further repercussions of the financial crisis in–is it contained? Or is this still contagion, possibly, for the rest of Europe?
HENRY: I think that the fears of this really fundamentally affecting the euro were really overstated by some pundits in the investment community who were exaggerating the potential every time there is this kind of ripple, people talking about this escalating to Spain and Italy. And, you know, I just don’t see that as a problem.
I mean, what’s clear is that all of the private banking types in Europe are, you know, sort of circling the waters here. And, you know, we’ve had Swiss bankers and even Latvian bankers looking, you know, saying, you know, bring your deposits here; we’re still open for business. And on the other hand, some people have suggested that maybe the Cypriot model is a good one for Europe. They need a bad bank where they put all their bad assets and they begin to clean up all of the European havens, starting with Switzerland and the U.K. and Luxembourg and Lichtenstein, which–you know, Andorra. These are all still wide open for business. And several of them are members of the E.U.
JAY: Thanks for joining us, James.
HENRY: Right. Quite welcome.
JAY: And thank you for joining us on The Real News Network.
DISCLAIMER: Please note that transcripts for The Real News Network are typed from a recording of the program. TRNN cannot guarantee their complete accuracy.