The Deauville zombie is back.
Europe’s aid package for Cyprus brought back memories of the German-French deal at the English Channel resort of Deauville in October 2010 that made bond writedowns part of the debt-crisis management toolkit. Investors responded then by pushing Ireland and Portugal to follow Greece into bailouts. Only 14 months later did European leaders decide that imposing losses on creditors wasn’t such a good idea after all.
Now Germany has broken another taboo, forcing Cyprus to siphon money out of bank accounts to earn its 10 billion-euro ($13 billion) rescue. The markets’ snap reaction was the same, turning the Mediterranean island into the latest threat to the stability of the euro area.
“It looks like a botched and improvised job, and unprofessional -- groping in the dark without much consideration of what sort of signal it sends,” said Alessandro Leipold, a former International Monetary Fund official who is now chief economist at the Lisbon Council research group in Brussels. “That’s no way to really run a crisis.”
Three years of measures -- including the setup of two rescue funds, the passage of eight economic-governance laws, the enactment of a deficit-limitation treaty, the institutionalization of “euro summits,” and at least one “roadmap” and “blueprint” for a better-run monetary union -- couldn’t prevent the smashup over a country that makes up less than 0.2 percent of the 17-nation euro zone’s 8.6 trillion-euro ($11 trillion) economy.
Less than 72 hours after announcing their initial plan on March 16, euro finance chiefs convened a conference call late yesterday and confirmed their demand that Cyprus raise 5.8 billion euros from the levy while suggesting sparing small- scale savers. Meantime, the U.S. Treasury issued a statement calling for a “responsible and fair” solution in Cyprus.
The Market Now Blog: Two Contrarian Arguments for the Cyprus Deposit Tax
The euro slid 0.9 percent against the dollar to $1.2957 yesterday. Bond investors sought the safety of German bunds, pushing two-year yields below zero for the first time in 10 weeks. Notes fell in Italy, Spain, Portugal and Greece.
As after German Chancellor Angela Merkel’s beach-front walk with France’s then-President Nicolas Sarkozy in Deauville, the Cypriot package set off a flurry of recriminations, with European and national officials alternately taking credit for and distancing themselves from the deal.
First up was German Finance Minister Wolfgang Schaeuble, who blamed the idea of a confiscatory tax -- and by implication, the market fallout -- on the unelected technocrats at the European Commission and the European Central Bank.
“We of course would have respected the deposit insurance that guarantees accounts up to 100,000 but those who opposed a bail-in -- the Cypriot government, also the European Commission and the ECB -- they decided on this solution and now they have to explain it to the Cypriot people,” Schaeuble said.
What he neglected to say, on ARD television March 17, was that Germany favored an even more radical “bail-in” that would have exploded Cyprus’s banking system and propelled the country toward a euro exit, potentially making for a bigger mess than the one that unfolded on the markets.
Schaeuble drew criticism from the Cypriot side for heavy- handed tactics. At one point, a Cypriot official said under cover of anonymity, he demanded a 40 percent depositor tax. A Schaeuble aide contacted by Bloomberg didn’t immediately respond to that observation.
Also initially backed by the IMF, a complete bail-in would have been the nuclear option, putting Cyprus’s bloated banking sector into default, magnifying the losses and triggering repercussions throughout credit markets. Under this threat, the Cypriots went for the tax as the lesser evil.
“It was a very difficult compromise that we reached after 10 hours and I don’t think that there is a lot of room to maneuver,” Luxembourg Finance Minister Luc Frieden said in an interview yesterday. “We want to avoid the bankruptcy of Cyprus and of the Cypriot banks, which would have serious social and economic damages.”
As agreed in the early hours of March 16, the Cypriot government would raise 5.8 billion euros by skimming a sum off every bank account on the island during a three-day holiday weekend. Dubbed a “stability levy,” the tax brought down to 10 billion euros the amounts to be put up by European creditors and the IMF.
The euro finance chiefs yesterday suggested exempting acccounts below the European Union deposit-insurance threshold. The group “reaffirms the importance of fully guaranteeing deposits below 100,000 euros,” the statement said.
In another echo of Deauville, the tax showed how crisis policy is hostage to the domestic politics of Germany, Europe’s most powerful country. Merkel, campaigning for re-election in September, couldn’t risk being exposed to the charge of bailing out wealthy, often Russian, clients of Cypriot banks.
“I have to go to my constituency and explain to my people in my constituency why we are willing to lend more than 3 billion euros to Cyprus,” Michael Fuchs, deputy parliamentary leader of Merkel’s Christian Democratic Union party, said in an interview with BBC Radio 4. “Why should Germans bail out these people and they are not willing to accept at least a minor bailing out by themselves?”
As the Cypriot government toiled to redo what was roundly criticized as a socially unfair tax, European officials sparred over who was responsible for setting the rate at 9.9 percent on accounts above 100,000 euros and 6.75 percent on lower sums, with no tax-free exemption.
At the center of the controversy was the ECB, represented at the all-night Brussels talks by Joerg Asmussen, Schaeuble’s former deputy and now a member of the bank’s Executive Board. The central bank didn’t insist on “this specific structure of the levy,” he told reporters in Berlin.
That came as a surprise to Austrian Finance Minister Maria Fekter, who said the ECB exerted “massive pressure” to cap the tax on bigger accounts at about 10 percent. Speaking to the Austria Press Agency, Fekter said: “I don’t understand why this route was taken and Cyprus turned down the social progression.”
One official who declined to be named counted as many as 27 proposals for spreading the tax between the two classes of depositors. For its part, the Cypriot government denied assertions from Germany and Finland that it could have spared the sub-100,000-euro accounts.
It would have been “impossible” to raise the sums demanded by the creditors without hitting small savers, Constantinos Petrides, undersecretary to President Nicos Anastasiades, said by phone from Nicosia.
German influence reflected another legacy of Deauville, which marked the end of German-French parity in handling the crisis. Sarkozy knuckled under to Merkel’s demands that investors be made to pay for buying the wrong countries’ bonds. After that, the balance shifted continually toward Berlin.
Sarkozy’s electoral defeat in May 2012 accelerated that trend. The new president, Francois Hollande, broke with Merkel and sought allies in Spain, a country now tapping emergency aid for its banks, and Italy, a country now without a government. France’s economic slide further sapped its leverage.
Those forces came together in Brussels over the weekend, in a package colored by Merkel’s election-year imperatives. For starters, the German chancellor kept Cyprus off the agenda of a March 14-15 summit of euro leaders, giving her some distance from whatever the finance ministers decided a day later.
“We want to see to it that the euro overall remains stable, but that’s not what I’m here to talk about today,” Merkel told a business conference in Berlin yesterday.
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