Cyprus Has Not Yet Seen Bottom: Self-Interest, Collusion and Ignorance

Was Adam Smith wrong when he claimed that the actions of self-interested actors lead to the collective good? This has certainly not been the experience in Cyprus. To be fair to Adam Smith, he assumed that the self-interested actions took place in a competitive environment by competent and knowledgeable optimizing actors. The Cyprus experience instead differs in that the environment is non-competitive and collusive and key actors are too often incompetent or not real experts, besides been self-interested or loyal to party interests and personal ambitions. Self interest Self-interest motives start at the top of the Cyprus political establishment and run down through the ranks. Take the recent economic crisis leading to the troika intervention, for example. The specific tough memorandum on Cyprus was the result of pursuing self-interested political agendas by both large political parties on both sides of the spectrum. The previous government deliberately exaggerated the financing needs of the banking sector in order to shift the blame away from its own overspending and mismanagement of public finances, leading to the debt burden being judged unsustainable and bringing about the strict and damaging provisions in the final memorandum, with catastrophic effects for businesses, (un)employment and growth. The above is rather obvious and clear to everybody so no further elaboration is needed. The current government´s contribution to getting a memorandum with unduly tough terms for Cyprus was more subtle but no less pivotal. The government deliberately avoided using in its memorandum negotiations with troika the non-trivial value of undeveloped gas reserves (of the order of 500 Billion Euro) or any future income deriving from it, possibly because another candidate in the presidential elections campaign argued that they are of value. The Energy minister stated subsequently that he was proud to manage to keep the gas reserves prospects out of the negotiation with troika. In this way the current government is equally responsible with the previous one for the funding gap that arose (between the 15 Billion Euro estimated total funding needs and the 10 Billion contribution by European lenders and the IMF). Had they negotiated better loan terms tying the loan interest rate to the growth of the economy and/or given an option on future quantities of natural gas production (a GDP-loan convertible into natural gas), for example, they would have narrowed or closed the funding gap, avoided the tough memorandum terms that strangled the economy and would have created more incentives leading to future growth and economic development, by tying the incentives of the lenders and the country together with its future growth prospects. It should not go unnoticed that the current President out of self-interest tipped relatives (that manage own funds) and clients of his law firm to move large funds out of the country before the impending haircut. If a manager did this kind of “insider trading” in the US, they would be forced to resign and be prosecuted. The same thing of course would happen to a president for the stupid political decision to keep explosives in a naval base next to the country´s main power station, leading to the death of innocent citizens and the handicapping of the country´s energy supply and economy. Collusion The Cyprus economy has been suffering from serious structural inefficiencies: public employees have been getting paid more than they produce, benefits have been excessive, effective monopolies and professional cartels keep up prices and sustain inefficiencies. Politicians, banks, the media and the enforcement system have interlinked and collusive interests. Banks selectively make and forgive loans to public officials, political parties and influential members of the media; politicians give generous subsidies and bail out inefficient and corrupt banks (with taxpayers´ money); and the media and enforcement system routinely cover up or let go any scandals and suspects that occasionally might surface. Self-interest and collusion appear to be at the core of the main policies of main political parties and many public officials in Cyprus. It is usually covered up by populist rhetoric in the interest of the common or working people. Take the issue of privatization of public entities, like the electricity authority (EAC), the telephone authority (CYTA), the national airways company or the Ports Authority. These are in fact monopolistic vehicles for exploiting the common citizens through excessive charging for common utilities (the EAC charges the highest electricity rates in the entire EU while the Ports Authority charges extortionate fees) causing further increase in the cost of living by passing rip-off charges to the Cypriot consumer. The administration and employee unions of these entities usurp and benefit from the excess profits made on the back of the citizens. After covering for significant waste and operating inefficiencies and generous allowances and benefits to the management and employees of these organizations (driving and lunch allowances, risk-free loans to send their children to university, subsidized holidays etc.), there are still hundreds of Millions of Euro in cumulated excess profits and pension funds that the government can borrow from and political parties can usurp in the form of party contributions to get any normal business done. These semi-governmental organizations (SGO) are a convenient vehicle for political parties and certain public officials to implement their corrupt practices. No wonder almost all political parties in Cyprus have been against privatization of these SGO entities. They don´t recognize that their favored policies of keeping local monopolies in place in effect lead to exploitation of the poorest strata of society, digging the grave of national competitiveness in the name of protecting future generations? Political parties and public officials actually are in collusion taking cuts from the excess profits made on the back of the working people and sharing bribery profits. The recent scandal regarding the sale of Turkish Cypriot property to the telecom authority´s pension plan reveals extensive involvement by all layers of the establishment, including the secret service, the police, union bosses, boards of directors, political party members etc. Some political parties have been so overconfident with this routine process that they accept checks deposited in their bank accounts (rather than only trace-less cash) and even issued a receipt. Yet the justice system ordered the immediate release of the captured suspects on the grounds that the only evidence found in the last week was just one receipt for accepting money by a political party, beyond the statements of the person who admitted he gave the bribes! How ridiculous this theatre of the absurd can get in this country? What else do you need (to order the detention of accused suspects) besides eyewitnesses admitting they gave the bribes, bank accounts proving so, and even a receipt issued for receiving money? The 1 million Euro allegedly received by the Chairman of the telecom authority in the above scandal or the 1 million received in an account controlled by an ex Governor of the Central Bank of Cyprus (allegedly a down-payment for providing future consulting services in the next decade… an unheard of excuse) may actually pale compared to other more subtle deals or potential deals. Last March the Cyprus government agreed to sell the interests of the Greek branches of the two main Cypriot banks to Pireaus Bank of Greece “with the most beneficial terms under the circumstances and with an important benefit for the Cypriot side.” The sale included 300 branches and their portfolio of about €15 Billion of deposits and €20 Billion of loans–exceeding Cyprus’ annual GDP of €18 Billion. The sale followed moves that sunk in €1.8 Billion of Cypriot taxpayers’ money in Laiki Bank last year and over €10 Billion of emergency liquidity funds since then. Piraeus shares closed up 20% on that the day giving more than €50 Million one-day bonus to its shareholders. Over the two days this represented a 37% increase or over a €100 Million bonus from the Cyprus Government (people) to Pireaus Bank. The previous day the shares were at an annual low. The annualized return might make the Guiness records. All this in the name of “saving” the Cyprus economy. As an incentive to “accept” this bonus, Cyprus was even supposed to pay Piraeus Bank €717 Million on top. The €817 Million difference could have been used to help close the €6 Billion gap facing the nation (as a result of the selfish, vote-fishing policies of both main political parties). Some other situations might appear to belong to the sphere of the unimaginable. A wealthy Cypriot businessman called me from Australia recently and explained that at the end of last year he visited Cyprus officials in an effort to bring more than €20 Billion of foreign pension funds under his influence in exchange for some energy rights in an effort to avoid the tough troika memorandum. He claimed that the leaders of the two main political parties asked for 5% commission. The deal did not go through and the tough memorandum terms are an everyday reality. If true, that commission would dwarf any previous deals. I am not in a position to ascertain the validity of the above claims. Ignorance The above is not meant to defend the investigative committee on the economy. Its main conclusion that the ex President bears much of the responsibility for our current economic mess is correct, but self evident. But what were the other contributing forces and actors? Who has taken advantage of the public trust and exploited situations? Who should be further investigated or prosecuted? What is the responsibility of the current president for funds leaving the country before the haircut, for example? It seemed from the very start the committee was set up with senior lawyers with no knowledge of economics more to cover than uncover the true underlying causes and culprits of our ailing economic system. And the appointment of advisors to the committee who are either themselves ignorant of the workings of economic forces and interactions or are part of the corrupt system itself (as an ex Governor of the Central Bank quietly attending the committee hearings who is accused of opening the doors for branding our nation as one of money laundering) did not help. Despite the appointment of wise men, advisors and national economic councils by this government, we have not yet seen a single economic proposal that makes genuine economic sense. A proposal to train locals for the hotel industry and pass the bill to the taxpayers is subsidizing the hotel owners, not benefiting the people. Reluctance to go after big non-performing loans continues to subsidize the big developers at the expense of the taxpayer. Plans to develop casinos and golf courses to supposedly boost the tourist product are masking more serious structural problems of our non-competitive tourism sector that we fail to face. Proposals like expediting the formation of companies and conducting of business are not going very far when the political parties (regardless of who is in power) are extracting commissions for business to get done. Natural gas discoveries might have been a prospect for development, but in this environment our wise political leaders will assure through unwise development decisions and wealth appropriations through commissions all around that not much is left for the broader public and future generations. Our political leaders have little understanding of how to make contingent decisions under uncertainty and that future economic (or political) decisions should be staged based on future scenarios. Already, even though the quantity recently discovered at Aphrodite was below expectations and below the critical viable quantity needed to justify building a big liquefaction plant on the ground at Vassiliko, later on the same day the Minister of Energy announced that the government is going ahead with its plans to build the LNG plant. Just put the whole thing on autopilot, regardless of basic economics or regional developments. These public officials make strategic economic decisions based on political considerations. Our wise politicians in the National Council can solve all problems. They can´t even think right what is best for us on the national political problem (which might be the exact opposite of what they think and repeat as mantra for four decades), but they still want to make economic and energy decisions as well. The previous government thought that they know it all and took no advice from anyone. The current government appoints experts and advisors as ignorant as themselves. The established political forces are in fact in collusion, simply playing musical chairs, alternating who is going to sit in a chair of power, to take a bigger cut. But they diversify, such that regardless of who is in the government they all take their quota of appointing employees in the government sector, boards of directors in the Bank of Cyprus or semi-governmental organizations, semi-governmental organization related deals, forgiven bank loan money etc. And the smaller political parties in the middle habitually flex their principles (if any) to be power brokers so as to ensure their cut in this musical chairs expropriation game. What is equally amazing is that the Cypriot public takes all this passively, hands down, and keeps voting for the same (or similar) individuals. One wonders, after all, perhaps they deserve what they get? It seems that self interest, entrenched collusive forces all around, ignorance and incompetence at all levels guarantee that we have not yet seen the bottom in Cyprus.  Lenos Trigeorgis holds a PhD (DBA) from Harvard University and is the Bank of Cyprus Chair Professor of Finance at the University of Cyprus and President of the Real Options Group. He has been a Visiting Professor of Finance at the London Business School. He is the author of Real Options (MIT Press, 1996), Strategic Investment (Princeton University Press, 2004) and Competitive Strategy (MIT Press, 2011).