Tuesday, March 26, 2013

Where Credit is Due

How is an economist like a fortune teller? They both get tired of being asked "Why didn't you see it coming?" when things go wrong.

Ok ok, it's not a very funny joke but economics is the dismal science after all.

Cyprus is the big news again this week, but honestly if you weren't already following that story you're unlikely to start now. So for those of you that are interested I'll just briefly mention that a bailout was pushed through despite the legislature's objections. The bailout obliterated Cyprus's second largest bank and along with it a large portion of the local economy, but preserved deposits below 100,000 euros. It's not a pretty picture and Cyprus is unlikely to recover any time soon.

But... why didn't economists see this coming? In retrospect all the signs were there. An oversize banking industry, exposure to toxic Greek assets, a fast and loose credit market. How could it have been missed? There should have been warnings! There should have been policy suggestions! Isn't economists' entire job to prevent these things!?

Yep. Here's one. And here.  Oh and here. Oh, and those are all just from one economist. He's not someone you're likely to have heard of (or will hear of again), but as early as four years ago Constantinos Stephanou was presenting papers which clearly outlined the risks Cyprus faced and how to mitigate them. Not only that, his papers were presented at the University of Cyprus. It's hard to imagine the message didn't make it from the campus to the capital (it's not a big country). Nor was Stephanou some lone wolf espousing strange and wild doctrine. Most economists who studied banking in the region knew something along these lines was coming. Many took the time to craft warnings backed by experience and data.  Unfortunately, most of them were also ignored.

This wasn't an unanticipated event.  It's unfortunate and poorly handled, but not unanticipated. The decisions that led to the current state of Cyprus were made years ago when a potential crises seemed unlikely. When Greece collapsed higher reserve and liquidity requirements started to seem like a prudent measure.  But by then such changes would have only exacerbated a problem that the banks already couldn't handle.  The banking sector which had been artificially inflated by the government in order to fuel economic growth was so over sized that the rest of the economy couldn't possibly prop it up for even a short time.  Which leads us to a nation dependent on failing banks that the rest of the EU must somehow try to save. 

So who's to blame? Economists did their job. Warnings were given.  The banks did their job. They kept the economy growing. The politicians did their job. They paved the way for the banks. Yet here we are with Cyrpus's economy decimated.

If there is anywhere to place blame it is with ourselves.  The idea of growth at all costs has become a political addiction. It seems any problem can be solved if we can just grow our economy fast enough to out race it. We pile risk upon risk in an effort to outrace our fiscal demons and eventually they catch up.  When that happens if you're not wealthy enough to pay them off you're just another Cyprus, or Greece, or Spain.

If you have any interest in Cyprus I encourage you to read the papers by Constantinos Stephanou linked above. They span several years and thus follow the progression of Cyprus's downfall nicely. In particular his point about how the euro transitioning into local currency played a part in the collapse was fascinating. 

Next week more economics. Until then stay safe and rational. 

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