Cyprus bailout "deal" reached

End of banks.  No deposits anywhere can be considered safe from government confiscation.

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http://www.washingtonpost.com/world/cyprus-bailout-deal-reached/2013/03/25/1e11f04a-9530-11e2-95ca-dd43e7ffee9c_print.html

Cyprus bailout deal reached

By Michael Birnbaum, Monday, March 25, 6:10 AM

BERLIN – Cyprus and the European Union on Monday reached a deal on a bailout that will drastically reshape the island nation’s economy in the name of salvaging its government’s finances.

The agreement comes after a week of high-stakes negotiations in which European leaders came closer than ever before to cutting a support lifeline to a member of the 17-nation euro currency union. Cyprus becomes the fifth country in the troubled euro zone to take a bailout, after Cypriot leaders searched unsuccessfully for a way to save their nation’s status as a financial hub.

In the end, the $20.5 billion rescue package will protect small depositors’ savings, thus respecting deposit insurance, a precept of a modern banking system. But many larger depositors may suffer deep losses, with European leaders holding firm to a demand that Cyprus come up with $7.5 billion toward the bailout on their own. The decision will drastically shrink the Cypriot economy, and likely puts an end to the country’s business model as a low-tax business haven.

The week’s turmoil underscored the vulnerability of the euro zone three years into a debt crisis, and it showed how far Europe remains from putting into place broader protections that could prevent problems such as those in Cyprus from escalating out of control. European leaders have been working on a unified banking system to help improve the resiliency of the currency union, which contains 300 million residents. The upheaval in Cyprus – a nation of 840,000 – may have weakened the broader project in the long run, many analysts said.

In the short term, bleary-eyed finance officials said Monday that the bailout deal, which is still subject to final approvals, will help avert complete banking collapse in Cyprus. The agreement came just hours before a deadline set by the European Central Bank, after which it had threatened to cut off emergency funding to Cyprus’s banks. That could have forced Cyprus to abandon the euro.

“We've put an end to the uncertainty that has affected Cyprus and the euro area over the past week,” said the official who heads the bloc of countries that share the euro, Dutch Finance Minister Jeroen Dijsselbloem on Monday.

Cypriot leaders were far less positive.

“It's not that we won a battle, but we really have avoided a disastrous exit from the eurozone," said Cyprus Finance Minister Michalis Sarris.

Banks in Cyprus remained closed on Monday for the 10th day straight, an unprecedented event for the euro zone that has put a squeeze not just on the large depositors who will take a hit on their assets but also for ordinary people and small businesses, who have now been restricted to withdrawal limits from ATMs of about $130 a day in an attempt to avoid bank runs. Cypriot leaders last week imposed capital controls on bank accounts, meaning that even once banks reopen, account holders will not be able to access all their money.

The deal will force large losses on those who held deposits above $130,000 in Cypriot banks, and it will split the country’s second-largest bank, Cyprus Popular, or Laiki, into two. Deposits underneath $130,000 will go into a so-called “good” bank. Deposits over that level will go into a “bad” one, and depositors and bond-holders may recover little or none of their money.

Cyprus also agreed to cut government spending, to privatize state assets and to drastically shrink the size of its banking system. As of the end of 2012, deposits in Cypriot banks were seven times the size of the country’s economy.

“The agreement reached today on Cyprus provides a comprehensive and credible plan to deal with the current economic challenges in the country,” said IMF Managing Director Christine Lagarde.

But the bailout puts an end to decades in which Cyprus had tried to diversify its economy beyond its warm Mediterranean beaches. Starting in the 1970s, the country set low corporate taxes and tried to emphasize its stability as a good place to locate companies. That reputation was enhanced in 2004, when it joined the European Union, and even more in 2008, when it joined the euro zone, tightly binding the country to the far larger economic block on mainland Europe. Deposits poured in, many of them from wealthy Russians whom many Europeans suspect used Cyprus as a haven for money laundering.

That reputation led Europe to take a hard line on any bailout, pushing for Cyprus’s wealthy depositors to be on the hook along with European taxpayers. The initial plan proposed nine days ago would have seized a portion of all deposits in Cypriot banks, even in smaller accounts that were insured under E.U. rules.

The new precedent may make Europe weaker in the long run if bank depositors in struggling countries such as Italy and Spain fear for their own savings in a future crisis, analysts said.

“Failing banks remain the problem of their home country, even if that cripples government finances for many years,” ING senior economist Carsten Brzeski wrote in a research note on Monday.