The following article was published on July 26, 2013 (exactly 9 months ago). Unfortunately, it is still very relevant. As discussions about the split of the bank gain traction the focus should be on how to fund this bank (not on what it will be called!)….

A few years back a bunch of teenagers in the United States devised a very smart yet deadly game to show who amongst them was the worst coward, a chicken as they would call him. Unsurprisingly they called it a game of chicken. There are a few versions of the game, one of them went something like this. The game starts with two drivers in cars with no brakes, driving at high speeds, both headed for a single lane bridge from opposite directions. As the drivers approach the bridge they both know that if neither of them swerves before long they will have a head-on collision with a potentially fatal outcome. However, if the other driver swerves first, not only would both drivers make it out alive from the game but the driver that swerved first will be dubbed a coward. So the best outcome for either driver is for the other driver to swerve first. If however, the other driver is not going to swerve then it is better to swerve and be branded a coward but make it out alive than not swerving also and have the collision. Diagrammatically, the payoffs of this game look something like this:

This creates an interesting set of incentives. As both drivers are driving towards the bridge both want to figure out a way to convince the other that they do not intend to swerve, that they do not intend to back down, as they say to not blink no matter what. If they are successful in doing so then the other driver is better to swerve than stay on course. You might wonder how could one driver convince the other that he is crazy enough to not swerve whatever happens. Well one way of doing that would be if he could throw away the steering wheel just as the game started. In such a case, the driver who threw away the steering wheel has limited the choices of his future self but by doing so has effectively won the game as the other driver knows that no matter what the other driver cannot swerve and hence the only rational thing to do from the point of view of that driver is to swerve.

You might think what do teenagers and chickens have to do with our little island, especially as the Cyprus summer is reaching its peak and increasingly relaxation at the beach is replacing worrying at the office? In fact, they have more to teach us than you think. In fact, a variation of this very game is being played right before our eyes and its outcome will affect most of our lives in the years to come…. And one of the drivers has just blinked!

So let’s take a closer look at this very particular and very important game and let’s meet our two drivers…. The first car is driven by an Italian called Mario, a very smart guy as everyone acknowledges not one to be easily intimidated. The second car is driven by not one but a bunch of Cypriots (oh and a saint, but we will come to him later) who do not seem to know much about driving or that they are in this game to begin with….

For the Cypriots, swerving in this game means doing exactly what the Troika Memorandum dictates, in other words, proceeding with the tough structural changes, the privatizations, the fiscal tightening, all these things that are anathema to politicians because they make their voters very unhappy and hence unlikely to vote for them again. So if this is swerving what happens if the Cypriots do not swerve?

Well, this depends on what the smart Italian does who, in fact, is driving a much bigger, German-made car, with a big bazooka on it called ESM. If this Italian does not swerve then the two cars will collide which will destroy the Cypriots car. You might think that in the collision nothing will happen to the Italian’s car but that is not entirely true for this particular Italian has a weakness, he is in love with a small porcelain dog, let’s call him Euro, who sits on his car’s dashboard. Euro is a strange dog. As long as he is inside the Italian’s car it seems nothing can get to him, he is there to stay as the Italian would say. However, some fear (the Italian included) that this is partly an illusion and if somehow this big massive car was rattled a bit (even in a small collision with a bunch of Cypriots) maybe Euro would break and once he broke even a little bit who knows what would follow. Maybe other bigger cars, say like the one the Spanish are driving, would start getting their own ideas about how strong this Euro dog is and go after the Italian’s car as well.

So the Cypriots are starting to get ideas. They too have a dog on their dashboard, let’s call him Euro Minus. Euro Minus will definitely shatter if a collision were to occur and this will be very bad for the Cypriots (and no, replacing him with that old rag doll called the Pound will not make things better) but they are hoping that the Italian might help them a bit given that he doesn’t want a collision either. How can the Italian help them? Well, the Cypriots have also a serious problem with the engine of their car, called BoC. Unless the engine is fixed the car will crash anyway. Unfortunately the Cypriots cannot fix BoC on their own, they need the help of the Italian, who being Italian, is also an expert on cars. So if the Italian can fix the engine this will allow the Cypriots to live and fight another day.

So on one hand, we have the Italian who probably wants to avoid the collision but in order to do so he must help the Cypriots with their engine and on the other hand we have a bunch of Cypriots who are in badly need of a fix-up but at the same time must promise this Italian that if their engine is fixed they will promptly swerve (i.e. implement all that is required of them by the troika). And this is a problem. Because the Italian fears that if he is to help with the engine (this is like swerving for the Italian) the Cypriots might renege on their promise and not swerve after that and continue doing all those bad things they were doing in the past. So from the Italian’s point of view he doesn’t want to blink, he doesn’t want to swerve too early as this is his only leverage on the Cypriots. If he can convince the Cypriots that he is willing to risk a collision unless the Cypriots do as they are told then the Cypriots will have no alternative than to swerve first (i.e. implement all these painful measures) in the hope that the Italian would then fix their engine.

At some point the Cypriots were worried they were running out of time and sent a letter to this Italian (only they made the mistake of sending it to a Portuguese and leaked it to the media as well) to ask for help but the Italian called them in his office and explained to them that they must do more (i.e. swerve more) so that he knows for sure that the Cypriots can be trusted before he can help by swerving a bit as well (i.e. by fixing this engine called BoC).

So seven days ago this was the setting. The Cypriots, with their broken engine, were driving towards collision while trying to convince the Italian that they have indeed started swerving and that he now should help them by fixing their engine.

Well, a few days ago the Italian blinked.

How did he do that? Through his messengers, also known as Troika, he told the Cypriots that he would be willing to fix their engine by splitting it into two, leave one engine with all the good parts (the traditional engine) which would power the car from now on, and take the bad parts in another engine which will be stored in the trunk of the car to be fixed later on, again with the help of the Italian. Many people in Cyprus thought what’s so great about splitting an engine in two, how does that fix it? Well to understand this you must know a bit about banking, I mean engine, mechanics. This engine was running on a special fuel called ELA. This ELA brand is very hard to find, in fact it is only sold by the Italian and it is so expensive that you never actually buy it, the Italian extends it to you for as long as he likes. So when the Italian said, through his messengers, he would be ok to split the engine what he was really saying is that he would be willing to take a lot of his fuel, this ELA, into the bad engine which would help the traditional engine quite a bit. The second thing he was saying is that he would not be so strict with the requirements of this bad engine (what he calls the Tier 1 ratio) which implied he would be happy to take very little capital in this bad engine which would leave most of the capital in the traditional engine.

Great news wouldn’t you say? The Italian seems to have swerved, the Cypriots are close to having their engine fixed and they have swerved also so no collision is imminent. Time to let out a sigh of relief….

But wait! not so fast! A towering figure, dressed in black and gold, speaking the words of God, a saint for sure, takes the microphone and addresses his flock (or more appropriately, the sheep). Stop this madness, he says. This is a ploy, a way to steal our land, he says. And he calls upon the people to rise to stop this unholy act. And there is more. The President’s co-pilot comes out in a press conference and joins the saint and so do almost all other men of importance in this tiny island. It is a rare thing all these men who usually are at each other’s throats are joining forces to fight against this evil plan. God is on their side for sure….

Word of this reaches the office of the Italian. His messengers explain to him that even though he offered to fix the Cypriots engine, apparently noone is happy with him, not the politicians, not the saint, not the people, not even the ‘developers’ of this engine who would benefit the most from this…. He listens to the news, calmly it seems, slides open his iPhone, turns on Snapchat and sends the following SMS to the President…”WTF???” …

a few minutes later, the President replies back…”Welcome to Cyprus!”

The title of this article could just as easily apply to the depressing fact that a year after the Eurogroup events of March 2013 no legal entity or natural person has been brought to justice to answer for the myriad criminal offences that lead this country to near economic collapse a year ago. It is frustrating and disappointing that the administration has fallen short of its promise to bring the culprits of this disaster to answer for their negligence and crimes.

But I will not dwell more on this subject, maybe some other time. As this has become again a time of crisis and unlike the months after March 2013 we do not feel the urgency to react as we have been numbed by our success. For it is true that within 12 months the Cyprus economy has responded better than the most optimists predicted (me being one of them). We have managed to walk away from the brink and have regained our confidence to hope that the worse is over and 2014 will be the last year of contraction. And while this is true, what is equally true is that there are still problems in the Cyprus economy, problems that if we do not address might destabilise the fragile recovery we have been experiencing. And the biggest of all is just three letters, NPLs. Non performing loans are a problem for almost all banking institutions but while Hellenic has its shiny white knight ready to step in, and the CoOps still have another EUR 500mm from which to draw from if need be, poor Bank of Cyprus finds itself (again) without much help and is heading in dangerous waters while some of its Board Members are more worried how to undermine their CEO rather than how to save their ship.

Unfortunately for BoC, its current loan portfolio has hidden losses that have not been provisioned for so in other words, once these losses are realised the reduction in Tier 1 ratio will be significant enough for the bank to need more capital. To put it as simply as possible, there is a hole in the bank’s books and someone has to pay for it.

This should not be surprising and it has nothing to do with how well the economy has responded in the last twelve months. Rather this is the cumulative result of many years of bad lending practices coupled by the fact that most lending was done on an asset basis (i.e. with a focus on having adequate collateral to support the loan rather looking at the repayment capability of the borrower) and in Cyprus’ case the overall asset basis has lost close to 50% of its underlying value in the last six years. This simple fact goes a long way to explain why efforts at restructuring loans will only have limited success because a restructuring, like any therapy, only works when the underlying has enough viable elements to be able to come back to life given the time. Unfortunately, as Mr. Hamilton is finding out, this is not the case with many of the NPLs.

Which brings us to a fundamental question: who is to pay for this hole? There are 5 (unwilling) contenders for this role: the borrowers themselves, the European Central Bank, the BoC depositors, the BoC shareholders and last (but alas not least) the taxpayers.

Let’s bring the spotlight to each one in turn. First, the borrowers. They are the natural target as they are after all the ones who borrowed the money (usually with a little encouragement from their over-eager bankers but this is a story for another article). We can deal with them here easily enough because I think everyone agrees that no matter who else will also pay every effort should be made to maximise the amount to be retrieved from the borrowers. That being said though I believe all but the most idealistic realise that this amount will not be enough to cover the hole and hence someone else must contribute the rest.

From our perspective, the best one to do that would be the European Central Bank. Would this be possible? Well, about 9 months ago in an earlier article of mine I had argued that we were in a game of chicken with the ECB and at that moment the ECB had blinked. Unfortunately, our leadership (both secular and religious) once more let us down having failed to realise the golden opportunity which presented at the time to create this bad bank with funding provided by converting the ELA into long term bonds. To be fair, it was not a straightforward task and the ECB never clearly signalled that it was willing to bring the ELA to the bad bank but on the other hand, we never really tried to make this into a reality.

Today this is much harder to achieve, ironically, because of our success. For our better than expected performance has created a buffer of around EUR 1.5bn in the programme which is available to be used. In other words, there is already a plan B in place which explains why international investors have not stopped buying the Cyprus government debt keeping its yields at record lows. All this plan B needs to be put in motion is a decision by the Eurogroup to allow this money to be used to re-capitalise the Bank of Cyprus. However, were this to become a reality this would be bad news for the existing shareholders (former depositors) who will be diluted and once more will see the value of their investment significantly decrease. In such a scenario, given that any money given by the troika programme is ultimately paid by the taxpayer both the taxpayer and the current BoC shareholders would share the cost. The only upshot in this case is that it is extremely unlikely that any (new) harm will be done to the BoC depositors both because there will be no need for a bail-in but also because it is my conviction that a bail-in is first and foremost, a political decision not a financial one and at this moment in time the Eurogroup cannot afford a second bail-in.

Is there another way? I believe there is. The idea of a bad bank makes sense in many levels and we must become more aggressive in pursuing it. And even though it has taken our politicians almost nine months they finally get it which makes it more likely for the idea to become a reality. The crux of the matter as most recently the BoC CEO explained is the financing of the bank. Nine months ago, when we could credibly argue that the whole country was on the verge of economic collapse we could have maybe gotten the ECB to foot the bill. Now that we are healthier we are also weaker in our negotiations with the ECB; as I said before, our success has become our weakness. So if the ECB will not finance the bad bank the next best thing is, unfortunately, the taxpayer. The government can guarantee long term bonds issued by the bad bank which effectively would mean that the losses the bad bank would make in the ensuing years as the NPLs are slowly unwound would be absorbed by the taxpayer.

Beyond that the creation of the bad bank has a number of benefits, mainly for the good bank left behind. Assuming that the Bank of Cyprus would transfer the NPLs to the bad bank at their face value less all provisions made so far this would mean that the Bank of Cyprus will stop the bleeding and cauterise the wound so that it can immediately begin to heal. The new Bank of Cyprus will be healthy while the 18% held by the old Laiki will become instantly very attractive to a number of investors which in turn will spark a number of other positive developments. Having said that one should not think that this will solve all issues that the bank is facing. Because aside from the NPLs the Bank has a serious challenge in integrating the former Laiki bank, to reduce its cost base (yes, it has too many employees!), and become much better in servicing its clients who are waiting for weeks on end for the bank to respond to simple requests.

In all, looking back where we were in March 2013 and where we are now I think Cypriots should feel proud of what was accomplished in twelve months. Similarly, a lot of credit should be given to the Minister of Finance and his colleagues for they have managed to gain the respect of our international lenders but also, to implement a tough programme with great success. At the same time, there are other areas where we fell short. Namely, a complete failure to have those responsible answer for their actions and so far no real structural changes in the public sector. More pressing though at this time is to address the issue of the NPLs in the Bank of Cyprus and to come up with a solution fast. To fail that test would render a lot of what we have accomplished mute and would truly be a disservice to the collective effort and sacrifice of countless Cypriots who took a hit, fell down, dusted themselves off, looked up and kept going!

Disclaimer: This will not be a popular article.

In our round up of usual suspects as to who is to blame for our current economic predicament we have been all-encompassing in assigning blame including politicians, bankers and businessmen in this notorious line-up. We have been very strict with all of them, some more than others, even over-zealous one would say, and we have assigned blame not only for actions taken but also for actions not taken that should have been taken and even for not forcing others to take actions that should have been taken. In many cases, we have been right in our criticism for our economic failure has been so monumental that it takes a large number of people from various posts and for a length of time to push a whole country into an economic abyss.

What is lacking in our criticism, or better, one who has escaped our harsh words has been ourselves. And yes we are to blame, maybe not all of us, or maybe some of us more than others (and I am sure as you read this you are thinking you are under the blameless category). And not only are we to blame but our collective responsibility probably equates or surpasses the one we are assigning to the usual suspects. And our blame lies in many levels which I will now go into the unpopular task of analyzing.

Firstly, we are to blame because as a society we have not matured enough and have not been intelligent enough to produce a level of discourse in our politics that is characterized by thoughtful arguments, understanding that right choices are not always the popular ones and understanding that the world is not black and white and real-life solutions involve compromise and pragmatism. And as all this probably sounds too theoretical cue the real life examples: discussion on COLA (also known as ATA), discussion on privatizations (also known as how to keep the few enjoying the super privileges financed by the many), recent discussion on social pensions, on Cyprus Airways, on banking payroll cuts and so many others.

We like so much to blame politicians of incompetence or corruption that we forget a very fundamental truth which is that in a democracy the elected leadership is a reflection of the quality of the underlying populace. Politicians pander to their electorate not because they know no better but because they want to be re-elected. Hence, to change the quality of the leadership we must first see how to change the quality of the society that produces this leadership.

Secondly, we are to blame because we do not understand that to achieve extraordinary results in any leadership post whether that is the Central Bank, or the Electricity Authority, or CYTA, or the Cyprus Tourism Board, or the Cyprus Stock Exchange you need extraordinary people and to attract extraordinary people you have to compensate them accordingly. And compensation should be linked to performance to incentivize individuals to apply themselves and achieve over and above the expected. Example: we are in badly need of a world class stock market. In case you have not noticed… we do not have one. But let’s say that the current stock exchange leadership works extremely hard, takes risks, has vision and manages to achieve this in the next few years. Do you know what difference this will make to the whole economy? Huge! Do you know what difference this will make to the financial reward of these people, the leadership, that will be responsible for this stunning success? None! In other words, the people who will have a direct impact on the future growth or not of the stock exchange have absolutely nothing to gain from it (other than a pat on the back maybe) and everything to lose in case their efforts do not succeed (in which case they will be blamed for the failure). Do you want to take a wild guess as to whether we will see an extraordinary result in this area?

We fail to understand that extraordinary individuals can change the course of history (Karl Marx will probably come to mind to a left-wing friend of mine who reads my articles) and in the business world, if you want to attract those extraordinary individuals you need to compensate them in a way that their financial success mirrors the success of the organization they lead. In plain words, you have to be willing to pay them what most people will think is too much (the case of the current BoC CEO is an example of this). As a society we do not subscribe to this notion. Our notion of equality is a similar to the assessment system in the public service where everyone is graded “Excellent” negating the very notion that the excellent are the exceptional and hence the few. And while we are not willing to compensate the exceptional, we are surprised when we end up with mediocre people and mediocre results.  

And finally we are to blame because we are undeserving of the quality of life we have. A lot of people like to work for fewer hours, have fewer responsibilities, have job security and have little to no stress at work. The difference is that in other countries, these same people do not expect to have all these and be paid the salaries we pay here and have the lifestyle we have here. And this is probably our most serious offense. 

In the past, we liked to make fun of those Europeans whose life was all work and no play. And we felt that we have found the right balance in life between work and play. But what we did not understand, and hearing the banker’s union demands evidently we still don’t, is that our celebrated

lifestyle, the one that involves daily trips to the gym, coffee with friends every afternoon, dining out 2-3 times a week, weekends at the beach, a large house (or a large apartment), a fancy car, a fancy watch, fancy clothes and handbags and fancy trips (plus trips to watch our favourite football team playing at the Champions League) is undeserving. This is a lifestyle that is being paid for by other people’s money because when you are being paid more than what you produce someone has to pay the difference. Compounding the problem is the fact that we are not only consuming more than what we are producing but as we want to consume more than what we are being paid we have borrowed the difference (enabled by our over eager banks) and then claim this lifestyle as being our entitlement. And you might feel that at the individual level the numbers are small but once you add all of us and you multiply that by many months and many years you realize that for a long time we have been sawing away the legs of our Atlas and finally he has shrugged.

So yes, the usual suspects were to blame for our predicament but in order for them to have failed us they needed a very large number of willing executioners, a large number of people willing to turn a blind eye to mismanagement and corruption, a large number of people to be under-producing and over-consuming and a large number of people to choose to stay on the sidelines and not take a stand… and they found them in us. So yes we are to blame, we are to blame deeply. Have we at least learned our lesson? No reason to answer, this is a rhetorical question. Worse, some of us think it is irrelevant! Why? Well, haven’t you heard? The gas God’s arrival is imminent, and he is about to wipe out all our sins, no need to repent or change, no need to face ugly truths… like a spoiled brat we are about to be saved by our wealthy father! …and if you think that then we are in more trouble than I thought!

Disclaimer: this post is written by an optimistic person

Before reading this blog you should be made aware of two facts that decidedly changed my outlook on the brightness of our financial future. Firstly, I found a two euro coin on my way to work today which I have unashamedly appropriated and used to buy a small latte which in turn started my day on a bright and positive note. Secondly, my 6-year old son scored three goals in a game of football thus allowing me to hope that if all else fails I might have a budding Messi in my family tree who will earn enough money to ensure my old age.

So with my personal financial future ensured I am decidedly more sanguine when it comes to my country’s. My optimism is partly supported by facts (but only partly) and more so from anecdotal evidence which many times are more accurate than all the facts in the world (two examples of this come to mind… the first, from George Soros, who famously admitted that he used the onset of acute back pain as a signal that something was wrong in his portfolio while the second comes from the 1929 market crash when Joe Kennedy decided it was time to get out of the stock market not because of any statistics or indicators (i.e. facts) but because he saw that even his shoe-shining boy had started giving out market tips)

And so I invite you to look at the future with some optimism. Let’s back this claim a bit….

Exhibit A is the economy’s aggregate performance in 2013 measured by its GDP. Almost everyone is agreeing that we will end the year with a contraction of 7 to 7.5% which is markedly lower than the 8.7% the troika was predicting and much lower than the 12% Moody’s was predicting just two months ago in October (actually this says more about Moody’s than it does for Cyprus). It is also much lower than what most of us (and I include myself in this category) were predicting back in early April 2013 when we were still shell shocked from the Eurogroup events. In plain words, the economy, as a whole, has done much better than what we were expecting. Now, I expect some of you will respond and say, yes, but just wait and see what will happen in 2014 which is when we will see the real teeth of this recession. I worry about that as well. I worry that maybe 2013 was not as bad because a lot of the pain has been postponed or pushed to 2014. But when we think of that we should also ask ourselves if that is the case, why did we not predict it back in April or May? Are we a bit like the doomsayers that predict the end of the world on a specific date and when that date comes and goes instead of admitting they were wrong and shutting down shop they come up with all kinds of imaginative excuses why the actual end-of-the-world date was not the one they originally said but one that is sufficiently and conveniently far into the future to allow them to live and fight another day?

Correlated to the above is the government’s fiscal performance. Again, it is better than expected and I believe the reason is two-fold. One has to do with the fact that somehow collectively as a country we decided that even though many of us had every reason not to pay our taxes most of us choose to do so. The property tax is the best example. I was genuinely surprised on the high percentage of people that have paid this tax. But I believe it speaks to a broader point. That as a country we seem to understand (or at least we behave as if we do) that in order to get out of this mess we have to pull our collective weight and in many cases this means paying our taxes. The second reason is the performance of the government. I am always weary when someone sings the praises of a certain politician or government but I think most people acknowledge the really great work done by Mr. Charis Georgiades who has led the charge, gained the respect of our international lenders, the respect of the social servants who work for him and has brought results. By many accounts of people who are around him, he is methodical, efficient, patient and very importantly, understands that he does not know everything and listens. He also understands the tough times that lay ahead which is evident in the strict 2014 budget that he has put together. In some ways, the future of our country is in his hands and I for one I am glad of that.

Equally important to my optimism is the reaction of the people in the private sector and most importantly its leaders. Talking with businessmen from various industries it is truly heartening to see how people have dusted themselves up and have found new energy in trying to revitalise their companies. Many of them are turning their businesses towards exports or by opening up branches abroad. Others are changing their cost structure by relying more on part-time work and freelance work. Others are joining their distribution channels, sharing office space, finding new ways to do old things at half the cost, doing everything it takes to keep their companies alive. For sure not all of them will succeed and as such, unemployment will continue to increase in the months ahead. But we have to understand this is an attrition war and we are not going to go through it without casualties. Our economy is changing, structural inefficiencies are being corrected and this will not happen without pain.

Importantly, we are finally changing how we do business. Before March 2013 and after 2010 when things started to go south many of us instead of radically changing the way we work, we just slowed down our pace, cut some costs, conserved energy and basically adopted a wait and see approach in the hope that somehow things would get better in the near future. We went like this for a couple of years, depleting our cash reserves, hoping that the signing of a troika memorandum would be the end of our troubles. Well, March 15th 2013, shattered that hope. And for a few days, it shattered all hope. But at the same time, it liberated many of us to try different things, different business models, different markets. You see when you have nothing to lose, you also have everything to gain from trying something new. And in the months ahead another thing happened. We realised that this bleak, dark financial future we were predicting did not come to pass. People still managed to go out (for a drink instead of dinner), people still went on vacation (to the nearest beach instead to the nearest island), people still made ends meet (with more imagination and less bragging) and in all, people still managed to go on with their lives with fewer means but with dignity. Some have been hit much harder than others and for them the above will be hollow words. I am sorry for that; their only consolation comes from the strong wave of charitable work that is helping alleviate some of their pain and anxiety.

The suffering of these people is a very stark reminder that we still have a long way to go. And victory at the end of this road is not yet a given. 

As such there are still a great deal of things that worry me about the next 12 months. How will the banks start lending again, how will they deal with their huge NPL portfolios, will the painful structural changes in the public sector go through, will privatisations take place, will politicians (and one saint) stop meddling in everything, will we be able to capitalise on our natural gas finds and not have them turned from a blessing to a curse, will the economy hold up in 2014, what will happen with the negotiations for the Cyprus problem (the original one not the current one), will the guilty that wrought so much damage to this country face justice, will more people of merit and fewer people of means occupy the key spots in our public institutions…? Tough questions, many unknowns. 

But as the end of the year approaches I am definitely more optimistic than what I was in March 2013. Part of that is just me (you see a two euro coin and a smile from your son will do that to you). But another part, the one you are interested in, is fuelled by a great deal of things that I see around me, some measurable and some not, but all pointing in the same direction. We were down but not out. We were bleeding but not dead. And now I think some of you are smiling because you feel it too…(now why is my back aching?)

What is it with these people? and what is it with us? … disclaimer: this post is being written by a really angry person….

What has gotten me so angry you might ask? well, it started off with my hands…. you see I now realise that I have very special hands, hands that allow me to do all sorts of things better than most other people on the planet, and to be exact, better than 7.121 billion other people (that’s the Earth’s population in case you are wondering minus 838,897 ‘special hands’ persons - my first clue of where I am going with this).

And what makes these hands so special? Haven’t you guessed already? You probably have them too! They are special because they are Cypriot. Yes, my fellow reader, if you are one of the 838,897 people that according to October 2011 census reside in Cyprus this gives you automatically these special hands. But if you are not one of these people have no worries; just register a company in Cyprus (cost EUR 1000) and regardless of where you come from you are immediately endowed with these special hands as well!

And what can you do with these special hands? Well, the first thing you are qualified for is to run a bank. You might think that this is a complicated type of company with a vital role for the well-being of the economy and thus requires specialised knowledge, intelligence, skills etc etc but no you are mistaken, all you need is to have Cypriot hands. Do you doubt it? Ask God. Or if you cannot find him then ask the next best thing, his representative on planet Earth.

And in case you have any doubts (which you shouldn’t by now) we also have history to guide us about how the strategy of Cypriot hands has worked wonders for our small island. Look at Laiki and how bad it was doing when we had those ‘Asian’ hands  (also known as HSBC) being part of it. Heck after they left, Laiki has gone from strength to strength. And what about that other paragon of success called BoC? Under the Cypriot hands of Mr. Eliades, Mr. Aristodemou and fellow Cypriot board members it has done so well it took down the whole country with it. And lest not forget the best example of all, our beloved CoOP Banking Society led by the Cypriot hands of Mr. Hlorakiotis, the man who borrowed 10mm for him and his family, forgot to pay them back and will not give to publicity the terms of this loan for us to see if he got any ‘special terms’ because he ‘walks in the avenue of Honesty’. In another global first, these Cypriot hands managed to create a hole of about 1.5bn without the help of the Greek PSI haircut not to mention having percentages of non performing loans reaching close to 80% in some cases!

But Cypriot hands have enjoyed successes in so many other fields that it is unfair to concentrate on banking. Look how well they have been managing the country since it was created. Or don’t go so far back. Just look at the last few years and how the Cypriot hands of Mr. Christofias have firmly and steadily taken this country apart, demoralising our youth, destroying value all in the name of ‘I know better’. Yes, these are hands I would trust my own children and their future with (oh, wait, I did do that, didn’t I?).

And what about so many other patriotic Cypriot hands that have been milking companies like the Cyprus Airways, CYTA’s provident fund, abusing government resources, taking arms commissions all without a second thought? Don’t you feel so much better to know that at least your hard earned money have been stolen by Cypriots hands rather than those nasty, dirty foreigners?

And now we come to dear old Hellenic, the jewel of the crown that is so valuable that after 2-3 months of feverish fund raising no Cypriot hands were found to put in EUR 40MM. But then the evil dark lord, that answers to the name Satan or David Loeb comes along and decides that this is an undervalued asset and wants to buy it. But no we cannot have ‘foreign’ hands take control of the jewel. It must stay in Cypriot hands, it must. And if they cannot be Cypriot hands in the form of natural persons, at least let them be Cypriot hands in the form of legal entities and hence Wargaming.net, an incredibly successful company in the field of online gaming owned by Ukrainian interests. Now I am a bit old-fashioned and I tend to think that if you are successful in one field that doesn’t mean you will succeed in another (I suspect Mr. Miltiades Neofytou will agree with me on this one). So the fact that Wargaming.net has been successful in online internet gaming... well, I don’t know what this means for banking. But have no fear. At least they are ‘Cypriot’ hands. And, in any case, the other Cypriot suitor, Demetra Investments, is in the finance field so at least we have that (even though there is the problem of track record there but let’s not fret with details).

And finally, we have the media (not all of them, to be fair). Who took up the banner of the Cypriot flag and presented the whole story as an us vs them; that the foreigners are trying, once more, to steal our pride and glory and that Cypriot companies are coming to ‘shield’ Hellenic from all these evil-doers (as George W used to say). Instead of the focus being on who is the best owner for Hellenic (and best here is defined as he who will maximise better shareholder value) the focus was on the nationality or origin of the investor starting with the maxim Cypriot is always better than foreign.

Yes, there are issues to consider when an activist hedge fund investor like Mr. Loeb takes an interest in a bank and yes, all is not rosy or simple when you are dealing with hedge funds. And yes, there are certainly extremely capable, smart, successful people that also happen to be Cypriot. But what is clearly irrational, misplaced and short-sighted is to somehow feel that the nationality or origin of the investor is important in this case. Mr. Loeb took $3.3 million and turned them into $10,000 million in less than 20 years (and to avoid confusion note the direction of this i.e. from $3.3 million to $10.0 billion NOT the other way round which is pretty much what the beloved Cypriot hands of our politicians and bankers have done). So he has that going for him and at the end of the day, it doesn’t matter. Hellenic needed money and went to the world to get them. If the Cypriots were so worried about not having these evil foreigners running their bank then they should not have asked for money from them in the first place. And while we are at it, maybe we should not have asked for money from those other foreigners called Troika and relied on our own solid Cypriot hands to choke us to death completely!

 

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Being a company in a free market economy ain’t easy. It means subjecting yourself to the faceless, emotionless and ruthless forces of the market where every day you are judged not by what you were in the past but what you will be in the future. Companies who forget that do so at their peril (Nokia, Research in Motion (Blackberry), Kodak are but a few examples). In such an environment the need to innovate, to reduce costs, to create more value is constant and relentless. At no point does the market allow you to take a breather, to sit back, relax and enjoy your success. Because if you do there is always a competitor breathing down your neck who will take advantage of your ‘holidays’ and come out with a better and cheaper product than you.

IBM blinked, Microsoft emerged. Microsoft stagnated, Apple re-took the crown. Microsoft ignored smartphones, search and social media; out came Samsung, Apple (again), Google and Facebook. Sony used to be synonymous with cool devices such as the walkman and flat screens TVs; now Samsung and LG dominate TV screens while iPods are the walkmans of the new generation. Kodak used to be synonymous with cameras, today it is bankrupt. Blackberry and Palm were pioneers in smartphones, now both are fighting for survival. Yes, life for companies in a capitalist system is solitary, poor, nasty, brutish, and short (apologies to Mr. Hobbes for stealing his quote).

Which in turn begs the question why would anyone in his right mind design such a system; why would anyone want to live in a system where a misstep can prove fatal, where there are no points for seniority, where an upstart (Google) can displace the dominant player (Yahoo) and where customer loyalty needs to be earned day in day out? Well to answer this we need to look at a completely different constituency, the consumer. For it is the latter who is the huge beneficiary of this system. She benefits by getting low prices and better products. She benefits because constant innovation by companies translates to new products, new services and many times to lower prices. She benefits because if there is a way to produce the same product for a fraction lower then someone will do it. She benefits because as a consumer she has power and companies bow to her. Yes, life for consumers in a capitalist system is fun, varied, exciting and cheap.

That is until someone figures out how to game the system or better still how to change the game. And this is a lot easier than it sounds for the system described above while complex in some ways in many others it is simple. As a matter of fact one could condense all the complicated micro-economic equations and all the long winded analyses of why a free market economy works so well in two simple words: profit and competition. Remove any one of the two pillars and the system crumbles, remove both and you get something so inefficient, so slow moving, so expensive that in my opinion should be made illegal. In our small island though it actually has a different name… it is called the Electricity Authority of Cyprus.

Now I concede that I am unfair in singling out the EAC to bear the brunt of my complaints. So let me rectify this by inviting some other illustrious names to join our play date. Please welcome to the stage: the Cyprus Telecommunications Authority, the Ports Authority, Cyprus Airways, the State Fair Authority and the Cyprus Broadcasting Corporation. What do all these companies/organizations have in common? All of them operate without having a real motive for profit as any organization that is managed by a politically-appointed board and a CEO whose pay is not linked to performance and whose performance is not linked to his tenure inevitably will not be as efficient, or innovative or cost conscious or customer friendly as a company that is. Similarly, any organization that operates without competition, as is the case with the EAC, inevitably will operate at a leisurely pace, without much concern for innovation or cost control. For EAC, being a monopoly is being in paradise, wish I could say the same for the poor consumer who ends up paying one of the highest electricity costs in Europe.

And while you would expect that consumers, being a lot more in number than the business owners, will be cheering the plans for privatizing or introducing competition in these companies, consumers are siding with the likes of Mr. Stathis Kittis who back in February was arguing that CYTA et all should borrow up to €1.5bn to give to the troika and thus avoid privatization. From the point of view of Mr. Kittis this makes perfect sense. I mean if it were me being paid the salary he was getting, and the perks he was enjoying plus the opportunity to engage in all those extra-curricular activities he was participating using as petty cash the employees Pension Fund, well I would be up in arms as well, calling the idea of privatizing CYTA the biggest crime since the Holocaust.

But the consumer is not enjoying the high salaries and the nice perks and that is why it is truly puzzling, or better maddening, that most of us have joined ranks with the likes of Mr. Kittis and fail to understand that all these organizations that have been operating without a care in the world for the last few decades inevitably, not by fault of its employees but because of the nature of all human beings, would become inefficient, slow, expensive and slow to innovate.

We know this when it comes to the education of our children. Can you imagine a school where students would be given their textbooks and told that there will be no exams, no penalties for not performing well and everyone would graduate with A+? Do you think this would produce excellent students? We know this in sports. Can you imagine athletes training until exhaustion, in cold weather, often risking injury if there was no competition or no reward for profit? And yet for some reason we seem to think that employees that have no risk of being fired (and this goes for our civil servants as well), no reward for performance, where profit is not the driving force and where managers are there to stay for ever, that somehow this group of people will be different than any other group in history and that somehow this group will motivate itself to be as efficient and as hard working as all these other groups that work in companies where they are forced to be all these things for the alternative will be bankruptcy and the loss of their jobs.

UPS, the global parcel service, in its never ending quest to reduce costs changed the way they calculated driving routes as to minimize not only the distance to be travelled but also the number of left turns in a route because they realized that left turns slowed down their trucks but also increased the risk of accidents. You know how much they saved by doing this? 98 million minutes of idle time per year! Do you think this idea could come from an organization like the Cyprus Postal Office?

Some of you might have smiled at the thought but why do you think is that? It is not that there are no bright people working there. Rather it is because you know and I know, that in order to come up with such an idea you must have employees and managers who really spend time and worry on how to improve on their costs and the only reason you would spend this time is if you felt that by reducing costs it makes a difference to your compensation or to your assessment by your superiors which in turn affects your chances of a promotion. If neither of these incentives are there then it is makes no sense to wreck your brain trying to figure out better and smarter ways to reduce costs.

Innovation is difficult. Cost cutting is painful. You would not engage in these activities unless you were forced to and few things are better motivators than the quest for profit or the threat of bankruptcy.

Semi-governmental organizations have been operated under a model that ignores everything we know about human nature, everything we know about incentives and motivation and everything we know about the workings of free market economies. This model was dead upon arrival but unfortunately it took us a long time, and a lady from Romania, to realize this. There are many models of privatizing such organizations and there are nuances to each one that I will not go into for they are not relevant. What is relevant is that as we are waking up to the reality that our resources are limited and if we want to prosper we must work hard but also work efficiently. We need to understand that we do not have the luxury of inefficient organizations, of mismanagement of public resources, of under-utilization of infrastructure. And what smarter people than myself have long since realized is that the best way to ensure the optimal usage of resources and people is through companies operating in a competitive environment and pursuing profit within a legal framework established by democratically elected governments.

In the world of economic ideas, Adam Smith invented the wheel a long time ago; Mr. Kittis and his friends should stop trying to compete with a cart on square wheels.

 

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