Cyprus Rescue: From Bad to Worse: El-Erian

Mohamed El-Erian
Joshua Roberts | Bloomberg | Getty Images
Mohamed El-Erian

The press conference at today's Eurogroup meeting in Dublin showed the sad incoherence of the Cyprus rescue. Also, by confirming the concerns outlined in this note a week ago, it served to further weaken the credibility of the mechanism that is at the center of Europe's crisis management.

In approving a 10 billion euro package, Europeans called on Cyprus to find an additional 6 billion euros to cover what is now a larger funding hole. In other words, it now needs to generate a total of 13 billion euros. This is a huge amount for a country the size of Cyprus, even after it goes after uninsured deposits in local bank accounts.

Some European politicians suggested that Cyprus should sell its gold holdings for this purpose. But this was quickly countered by the head of the European Central Bank. He reminded his European colleagues that the priority for the gold is to cover potential losses by the national central bank.

These were not the only issues fueling a general sense of confusion and indecision in Dublin today, and a related sense of despair in Cyprus. To make things worse, a top European Union official stated that neither he nor other members of the Troika had a good handle on Cyprus's growth outlook.

All this confirms what I argued a week ago — namely, that "anyone even remotely familiar with the details of the Cypriot program realizes that the country is a long way away from what [a Troika official claimed to be] "a durable and fully financed solution," let alone a sustainable path towards recovery."

Despite losing control of both growth and funding dimensions, European officials are yet to find the courage to recognize publicly what must be crystal clear to them in private (and was evident to others a week ago): "Key assumptions of the program are outdated if not totally obsolete."

For its part, the IMF is yet to acknowledge that adherence to its operational principles would preclude it from lending a country with an incomplete program design and an uncovered financing gap. If, instead, it opts to stick with a non-credible approach (as a means of kicking the can down the road), its ability to convince others to follow its lead on this and other rescues would be undermined further.

The immediate victim of all this is, of course, the Cypriot people: Having hoped for leadership from Europe to help them recover from a massive crisis, all they see is confusion and incoherence. The result is an even more uncertain daunting future for them.

The credibility of the Troika is also taking another beating. Its ineffectiveness and internal coordination problems are clear for all to see.

In sum, we are now watching the second botching of a Cyprus rescue in less than a month. The implications cannot be good for Cyprus ... and for Europe as a whole.

Mohamed A. El-Erian is the CEO and Co-CIO of PIMCO, which oversees $2 trillion in assets including the PIMCO Total Return Fund, the largest bond fund in the world. His book, "When Markets Collide," was a New York Times and Wall Street Journal bestseller, won the Financial Times/Goldman Sachs 2008 Business Book of the Year, and was named a book of the year by The Economist and one of the best business books of all time by the Independent (U.K.).