April 3: slightly updated, with fresh quotes and modified commentary
Many people have been asking us about Cyprus. Its tax haven status is
central to the drama that has seen big depositors there stand to suffer large
losses, while small depositors holding amounts below 100,000 Euros,
who had previously been threatened with a 6.75 percent levy on the
capital value of their deposits, will be spared.
The question is: is this the right deal, from our perspective?
In
broad terms, yes. It absolutely is. And much of the world's media has not taken into account all the factors that are at play
here. (Though we do particularly like
this recent interpretation of events by Paul Krugman of the
New York Times, of course.)
Most
notably, Cyprus has been running a pernicious, unpleasant, grubby and
often violent tax haven racket for years. As a result, it long since left the
community of decent, respectable nations. (We should note here that the ordinary
population of a tax haven is different from the
financial services industry of a tax haven; but more on this below.)
This deal
will, we fervently hope, kill off Cyprus' entire offshore model which goes far beyond
banking deposits, and includes offshore companies and other structures.
We know, via specific cases, that Cyprus has been harbouring and
protecting vast subterranean funds from activities of the Russian Mafia,
criminal organisations, common thieves, wholesale tax evaders, insider
traders, and much more. We know, for instance, that Cyprus has been
harbouring illicit gains obtained (partly) through murder (see
this, for instance). Krugman
notes that:
"Whatever gloss you put on it, it’s basically about money-laundering."
Quite so.
Cyprus, of course, loudly denies being a tax haven:
they all do. It's part of the theatre of probity that is
de rigeur among corrupt tax havens that is required to reassure the world's hot money that their money is safe.
The
reality is entirely different. This has been, in effect, a substantially criminalised
state, and it is now being brought to book. So this is a highly positive
development, all things considered, and there
are grounds for hope that the offshore model will be effectively killed: as this article notes in the
Cyprus Mail:
"The
troika has potentially vaporised the Cypriot-based financial services
sector and undermined its status as a tax haven, a deliberate act which
aimed to police the wilder shores of capital flow in and out of Europe. .
. .The financial services sector may now prove dead in the water and
the tax haven status of Cyprus has been swiftly and comprehensively
compromised. If you have money to hide, you are not going to park it in
Cyprus any more.
Or, in the words of a Russian cited in the FT (in
an article that deserves a blog all to itself),
“The Cypriots killed their country in one day.”
The Cyprus Mail article is fascinating,
for although the authors clearly it describes something that we at TJN have long described and will
explore in far greater depth, in a forthcoming long paper: the
capture of, and capitulation by, an entire nation state, to the
offshore financial services industry. And this is the big point that the
world's media has largely missed, and which is perhaps the most fundamental of all. As the same
article notes:
"The interest of the
Cypriot political elite has, in large part, been tied to the financial
services sector since the early 1990s with lawyers, accountants and
others massively over represented in public life and wielding inordinate
power . . . the broader interests of the Cypriot economy have become,
to a significant degree, dependent upon this economic regime."
Take this
interesting article about Cyprus, for instance, which noted that the EU had held back on taking action against Cyprus banks because of imminent elections, which EU officials hoped would oust the current President, the Communist Dimitris Christofias, who was "considered too close to the Russian investors." The opposition leader, Nikos Anastasiades, is duly elected, and the article notes that "Anastasiades is a successful investment lawyer, who has several Russian billionaires in his portfolio" and the finance minister Michalis Serris "was also a member of the board of the second bank of Cyprus, the Popular Bank (Laika Bank in Greek.)" And those are just the most obvious examples.
David
Officer, one of the coauthors (along with Yiouli Taki) of the
Cyprus
Mail article, is an academic who has been conducting a "democratic
audit" of Cyprus. Officer told TJN in emails:
"Cyprus
is a remarkably un-reflexive society so this issue appeared to have
been ignored by every single journalist, academic and political actor on
the island. A consensus emerged here that if the goods were being
delivered there was nothing to be gained by reflecting on how those
resources were secured."
Or, as that same Russian businessman
cited in the FT put it:
"They are saying we laundered all the money, but they lived on that money for 10 years and forgot about it.”
Back to Officer and Taki:
The crisis has caught up
with us and I have grown inured to international media attention since
stories are spreading across the media but with no connection to the
context described above. Gave a 45 min interview to [a U.S. newspaper] a
couple of days ago which was reduced to two lines on their front page
on Saturday. The outsider cannot grasp the context and the Cypriot
insider is not in a position to join the dots because they have never
been given the conceptual framework or the motivation to do so."
TJN
has been told by Cypriot journalists that they had (until the recent
crisis) quite literally been afraid to report deeply on the offshore sector,
for fear of reprisals. Anyone who has read
The Life Offshore chapter in
Treasure Islands will instinctively understand what is happening here. Officer and Taki continue:
"Why
we can talk about 'state capture' by the financial services industry is
how a nominally left-wing party such as AKEL has never once raised any
substantive issues about how the economy had become absolutely dependent
upon the tax haven model and Cyprus a conduit for the flow of foreign
finance capital between jurisdictions. Political consensus emerged
around this model because it appeared to deliver the goods and common
resistance was forged to any attempt by international organisations -
World Bank, IMF, FAFT, EU....the list goes on - to impose an effective
regulatory regime which would undermine this particular cash cow."
Officer and Taki clearly have great sympathy with the ordinary citizens of Cyprus, as do we: the EU's response, they say, is
"a cruel and unusual punishment visited upon ordinary Cypriot citizens who have never been informed of the perpetual risks which have accompanied the tax haven strategy of economic development vigorously promoted by the political elite since the 1980s."
Now Cyprus - and ordinary Cypriots - have a huge, existential problem. When an island
gets captured by an offshore financial services industry - and we've
seen this again and again - it tends to kill off substantial parts of
alternative sectors. Among other things, it can create "Dutch Disease"
effects where local price levels rise in response to the inflows of
money, either via the exchange rate or via inflation, and the resulting
higher-cost environment then makes it harder for various other sectors
to compete in international markets. They consequently wither. More importantly,
though, the salaries in this sector are far higher than in any other,
and this leaches the best and most highly skilled people out of
other sectors (private and public) and thus further worsens their
prospects. In the face of all these adverse trends, policy makers then lose
interest in 'difficult' problems such as creating a viable agriculture
or manufacturing or tourist industry and instead let the easy money roll
in in pursuit of secrecy and lax criminal enforcement, no questions
asked. Dissenters are bought out or threatened.This makes the problem
worse still. It also tends to criminalise originally law-abiding people who come into
contact with this sector, who find that they are required to turn a blind eye to
foreign tax evasion and other criminality if they want to prosper.
And here we get to what exactly it is
that Cyprus has been selling. Its secrecy score on the
Financial Secrecy Index is not especially egregious in comparison to some other
havens, but that's not quite the point in this particular case. From our knowledge of what has
been going on, Cyprus's top offering has been to peddle non-compliance with
its own laws (for an example, see
here, at about 10.00-11.00 minutes in.) Officer on our Financial Secrecy Index itself:
"The index indicators through which measurement occurs are incomplete because they concentrate on the formal legal framework rather then the actual practice of lawyers, accountants and others which deviate from the legal norm established.
. . .
The usual vested interests from the President to the financial services industry have been repeating the mantra that 'there is no dirty money in Cyprus' and deflecting attention from implementation issues to the comprehensive legal framework in place - this is the same issue. Small island jurisdictions obscure from view the informal practices which circumvent the law.
. . .
This is the competitive advantage they then use to attract foreign capital to Cyprus."
(We don't disagree with this criticism of our index, other than to say we consider that deviation from the rules that we measure, is exceedingly hard to measure. We would argue that our index is made up of two components: a secrecy score, and a weighting for size, and deliberate non-compliance ends up being captured, indirectly and very roughly, in the scale weighting, which reflects the size of flows that are attracted by the non-compliance.)
In summary, though, when dirty money comes in, Cyprus' regulators and forces of
law and order have deliberately turned their face away. That is what
happens when you allow criminal financial interests to 'capture' your state. And international initiatives have not helped much, it seems: like so much that happens in offshore, it's easy to get good marks. Look beneath the hood, though, and a very different reality appears.
A new
report in the EU Observer, focusing on the EU money laundering body Moneyval, is worth quoting at some length:
"Moneyval in 2005 noted that Cyprus also hosts 14,000 offshore firms, 12,000 of which have no physical presence on the island. . . . It [Moneyval] operates by sending a questionnaire to the Cypriot government, which evaluates itself on compliance with international anti-money laundering standards.
It then sends six or so experts who spend three to eight days talking to people in Cypriot government institutions, such as the central bank, Cysec (its main financial regulator) and Mokas (the Cypriot attorney general's anti-money laundering division).
Its last report, in 2011, was described by an independent expert, Tommy Helsby, from the US-based audit firm Kroll, as full of "glowing words."
That sounds good. But what did they actually find?
"Despite the size of Cyprus' financial sector, it said that since 2005 authorities convicted just two people and issued nine orders to freeze accounts in cases focused on money laundering. It noted that "sanctions imposed in practice have been mainly in the form of warning letters." It also said Cyprus lacks the IT and human resources to implement laws."
This EU Observer article is worth reading in full: it's a shocker. Just for instance, in light of the Magnitsky case:
The plot involved the theft of three Russian firms, which were owned by two Cypriot companies, which in turn belonged to a UK-based investment firm called Hermitage Capital.
The directors of the Cypriot firms in June 2008 sent a complaint and two affidavits, seen by EUobserver, to the Cypriot authorities asking for help. The authorities never replied.
When EUobserver phoned the Cypriot attorney general in January to ask why, he said he is too busy to explain. . . . the Cypriot attorney general did not open a money laundering case until six months after he got the information and now appears keen for it go away."
Officer and Taki
continue:
"Small,
close knit societies like Cyprus thrive on a lack of transparency and
inadequate regulatory regimes in dealing with their own population. This
is the competitive advantage they then use to attract foreign capital."
Quite so. And there's another hard piece of evidence of state capture, which will probably surprise few Cypriots. From Greece's
Ekathimerini:
"According to the revelations, Bank of Cyprus, Cyprus Popular Bank (Laiki) and Hellenic Bank -- which were earlier this week acquired by Greece's Piraeus Bank -- has forgiven companies, MPs and local authority officials millions of euros in loans over the past five years."
That would constitute outright bribery, as a direct route to state capture.
This is exactly, exactly, the
sort of thing that
Treasure Islands, and our forthcoming paper,
describe. The trouble that Cyprus now faces is that there is no plan B
now. Other sectors have withered, skills have been lost, none of the
polliticians know what to do, the rest of economy has been hollowed out,
and even the banking sector is unable to function, since it was only
ever a business in pursuit of those easy, secrecy-suffused rents,
cosying up to Russians, Ukraininans and others. Cyprus turned itself
into
into a dodgy wealth management economy, and many of those skills aren’t transferable to other sectors.
As alternatives wither, political capture deepens, in a self-reinforcing dynamic.
And now, the consequences.
One final note. The countries pointing the finger at Cyprus are vast, unprincipled hypocrites. The UK, Germany, the United States, and many others are all tax havens in their own right. This is true, and raising this issue is our bread and butter. But this does not in any way change the arguments about Cyprus.
