By Peter Gumbel
The reaction to this weekend's European Union bailout deal for Cyprus has gone from initial shock to rather predictable condemnation. "Europe botches another rescue," ran the headline on an editorial in the Financial Times. "It's as if the Europeans are holding up a neon sign, written in Greek and Italian, saying ‘time to stage a run on your banks,' " Paul Krugman, the economist and New York Times columnist wrote on his blog.
As widely reported, the deal has an important claw-back component: a one-time tax on the deposits of everyone who has a bank account in Cyprus ‑ Cypriots and foreigners alike ‑ aimed at raising 5.8 billion euros of the total rescue package of 17 billion euros. It's always possible that the hyper-alarmist scenario of a pan-European bank run actually takes place, although by Monday afternoon, even jittery stock markets across Europe were starting to grow calmer, as EU officials insisted that the Cyprus deal was exceptional.
In fact, there are two compelling reasons why the EU actually has gotten this one right. The first is that Cyprus for years ranked highly on international lists of opaque tax havens, as it reinvented itself in the 1990s as the offshore banking center of choice for Russians. Under growing international pressure, and in order to join the EU in 2004, Cyprus eventually abolished its offshore tax regime and put in place a residence-based one with some clear oversight.
Still, the suspicions about Cypriot banks linger on. Last November, the German foreign-intelligence agency reportedly warned that any EU bailout funds for Cyprus could simply end up in the pockets of Russian oligarchs, according to the newsweekly Der Spiegel. The German agency estimated the amount of Russian money in Cypriot banks at $26 billion - substantially more than the total EU bailout package. Indeed, one Russian businessman, Dmitry Rybolovlev, owns almost 10 percent of Bank of Cyprus, the island's biggest. (The Bank of Cyprus is also one of the two banks whose soured loans to Greece sparked the crisis in the first place.) Cyprus remains on an Organization for Economic Cooperation and Development "gray" list of countries that have made progress to meeting international standards but have not yet been judged squeaky-clean. (So, too, does Luxembourg, which was the one country supporting Cyprus's objections in the weekend negotiations).
Under these circumstances, simply cutting Cyprus a check for the equivalent of more than half its annual gross domestic product with no strings attached would be politically incoherent. France and Germany for years have railed about the dangers of offshore tax centers, and have pushed their colleagues around the world at G8, G20 and other meetings to clamp down on abuses and harmful tax competition. The notion of "moral hazard" was much bandied about during the 2007-08 financial crisis, although in the end few were punished. But not to ask for a contribution from the Cypriots themselves would undermine their tough line on tax havens and what the French and German leaders have called the need for a "moralization" of finance.
Indeed, by suddenly showing that even preferred tax havens aren't 100 percent safe, the EU may have done a great service to international finance as a whole.
The second reason to support the EU bailout is more about economic pain than moral obligation. If you asked the Irish, the Spanish or the Greeks in 2008 whether they would have preferred a very sharp, one-time hit to their pocketbooks to deal with their national banking crises, or, as in fact happened, five years of intense economic pain, with soaring unemployment, rising taxes, cutbacks in social welfare and general impoverishment, the answer may be ambiguous.
It's not a choice anyone likes making, and the Cypriots, of course, aren't being given a choice. But there is one interesting precedent for the short, sharp shock approach: Iceland. It was left for dead by the rest of Europe after its banks blew up in 2008, wiping out the deposits of many British and Dutch citizens who had put their money in Icelandic online accounts. However, unlike Ireland or Greece, the Icelanders didn't bail out their banks with government money that they then sought to recoup by raising taxes or cutting social spending; they let them go bust. Iceland's president, Ólafur Ragnar Grímsson, in a fascinating interview with the French website Rue89, draws another distinction to the euro zone's austerity strategy. "We realized that this crisis wasn't just an economic and financial one, but a profound political, democratic and legal crisis." The upshot: Bankers and politicians are under criminal investigation, and Iceland has put in place a raft of legislation, including the creation of a special prosecutor investigating why the country got itself into such a mess in the first place.
Cyprus's population is about three times that of Iceland. But once the panic about their bank deposits subsides, Cypriots might take a closer look at what actually caused the crisis, just as the Icelanders have been doing. For the big question that Cypriots still need to ask themselves is why, despite attracting tens of billions of euros from Russians and others, an amount that easily exceeds the GDP of the island, Cyprus banks are in such a mess that they have almost brought down the whole country. Maybe the lesson is that being an offshore banking haven just isn't worth it. And if that's indeed the case, the EU policy that led to that realization will have been more than salutary.