The Cypriot bailout: A catalogue of farce

Having followed the twists and turns of the Cypriot bailout for the last couple of weeks we’ve been struck by how – even by the standards of eurozone crisis management – it has been spectacularly mishandled often with farcical results (FAZ's Klaus-Dieter Frankenberger described it as "hara-kiri crisis management"). Here's our highlights:

Sunday 17th – The blame game begins 
The tentative agreement between Cyprus and its creditors was only a day old when the different parties tried to shift the blame for the politically toxic levy on small insured bank deposits. German Finance Minister Wolfgang Schäuble kicked it all off by seeking to distance the German government from the decision by blaming the Cypriot government, the ECB and Commission, which in turn prompted a series of denials from everyone else. The suggestion was that it was actually the Cypriot government who opted to include small savers in order to avoid hitting wealthier depositors (mainly Russians) even harder. The blame game continued throughout the week.

Monday 18th – Gazprom steps in with an alternative bailout? 
Following the acrimony over the agreement, it was reported that Russian energy giant Gazprom approached the Cypriot government the same weekend with an offer to fund the €10bn necessary to restructure the Cypriot banking sector in exchange for rights to Cypriot gas reserves. Although the story fitted in nicely with the geo-political tension narrative, it was quickly denied. Despite that, the rumours of a Russian bailout continued to be batted around for the entire week - none of which proved to be true.

Tuesday 19th (Afternoon) – Cypriot Finance Minster’s non-resignation 
On Tuesday Cypriot Finance Minister Michalis Sarris flew out to Moscow to see if he could secure more favourable terms than those offered by the eurozone. While he was there, rumours began to fly around on twitter, seemingly substantiated by respectable news outlets like Kathimerini Cyprus, that he had resigned as he no longer enjoyed the confidence of President Nicos Anastasiades. Confusingly, further rumours began to circulate that Anastasiades had rejected his resignation. However Sarris later told Reuters that there was “no truth” to the original rumours.

Tuesday 19th (Evening) - Cypriot Parliament rejects bailout deal after days of negotiation
Originally scheduled for Monday, the Cypriot parliament’s vote on the deal negotiated by the eurozone finally took place on Tuesday evening after attempts at further postponement failed. The parliament voted overwhelmingly to reject the deal, with not a single MP voting in favour. Of course, the democratic vote is itself not the issue but it was farcical that the deal was pursued for four days before being put to a vote when it was clear it would need to be altered again. Not exactly effective crisis management, especially since the 'No' vote raised questions over Cyprus' place in the euro.

Thursday 21st - Cypriot ‘Plan B’ shot down immediately
Following the vote above, Cypriot officials sought to cobble together a ‘Plan B’ to keep their chances of a eurozone bailout alive. Options on the table included the creation of a solidarity fund securitised with social security fund reserves, state assets, Church property and expected natural gas revenues. However this was shot down immediately by the troika as it was feared that it would not lower Cypriot debt to sustainable levels. Adding to the farce, the WSJ reports that Sarris (still in Moscow at this point) wasn't returning calls from his eurozone peers. By Friday, the deposit levy was back on the table bringing negotiations full circle.

Saturday 23rd – Russia to retaliate by freezing European assets? 
With it looking inevitable that Russian interests would be badly burned however the Cypriot bailout was finally structured, the Guardian reported that former Kremlin advisor Alexander Nekrassov warned that “Moscow will be looking for ways to punish the EU. There are a number of large German companies operating in Russia. You could possibly look at freezing assets or taxing assets”. As usual, this was later denied.

Sunday 24th – Infighting within the troika
The negotiations also saw severe strains developing between different members of the EU-ECB-IMF troika with the latter (with German support) allegedly resisting attempts by the Commission to water down Cyprus’ own €5.8bn contribution to the bailout. The FT cites an IMF official as saying that “The commission keeps trying to work with [Cypriot leaders], to help them put something on the table, even if that something doesn’t add up”, although another source adds that the two sides have “kissed and made up”.

Sunday 24th – Cypriot President's resignation bluff backfires 
Unlike the non-resignation of the Cypriot Finance Minister, this really happened. Reuters cites a senior official as saying that this took place during a particularly heated exchange concerning the plans to restructure the country’s banking sector and the WSJ reports that at that point Anastasiades was calmly told by other leaders "to pack up and leave" if he wasn't ready to cooperate (he didn't).

Monday 25th (Afternoon) - Dijsselbloem's accidental honesty makes markets plunge 
You’d have been forgiven for thinking that with a deal finally having been hammered out, the situation would have settled down a bit. However, Eurogroup chief Joroen Dijsselbloem had other ideas, suggesting in an interview with Reuters and the FT that the Cypriot deal could become a template for any subsequent bailouts and bank restructuring in the eurozone. This saw markets around the world tumble for fear of further write-downs, particularly in Spain and Italy. Dijsselbloem then looked to row back from his comments reiterating that Cyprus was “specific” and that he was not even aware of the English word ‘template’ which had been widely attributed to him - although given this specific word was used by the interviewers we're not sure we entirely believe him. His comments got a mixed reaction - he was backed by the Commission and Finnish PM Jyrki Katainen - who said 'bail-ins' should be part of the eurozone's crisis management strategy - but ECB Executive Board member Benoit Coeure said that he had been "wrong" to suggest this.

Monday 25th (Evening) - Banks to stay closed even longer
It was originally announced that Cypriot banks would re-open on Tuesday with the exception of the two biggest - Bank of Cyprus and Laiki -which would re-open on Thursday. However, later that day, Cypriot authorities changed their minds and announced that all banks would remain closed until Thursday (this was just the latest of the many extensions to the bank holiday and the numerous other delays throughout the week).

Given that the final outcome of all of this was a plan which will likely slam the Cypriot economy and significantly reduce the standard of living (albeit while reducing moral hazard somewhat), it is hard to see the whole week other than an array of botched diplomacy and naive negotiations.

We shouldn't over-state the risk of deposit-led contagion,but the Cypriot bailout deal is political dynamite

Over on his Telegraph blog, Mats Persson argues that,

There are two ways to look at the hugely controversial bailout agreed for Cyprus in the early hours of Saturday morning, in which the small island nation – accounting for only 0.2 per cent of eurozone GDP but whose troubles will have an impact far beyond its size (including on some 25,000 Brits in Cyprus) – received a €10bn rescue package in return for a series of unusually harsh conditions. In a shock to everyone, including admittedly Open Europe, the deal included a “tax” on depositors: 6.75 per cent for anyone with less than €100,000 in a Cypriot bank account, 9.9 per cent for anyone with more than that.

The first way to look at the deal: lessons have been learned. Unlike in the case of Greece, Cypriot debt will come down to around 100 per cent of its GDP, following this deal. While not great, it’s not the type of maddening cocktail of continued austerity and increasing debt that Greece has been forced to swallow (the country’s debt is at 160 per cent of GDP this year). At least the combination of the deposit tax and privatisations in Cyprus will give the country some breathing space. And the alternative, letting Cyprus sink and leaving the euro, showing the world that the single currency is no longer "irreversible", would have been far worse.

The second way: All bailouts are unfair – the people who screwed up almost never pay – but this is in a league of its own. Seventeen Eurozone finance ministers locked themselves in a room and decided that every Cypriot depositor – whether super-wealthy or dirt-poor – will, out of the blue, see part of their hard-earned money seized. Remember, Cypriot President Nicos Anastasiades explicitly promised in his election campaign, only a few weeks ago, that depositors were safe. The Cypriot electorate now faces losses on deposits as well as years of austerity (under the bailout loan). What’s worse, deposits under €100,000 are supposed to be protected by EU law, not raided by EU leaders. And Cypriot banks have frozen close to €5.8bn, i.e. imposed capital controls which is meant to be illegal under EU single market rules. This is political dynamite.

Regardless of one’s interpretation, in the entrenched eurozone North-South stand-off, this clearly represents a victory for the German government and German taxpayers over their southern counterparts, as it was Berlin that drew a line in the sand. In many ways, Cypriot depositors fell victim to the forthcoming German elections in September.

What happens next? Well, the Cypriot parliament will vote on the deal tomorrow (conveniently, a bank holiday in Cyprus). This will be a nail-biter. The parties which supported Cypriot president Nicos Anastasiades only hold 28 out of 56 MP, so not a majority. Yesterday, Anastasiades issued a stark warning: accept the bailout deal or face “a complete collapse with a possible exit from the euro”. Given the huge stakes, I reckon that MPs will approve the deal, but it could be close – current voting arithmetic suggests 30 in favour and 26 against, but this is incredibly fluid. Even if the parliament does reject the package, there could still be room for further negotiation.

The bailout format is therefore a gamble on several levels. Most importantly, massive questions still linger over the precedent this sets. If Cypriot depositors are forced to pay today, why not Spanish ones tomorrow? People queuing up in massive numbers outside ATM machines is always an incredibly scary sight wherever you are and given the anger in Cyprus, we just don’t know how people will react when banks open again (unclear when, the Cypriot government may declare both Tuesday and Wednesday bank holidays as well).

But fears of deposit-led contagion to other parts of the eurozone should definitely not be be overstated. EU leaders have gone out of their way to say that the depositor tax won’t be repeated in other countries. And viewed with a depositor's eyes from Barcelona or Bilbao, Spain may have very little in common with Cyprus.

The eurozone also now has a contagion-fighting instrument in the ECB’s bond-buying programme (the OMT), which can be used should panic spread to Spain and Italy. There’s a problem here of course. If the Cyprus deal represents a more assertive German approach, it will be far more difficult to actually trigger the OMT as that, in turn, depends on whether the debtor country will agree to be put on a bailout programme, with tough conditions (a prerequisite for it to tap the OMT). Cyprus is small enough to boss around, but Italy or Spain?