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Editorials

March 21, 2013

EDITORIAL: The Cyprus Mess

Could a full-blown European financial crisis begin in tiny Cyprus, with a population of just more than 1 million and a gross domestic product of only $23.6 billion? The idea is only slightly stranger than the notion that this Mediterranean offshore-banking center, partially occupied by Turkey since 1974, belonged in a currency union with Germany in the first place. But Europe's leaders, in their wisdom, let Cyprus join the euro zone in 2008, and now the future of a continent hinges on bailing out the island and its insolvent banks.

European policymakers, led by Chancellor Angela Merkel's German government, have made a hash of things so far. Cyprus needs to recapitalize its financial system, which is badly damaged by exposure to the sovereign debt of neighboring Greece. The International Monetary Fund and E.U. governments agreed to lend $13 billion of the necessary funds, in return for the usual austerity and a contribution of $7.5 billion from the Cypriot government.

The only way Cyprus could get its hands on that much cash, however, was to "tax" the $88.4 billion on deposit in its banks. Though basically a polite confiscation, it was defensible under Cyprus' special circumstances, which include the fact that there was relatively little money to be had by soaking the banks' bondholders. Forty percent of the deposits belong to foreigners, wealthy Russians especially, who are relatively well-positioned to share in their tax haven's risks; a bailout that didn't hit the Russians would have been politically impossible in Germany.

For the Cypriot government, however, taxing fat cats risked alienating Russian Prime Minister Vladimir Putin, whose government Cyprus already owes $3.3 billion for a previous bailout. So President Nicos Anastasiades — with the inexplicable acquiescence of Berlin — tried to shift some of the burden onto small accounts, those with less than 100,000 euros, which is the upper limit for deposit insurance. Cyprus' parliament rejected the plan in the face of an entirely foreseeable middle-class uprising. And it's a good thing, too — violating the deposit guarantee for Cypriot savers would have set a dangerous precedent, possibly destabilizing banks across Europe.

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