Cyprus isn't going bankrupt.
The government reached a financial bailout deal early Monday morning with the "troika" of the European Central Bank (ECB), European Commission, and International Monetary Fund. Unlike last week's bailout plan, which was scuttled by the Cypriot parliament, this deal doesn't need further legislative approval.
Without a deal, the ECB was going to cut off financing to Cyprus' ailing banks, which would have been devastating to the Mediterranean island nation. Now, as part of the rescue plan, Cyprus will shut down its second-biggest bank, the largely state-owned Popular Bank of Cyprus, and shift deposits below 100,000 euros ($130,000) to the Bank of Cyprus, creating a surviving "good bank." The deal will raise $5.5 billion to cover the shuttered bank's losses and strengthen the remaining bank by forcing huge losses on deposits of more than 100,000 euros, which are uninsured.
So, what should we make of this deal? Who won, and who lost? Read on.
"Cyprus' economy is going to suffer terribly in the next few years," says Hugo Dixon at Reuters, but the last-minute deal "makes the best of an extremely bad job." Most of the pain from the bailout will be borne by the unsecured creditors of the country's two biggest banks, "but they are the ones who ought to suffer the most pain." A significant portion of the banks' creditors aren't Cypriots, so that will cut "the impact on the domestic economy," if only a little. But the biggest victory is that Cyprus will live to fight another day.
The big reason the previous EU offer tanked in parliament is that it imposed a 6.75 percent tax on purportedly guaranteed bank deposits of up to 100,000 euros. The new deal drops that, putting all the financial hit on bank shareholders and other unsecured creditors. That means when the banks open on Tuesday, most Cypriots will have access to their intact savings for the first time in more than a week.
The European Union
From the EU's perspective, the deal is almost exactly the same as the one rejected last week: Europe ponies up 10 billion euros, and Cyprus contributes the other 5.8 billion euros. But "this solution we reached tonight doesn't have the downsides that the solution of last week did," said Dutch Finance Minister Jeroen Dijsselbloem. Cyprus will no longer raid secured deposits for its share of the bailout funds, leaving bank depositors all across Europe breathing easier. It also means Cyprus likely won't ditch (or be forced out of) the euro single currency. "If this is how the game ends, it's... a win for the EU," says Felix Salmon at Reuters.
The Cyprus bailout package is a fascinating real-world experiment. The Popular Bank of Cyprus (also called Laiki) will be dissolved, with secured deposits moved to Bank of Cyprus. Unsecured creditors will likely lose most, if not all, of their investments. This will "give the world a very real example of what happens when a too-big-to-fail bank is allowed to fail," says Reuters' Salmon. "Laiki is small by global standards, but very large by comparison with Cyprus's GDP. If Cyprus can survive Laiki's collapse, then maybe — just maybe — the world could cope with the 'resolution' of a big bank like Citigroup." Indeed, Cyprus has just endured "an economy-destroying week-long" experiment "that would normally be barred by human research subject to ethical guidelines," says Matthew Yglesias at Slate. So far, "it's proven that 'contagion' from one country to another can be contained."
This bailout doesn't exactly save Cyprus, says Slate's Yglesias. "Even if nothing goes wrong, you're talking about the destruction of the island's main high-value industry and a huge evaporation of local wealth." The deep recession, or even depression, about to hit the tiny country will "be sufficient to make problems for Cyprus' remaining banks even if everything else goes fine." The "brutal truth," says Stephanie Flanders at BBC News, "is that the Cypriots held out too long." If they had negotiated back in the days when EU finance ministers were worried the euro was on the brink of destruction, they would have had a much stronger bargaining hand. But these days, "rightly or wrongly, European officials and the IMF think markets are confident enough now to take a lesson in 'creditor responsibility.'"
"The agreement between the Cypriot government and the Troika of the EU, IMF, and ECB is a bold and brutal geopolitical power-play," and the big loser is Russia, says Reuters' Felix Salmon. Under last week's scuttled deal, deposits above 100,000 euros (many of which were held by wealthy Russian investors) got a 10 percent haircut; now, the EU is "essentially forcing Russian depositors to contribute maximally to the bailout against their will." Bottom line: "All the uninsured depositors (read: Russian plutocrats) at Cyprus's two largest banks" are going to get hit hard. The lucky ones with savings in Bank of Cyprus will lose 40 percent, while the Laiki depositors are "going to lose everything."
The Cyprus central bank chief caused "large scale harm to the country, either by accident or design," says the Cyprus Mail in an editorial, and he "cannot remain in a post he has proved emphatically unfit for." Demetriades is a "novice academic with limited understanding and no practical knowledge of the workings of the banking system," and it showed as he flubbed and flailed his way through the worst period in the history of Cypriot banking. "The banking sector is in ruins and while the bankers have a big responsibility for this, the governor calculatingly made a bad situation much worse." He should be fired immediately.
Cypriots are frustrated, angry, and scared about what the future holds. But they also feel betrayed by Germany and the rest of Europe. "We had the impression that being part of Europe would be a good thing, that it would solve our problems," artisan Chris Kikas tells Reuters. "Well, it's not like that at all.... Where is the solidarity?" The sentiment was echoed by the president of Cyprus' parliament, Yiannakis Omirou. "This decision is painful for the Cypriot people. This decision was a defeat of solidarity, of social cohesion, which are fundamental freedoms, fundamental principles of the European Union," he told the AP. "As soon as possible we have to prepare our economy to go out from the mechanism and the troika."