Cyprus-Forum.com

[Jerry]

An interesting and thought provoking letter, will Cyprus go the same way as Iceland? Most importantly, how would an economic crisis on the island affect the Cyprus Problem.

Sir,
Three years ago, courtesy of your columns, I suggested that the worldwide property bubble would burst and that Cyprus should devalue by 30% before joining the euro to minimise the eventual property collapse which might otherwise crash the local banks.

When property prices advance by more than population growth and inflation, as in Cyprus, it creates bubbles of inflated value and bubbles always collapse. In the case of property the collapse is usually back to the fundamental value line which is inflation plus population growth since the last collapse bottomed out.

Only Romania and Lesotho worldwide have property bubbles on the same irresponsible scale as Cyprus. The greater the bubble the greater the inevitable collapse. This has been the case all over the world since modern economic records began in the mid 1850s.

Anyone who tells you – usually estate agents – that house prices will always rise because land isn’t being made anymore hasn’t studied the records. Bankers and property developers seem to have been seduced by this myth. Worldwide bankers have bet their banks on a property myth.

Three years ago, my analysis was somewhat premature but in those days I did not believe that bonus-chasing bankers, after the collapse of Barings, would ever again be allowed by their superiors to bet the bank. I was wrong.

Already three years ago the irrational exuberance of their lending had already gone too far and I expected it to be reined in. However they continued to lend, making the property bubble worse leading to the world’s worst financial crisis since 1929.

The world’s 100 leading financial institutions, all with higher credit ratings than Cyprus banks, had collectively $2.1 trillion US of tier one capital and this has now been lost by excessive exuberance in financing inter alia property bubbles.

All are now technically in need of capital restructuring – in other words bust and being rescued by nationalisation or merger. If the Finance Minister is to be believed, Cyprus bankers must be the most talented in the world in avoiding the multiple errors of their overseas contemporaries.

The people’s savings are safe but not the banker’s jobs: a recent Sunday Mail feature implicitly asked is Cyprus are banks safe or going the same way as their European and US counterparts. I would like to answer that by comparing Cyprus with Iceland, where the banks have already collapsed.

There are many similarities between the two countries and their banks. At the outset I should add that following the recent European summit, local banks will not be allowed to go under so people’s savings are safe. However it’s unlikely any local bank will survive the property price bubble bursting in their present format.

In Iceland, when cod stocks fell they declined to devalue the Icelandic Krona and seeking a new source of revenue, they went fishing for bank deposits instead. The decision not to devalue left the island terminally uncompetitive. These deposits they lent locally creating a property bubble.

They were also used to pay high prices for overseas assets. The property bubble, as always, happens with property bubbles, inevitably burst. As soon as prices started to fall, foreigners withdrew their deposits knowing the banks were overlent to property and property developers. This was before the realisation that the banks had also lent enormous sums to oligarchs to enable them to buy overseas assets which were worth 50% less than the loans taken out to buy them.

The banks that had attracted the deposits went bust and the country is now bankrupt and seeking a rescue. Iceland must surely now regret its decision not to join the European Union which would have been forced by treaty to rescue it.

But the Iceland story gets funnier by the day, except for those – including many charities – who have lost their savings. It has a population of 315,000, less than half of the Cyprus Republic – a GDP of $6.5 billion, representing per capita income of US$20,600. Its collapsing banks hold $76 billion of deposits which the government has guaranteed. That means every man, woman and child is guaranteeing $241,000 of deposits equivalent to 12 years total income. Who is kidding who?

Iceland is not alone. Neither Ireland nor Greece, who have similarly offered to guarantee their bank deposits, would be able to honour their promise. If it came to the crunch the response would be, ‘Sorry can’t pay; won’t pay.’

The guarantees would be worthless, which is why Europe and the USA are now copying the UK Darling plan of partial nationalisation in the event of a banking crisis.

Cyprus will inevitably do likewise with the support if necessary of the European Central Bank so people need not fear for their deposits, only their bank shares and dividends if they have been so foolish as to invest in bank shares during a global property bubble.

Cyprus, when tourism started to fall, fished for roubles!

When Cyprus became the most expensive tourist destination in the Mediterranean, it was generally assumed that the government would address the issue by a 30% devaluation. But the rich institutions and the local oligarchs, exactly as in Iceland, into whose few hands wealth is concentrated didn’t want to see their pounds devalued. So it didn’t happen. Tourism accounting for 77.6% GDP – contrary to popular myth Agriculture is only 3.2% - would have to be allowed to uncompetively struggle. The rich would do well out of changing their overvalued currency into Euros but at the price of rendering the island terminally uncompetitive and leaving the general public in due course to pay the price of their greed.
To replace the country’s falling tourist revenues, they went fishing for bank deposits and further developed the revenue stream of building houses and selling them off to foreigners but as you can only sell land once it is hardly a basis for a sustainable economy. What do you do when all the land is sold? To fund this massive building programme the banks sought overseas funds and raised them on the same scale as Iceland.

With a GDP of $18 billion, Cyprus has bank deposits of €56 billion – coincidentally the same as Iceland. Almost 30% of these funds are foreign funds which could walk to safer havens elsewhere as indeed could local funds. If the funds walk then like their Iceland and Irish counterparts all the local banks are in need of a capital reconstruction – i.e. bust.

Cyprus shares with Lesotho and Romania the distinction of having the most overpriced housing in the world relative to economic fundamentals (IMF Formula)
The Cyprus banks with little industry to invest in lent the money predominantly on property, funding a property bonanza. Result: Cyprus now shares with Lesotho and Romania, the dubious distinction of having the most overvalued property prices in the world – overvalued by 75% relative to economic fundamentals (IMF formula).

The 75% needs to be treated with caution for if the local unrecorded cash economy adds a hidden 30% to GDP prices are really only overvalued by over 50%. But even if the fall is only 30%, the Cyprus banks are finished in their present format by a combination of bad debts and fleeing foreign capital.

If property prices fall only 30% the local banks are finished in their present format. For the majority of home owners, a 50% fall would mean that their property is still worth what they paid for it plus inflation. For many buying in the last five years the situation is not so good: for the most part their properties will not be worth what they paid for them.

Not surprisingly, there are now relatively more empty and half-completed properties here than in downtown Miami, which has already seen a 60% fall in prices – but then Miami on the same formula used to be 60% overpriced relative to economic fundamentals. All over the world house prices are falling back to their fundamental levels. The boom so foolishly created by bonus chasing bankers with too much money to lend is over. The idea that Cyprus property prices are somehow immune to global trends is wishful thinking.

Cyprus Banks have poorer credit ratings than those that have already failed. The Cyprus government claims all local banks are robust with sound credit ratings – we’ve heard that before as it is exactly what Ireland and Iceland’s Finance Ministers said before their banks collapsed. As a matter of record all the banks in the top 100 internationally that have collapsed had higher credit ratings than any Cyprus bank. Mind you the credit rating agencies are themselves damaged goods following the world banking debacle and one must question whether any bank rating is worth the paper it is written on.

Given the excesses of the property boom bubble, can any bank anywhere survive a housing price collapse? In Australia, where the IMF says property is only likely to fall by its 24% overvaluation, the banks have had to be guaranteed by the government even before the fall gathers pace to stop foreign deposits fleeing.

With banks everywhere holding only between 3% and 8% tier one capital, it’s a no brainer to see they will not be able to cope with the current scale of worldwide property falls without government intervention.

Can a miracle prevent a local property collapse? If foreigners could be persuaded to buy up all the properties at current prices, thus effectively expanding the population, yes. But why should they when they can buy the equivalent in France or elsewhere in the Mediterranean for a third or half the price?

It is often said that foreigners leave their brains behind when they buy properties overseas in places with no guarantee of title and this may be true. But I don’t think there are enough foreign fools around to save the Cyprus situation. At risk of being premature again, expect Cyprus to be the next but one Iceland with collapsing banks, rescued by the government and an imploding economy as property prices fall to their fundamental value. Would like to be wrong, often am, hope I am, but somehow doubt it.

F Hunter
Limassol and London.
F Hunter Housing Economics



Copyright © Cyprus Mail 2008

[Sotos]

Some of this people have been predicted bad things for Cyprus for years. What happened? All those bad things happened elsewhere and they didn't happen to Cyprus. Maybe those people are mad because the kept their money elsewhere and not in Cyprus and now the lost them

[Oracle]

The only thing Iceland and Cyprus have in common is that they are both islands. The similarity stops there.

Cyprus has been at the heart of trade and civilisation for thousands of years longer than Iceland. We are practiced Merchants and survivors; with an enviable climate and lifestyle, and many other commodities.

[Jerry]

:roll: Some of this people have been predicted bad things for Cyprus for years. What happened? All those bad things happened elsewhere and they didn't happen to Cyprus. Maybe those people are mad because the kept their money elsewhere and not in Cyprus and now the lost them

Yes, right, like the people who, during the 1960s, predicted Turkish intervention - they got it wrong too.

We are entering a world recession but Cyprus, the centre of the universe, is not going to be affected. I admire your optimism Sotos!

[CopperLine]

Sotos, Oracle,
Where do you think citizens of Cyprus have deposited their savings ? Under their beds ? Where do you think the businesses of Cyprus invest or receive share income from ? Their back gardens ? In case you hadn't noticed Cyprus is a Euro member so where do you think exchange rate policy is set ? Downtown Nicosia. Who are these great Cypriot commercial traders doing trade with ? Their next door neighbours ?

Those of us who live in the twenty-first century, let alone the twentieth century, know that your picture of the economy is barely pre-nineteenth century.

[DT.]

Sotos, Oracle,
Where do you think citizens of Cyprus have deposited their savings ? Under their beds ? Where do you think the businesses of Cyprus invest or receive share income from ? Their back gardens ? In case you hadn't noticed Cyprus is a Euro member so where do you think exchange rate policy is set ? Downtown Nicosia. Who are these great Cypriot commercial traders doing trade with ? Their next door neighbours ?

Those of us who live in the twenty-first century, let alone the twentieth century, know that your picture of the economy is barely pre-nineteenth century.

whats your point?

[Sotos]

We knew about the invasion from years earlier. You didn't need to be an Oracle to know that Turks had plans to take at least half of Cyprus because they were never shy with advertising their partition plan! But what this has to do with the topic If the whole world enters recession we will enter too. But Cyprus doesn't have any more problem than UK or anybody else. It has much less problem!!

[Oracle]

Oh hello CopperLine ....

What is wrong with under the mattress? Suited my granny! Old Cypriot / Greek habit!

You Turks should try it! ... Erm do you have any money?

[Sotos]

Oh hello CopperLine ....

What is wrong with under the mattress? Suited my granny! Old Cypriot / Greek habit!

You Turks should try it! ... Erm do you have any money?

Do they have mattresses?

[kurupetos]

Cyprus is a very conservative economy (unlike most western industrialist economies) and therefore I think that it will be affected much less.