We know it was bad Greek debt that brought down Cyprus’s banks. But it turns out the banks bought much of that debt after Greece’s problems were revealed. So the big question is, what made all these Cypriot bankers run toward the fire in Athens instead of away from it, like everyone else?
For example, Bank of Cyprus, the country’s largest financial institution, had sold off most of its Greek debt by the end of 2009. Then, it performed a sudden about-face, buying €2.4 billion in bonds from the Cypriots’ Hellenic cousins over the next six months—even as European regulators launched a bailout of Greece and contemplated haircuts to its creditors.
The most likely reason for the speculation was that bank execs believed European governments would bail out Greece without asking its creditors to take a hit. If so, they were going pretty much against prevailing opinion at the time, but European regulators testing the Cypriot financial system in 2010 gave them pass, failing to include the possibility that banks could lose money on Greek debt in their model. (Good job, folks).
There are also more unsavory explanations, involving double-dealing and destroyed communications.
At Bank of Cyprus, ongoing investigations into the two senior executives responsible for the trades found evidence that the two used special software to erase records and e-mails about the Greek speculation. Meanwhile, the other bank at the center of the crisis, Bank Laiki, was acquired by Greek owners in 2007. That country’s parliament is investigating “serious conflicts of interest” between the bank and companies it loaned money to there.
When that haircut came due in 2011, the Bank of Cyprus took losses of €1.2 billion, leading it toward insolvency and last week’s financial rescue that included big levies on depositors. The same thing happened at Bank Laiki, which added billions in Greek debt to its balance sheet even as other major banks were reducing their exposure. The two banks combined lost €4.5 billion on their Greek investments, nearly a third of the total cost of the rescue.