University of Illinois, Urbana-Champaign: News

Kostas Kourtikakis, expert on the European Union

4/8/2013  8:00 am

Cyprus, an island nation about half the size of Connecticut and home to 1.1 million people, is the latest member of the European Union getting a bailout and rattling nerves in its financial system. Banks in Cyprus were closed for two weeks at the end of March, and, for the first time, the terms of the bailout require taking money from individual bank accounts and restricting how much money can be withdrawn. Why was that necessary? What risks does it raise? Political scientist Kostas Kourtikakis, a native of Greece and lecturer at the University of Illinois, is an expert on the EU and its institutions, as well as on the politics of southern Europe. Kourtikakis (pronounced kor-tee-KAH-kihs) was interviewed by News Bureau social sciences editor Craig Chamberlain.

The bailout proposal calls for drawing as much as 60 percent from large bank accounts, but an earlier version called for even small depositors to feel the pinch. What is the rationale for this? Who’s getting hurt, and what was the alternative?

image of professor kostas kourtikakisBanks in Cyprus suffered stark losses recently. They own scores of Greek bonds, the value of which was severely reduced, mainly as part of Greece’s own bailout deal in 2012. Now the government of Cyprus needs about 16 billion euros to prop up its banking sector. Failure to do so will result in a collapse of the country’s financial industry, which is one of its economic lifelines. Cyprus’ lenders in the European Union and the International Monetary Fund agreed to supply 10 billion euros. The question then became, where will the remaining 6 billion come from?

The first version of the bailout agreement on March 16 mandated that the missing funds should be retrieved from the accounts of everyone who has deposits in a Cypriot bank, no matter how big or small those deposits are. This caused immense public reaction in Cyprus and numbness in the rest of the EU. The agreement also appeared to violate existing EU rules, which protect deposits of 100,000 euros or less. The negative reaction to this original bailout deal resulted in an ongoing process of revision.

Although we don’t know all the details yet, it seems that small deposits will not be touched. But the government may extract a “haircut” of up to 60 percent from large deposit accounts. Some of these larger accounts, which are not guaranteed, will even be completely wiped out. This will affect the life savings of many Cypriots, but it will also affect the bottom line of many wealthy foreigners, primarily Russians, who had been given favorable tax and interest rate incentives to move their business and savings to the island for years.

What concerns you about the terms of this deal and how it came about? What does it mean long term for Cyprus?

The original Cyprus bailout was decided swiftly and without much public scrutiny, which raised important questions of democratic legitimacy not only for Cyprus but also for the entire European Union. Previous EU bailouts for Greece, Ireland, Portugal and Spain had been the subject of protracted public debate, both in the countries that supplied the funds and the countries that received them. In the Greek example, demonstrations in Athens and heated discussions in the German parliament gave the opportunity to opposition parties and the public at large on both sides of the bailouts to weigh in, before an agreement was final. This was not the case with Cyprus. No wonder Cypriots were outraged when the terms of the bailout first became public on March 16.

The revised agreement has been subject to much more public debate, but the Cypriot executive branch maintains significant discretion in approving the final deal. The absence of public deliberation is particularly striking because the agreement affects the financial sector. Banking employs a very large percentage of the country’s work force. Since the livelihoods of so many people are affected, shouldn’t the public be given sufficient time and more opportunities to be heard?

How does this bailout compare to the previous EU bailouts we’ve seen? And what might the terms of this bailout mean for the “next Cyprus”?

There is a common misconception that the cases of Greece and Cyprus are similar. Although the two cases are definitely linked, they are actually quite different. Greece’s main problem was corruption and excessive government spending. In contrast, Cyprus seems to follow in a line of countries that got in trouble because of their banking sectors.

A familiar pattern has emerged in those countries, in which banks overexpose themselves to risk and then governments are called in to save these financial institutions by assuming their debts. Yet, because those governments do not have the funds to help out their own banks, eventually they ask for assistance from their European Union partners. Although the particular circumstances are different in each country, this is, in essence, what happened in Ireland, which also received a bailout in 2010, and in Spain, which agreed to receive assistance in 2012.

The EU recognized the banking problem even before the Cyprus crisis erupted. Discussions have already begun for a “banking union,” which will create a common set of rules of “prudent” behavior for banks across the EU. But these plans are still a long way from being finalized and continue to be controversial.

In the meantime, many experts are afraid that the Cypriot bailout, by “taxing” people’s bank accounts directly, even if only large accounts, has set a precedent with potentially unpredictable consequences. The concern is that in the future even a hint of a bailout in a eurozone country – one of the 17 that share the euro as common currency – may send depositors rushing to the banks to pull out all of their funds, a development that would accelerate economic collapse.

Several countries that have received bailouts – Greece, Ireland and Portugal among them – are small economies within the eurozone. Yet each of their potential defaults has threatened the entire system. Cyprus is much smaller still, its economy only about a 10th that of Greece. How was it a threat?

Those countries are indeed small, but they share a currency with all of their big and small eurozone partners. And if there is anything we have learned from the 3-year-old economic crisis in Europe it is that every single government’s actions and decisions may reflect negatively upon the reputation of the entire union, no matter how small the country is.

An important reason for this is what seems like the absence of reliable crisis-handling mechanisms in the European Union. Every time a country calls for help, its eurozone partners seem to scramble to find an effective solution. As a result, when trouble appears even in the smallest of countries, worries about the common currency grow exponentially, because it is not certain that the crisis will be contained in that country. And since the euro is an important international currency, what happens to it has implications for the global economy.

It’s easy in the U.S. to catch the latest headlines about “crisis” in the EU and, especially given the complexities, think nothing is getting fixed – and that each new crisis has the potential to bring down the whole system. Is that the case?

The European Union sure seems like it can’t get anything right, doesn’t it? But if we look more closely, we can see that it has managed to develop important crisis-coping mechanisms. There is a permanent “bailout fund” in place now, which acts as an insurance policy for eurozone governments, in case they find themselves in trouble in the future. And as I mentioned, the possibility of common banking rules is being discussed.

At the same time, the emphasis on austerity as a condition for a bailout has sent a very clear message to all member states that the cost of imprudent economic management is severe and painful.

Does the EU still need to do more work to prevent future crises? Absolutely. Can the euro still collapse? It is possible, but Europeans have invested so much in it, I can’t imagine they won’t fight with all they have to keep it alive.