Former Cypriot Central Bank Governor Athanasios Orphanides, spoke at Hopkins on April 19 about the Euro Area crisis. Orphanides presided as Governor of the Central Bank of Cyprus from May 2007 to May 2012 and was a member of the Governing Council of the European Central Bank between Jan. 2008 and May 2012. Orphanides also previously taught graduate and undergraduate economics classes at Hopkins, while serving as a Senior Adviser at the Board of Governors of the Federal Reserve.
Orphanides was at the helm of the Central Bank in the months leading up to the Euro Crisis. Two months after Cyprus joined the Euro Area, in Jan. of 2008, a communist government was elected. Shortly thereafter Orhpanides said that he was escorted out of office.
“You need to have a strong character if you are going to work in a Central Bank under a communist government,” Orphanides said.
Orphanides began by providing background on how the Eurozone crisis developed, citing a lack of economic governance and political inefficiency as two of the major causes. The financial crisis began in August of 2007 when a disturbance in the European money markets triggered a bank run on the Northern Rock bank in the United Kingdom. In the ensuing months, a series of events, including the September 2008 collapse of the investment bank Lehman Brothers sparked a global banking crisis and recession that ultimately brought about the Euro crisis.
“The banking crisis and recession that was happening in 2009 morphed into the sovereign crisis in the Euro Area, but it then became just a problem within the Euro Area, for reasons specific to how the Euro Area operates,” Orphanides said.
After mentioning some of the most troubled Eurozone countries, including Spain, Greece, Ireland, Portugal, Italy, Slovenia and Cyprus, he went on to discuss how the problems escalated. Orphanides expressed his disapproval for the Eurogroup, which is made up of the finance ministers of the member states of the European Union that have adopted the euro.
“Greece is just 2% of Euro Area GDP. That debt problem would have been a tiny fraction of the problem, and had the Eurogroup sat down and discussed a way to solve that, we could have avoided the whole crisis. They face no legal repercussions, and tend to destroy economies,” Orphanides said.
The European crisis revealed significant gaps in monitoring and enforcement of certain regulations and an insufficient respect for the rules of the Euro Area governments. Europe is not a federal state, meaning that there is no central government with the power to enforce EU regulations. Therefore, solutions on key Eurozone issues require unanimous agreements by the governments of the member states. However, each government must then face their own electorate, requiring them to defend policies that are often unpopular domestically.
Orphanides then delved into a more quantitative approach, discussing the effect of the crisis on GDP per capita, unemployment and the sovereign bond markets.
He used a chart to display GDP per capita in both in the US and Europe, which showed a similar trend for the first 12 years of the Euro, but a large discrepancy between the two areas over the last two years. While US GDP per capita has been steadily increasing, Orphanides projected a widening discrepancy between the two areas in the coming years. He also expected a similar trend in unemployment rates, which have been steadily increasing in Europe.
One exception, according to Orphanides, is the German economy. Prior to the crisis, Germany experienced one of the highest unemployment rates in Europe, in 2005 and 2006. Since then, unemployment has fallen in Germany, while skyrocketing in other countries.
“It’s almost as if the policy has been designed to help the German economy. Youth unemployment (25 and under) has been the cause of so much turmoil in Europe, yet Germany hasn’t experienced much of this,” Orphanides said.
His discussion also covered the disintegration of sovereign bond markets in Europe, a major problem during the crisis.
“France, Germany, Italy and Spain account for 80% of European GDP, and you can see the problems that exist with the sovereign bond markets by looking at two year government bond yields. You have one currency, but it is much harder for Italy and Spain to finance themselves because of bond prices. These differences translate into financing households and business,” Orphanides said.
He had to watch the crisis in Cyprus play out from the sidelines, but during his speech he offered two different approaches for how to solve the crisis in Europe. The first was a “cooperative” approach, which would strengthen EU governance so that all member states would be bound to respect the rules and show solidarity when needed. However, the required strengthening would imply certain constraints, such as restricting a government’s ability to increase spending, potentially limiting sovereignty. However, Orphanides did acknowledge the potential moral hazard problem inherent in guaranteeing aid to countries undergoing economic turmoil.
The second, “non-cooperative” approach would make temporary assistance extremely costly to the government requesting help. While this approach would eliminate the moral hazard problem, it would also raise the cost of financing weak governments that have high debts or deficits. Orphanides was less enthusiastic about the non-cooperative approach, arguing it would show poor solidarity in a system that was built to unify the different countries of Europe.
“In October 2010, the governments of Germany and France moved the Euro Area to the non-cooperative approach. The idea was to raise costs on weak governments. Despite concerns raised by the European Central Bank, other governments went along,” Orphanides said.
He also discussed the proper role of the European Central Bank (ECB), and its inability to solve the Eurocrisis, which Orphanides described as a fundamentally “political” problem. The ECB has the capacity to buy the debt of member state governments, potentially averting fiscal collapse temporarily. However, this would ultimately come at cost to Euro Area as a whole.
One major policy enacted by the ECB that induced postponement was the use of outright monetary transactions (OMT), a program that alludes to the ECB purchases in secondary, sovereign bond markets of bonds issued by Eurozone member-states.
“Words continue to suggest a strong desire for a solution, yet actions suggest a continued dominance by local politics which ultimately leads to postponement,” Orphanides said.
The tail end of the lecture focused on the German elections in Sept. 2013, which have been responsible for delaying many of the decisions about how to solve the European crisis. Many policy options that might benefit the EU are unpopular in Germany, as the Germans have already effectively financed previous Eurozone bailouts. Further action might therefore jeopardize German Chancellor Angela Merkel’s re-election prospects.
The delay in finalizing a program for Cyprus pushed the problem into the German election cycle, Orphanides noted. Cyprus had a stable currency prior to its entry to the European Union, however many of its banks were holding Greek sovereign debt, and this large exposure to Greece eventually brought down the Cypriot Banking System.
In a confidential study by financial consulting firm Alvarez and Marsal, which was leaked in early April, it was reported that the Central Bank of Cyprus formally requested information regarding Bank of Cyprus’s holdings of Greek government bonds in March 2012. Nonetheless, no written response was received from the BOC. The CBC did not follow up on this on a timely basis; the reason for which is unclear.
According to Professor of Applied Economics Steve Hanke, this sequence indicates that Orphanides avoided some important aspects of the Cypriot Crisis in his speech.
“It’s always interesting to hear central bankers deny wrongdoing. Whether it’s a bankruptcy, an economic slump, or a financial crisis, it’s always ‘the other guy’s’ fault. In the case of Cyprus, many of us knew, as early as Fall 2011, that that several of Cyprus’ largest banks had gone bust. They went bust on Orpanides’ watch. It would have been interesting to hear more about how the Central Bank of Cyprus kept that dirty little secret under wraps for over a year,” Hanke said.
Recently, Hanke published research indicating that Cypriot banks deposits were heavily composed of money from Russian depositors. This parallels criticism that Merkel’s government faced during the debate over the Cyprus bailout. Some in the German press argued that helping Cyprus would be equivalent to “giving away German taxpayer money to Russian oligarchs who have deposits in Cypriot banks.”
“How could elections in any single state matter for a program in another area of Europe? That is a major problem for why the crisis is continuing,” Orphanides said.
Cyprus has recently scheduled a vote on the final version of the bailout developed by the European Union and the International Monetary Fund. This 10 billion euro aid deal would impose a tax on all deposits in Cypriot banks over the insurance threshold of 100,000 euro. This would force massive losses on big depositors in the island’s two major commercial banks, and would trigger economic turmoil likely to put the country deeper into recession.
Cyprus comprises only 0.2 percent of the GDP of the Euro Area, but this microcosm represents many of the problems that Europe as a whole faces. As Orphanides expressed, people need to address these problems as political, because the economic woes are the result of a lack of strong governance.
