Mention the tiny island nation of Cyprus, and the first thing that comes to my mind is Paul Newman and "Exodus."In the 1960 film of Leon Uris's novel, Newman stars as Zionist leader Ari Ben Canaan, who goes to Cyprus in 1947 to rescue Jewish refugees being held in British internment camps.All it takes is a borrowed ship, a few forged signatures, a hunger strike, and a threat to blow up the vessel and everyone on it to persuade the British to allow the renamed "Exodus" to set sail for Palestine.Today's plot involving Cyprus is more complicated. Any resolution will be less uplifting. And the heroes, if there are any, have yet to emerge.The Story So Far: As a precondition for a 10 billion-euro ($13 billion) bailout of its financial system, Cyprus was told by euro-zone finance ministers, the International Monetary Fund and the European Central Bank that it had to contribute 5.8 billion euros by levying a tax on bank deposits: insured and uninsured, at sick and well-capitalized banks.The Cypriot parliament on Tuesday rejected the "solidarity levy" - the only solidarity was the opposition to it - sending the parties back to the drawing board and newly elected Cyprus President Nicos Anastasiades looking for alternative financing, perhaps from RussiaWithout a capital infusion, Cyprus's two largest banks will collapse, destabilizing the financial system and presaging an early exit from the 17-member euro area.And that guarantee of deposit insurance on accounts up to 100,000 euros? Sorry.The issues
Why the authorities decided that when it comes to Cyprus, the last (depositors) will be first, and the first not at all, is anybody's guess.Although it's true that Cyprus's banks are largely deposit-funded, why not give the bailout a patina of respectability by making the senior bondholders take a hit? That's standard when it comes to resolving insolvent financial institutions.Instead, Europe's leaders chose an arbitrary policy that sets a bad precedent and carries a scary message: Your deposits aren't safe. The state can confiscate them anytime it wants.
Even the Russians, who excel at seizing entire fortunes and portfolios of companies, are up in arms.The politics
Facing parliamentary elections in September and pressure from both sides, German Chancellor Angela Merkel was in no position to offer up bailout-weary taxpayers as sacrificial lambs.
Because Cyprus is reputed to be a haven for Russian money laundering, supporting a deposit tax enabled Frau Merkel to strut her populist credentials by sticking it to Russian oligarchs.Anastasiades didn't want to jeopardize Russia's 2.5 billion-euro line of credit by forcing large depositors to absorb the entire hit.The initial plan had the government imposing a tax of 6.75 percent on all bank deposits of less than 100,000 euros - the deposit-insurance limit - and 9.9 percent on larger accounts.
What's more, Russian banks have loans to Cypriot companies, which may be fronts for Russian companies.Lastly, Russian energy giant OAO Gazprom reportedly offered to prop up Cyprus's banks in exchange for gas exploration rights.Oh, what a tangled web..
Cyprus is small. It is three-fifths the size of Connecticut with a population of 1.1 million, annual output of $23.6 billion (less than 0.2 percent of the euro-zone economy) and a banking system more than eight times the size.What happens in Cyprus isn't supposed to affect the entire euro zone.Instead, events of the past week may turn out to be a bigger deal than the country's size alone would suggest.First, the decision to tax depositors represents a confiscation of private property. If a country is willing to cross that line once, the second time is a lot easier.Second, violating a guarantee of deposit insurance in one country creates anxiety in others and undermines efforts to institute uniform banking practices across the euro area. It's puzzling why depositors in countries such as Spain and Italy aren't aggressively withdrawing money from their accounts.For the small price of 17.57 euros a person, European leaders could have raised the same amount of money and preserved the sanctity of deposit insurance, according to Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y.Third, the decisions taken by European governments this week may hasten the single currency's demise.They are using what amounts to "blackmail to confiscate deposits," said Athanasios Orphanides, a former governor of the Central Bank of Cyprus. "What we are witnessing is the slow death of the European project."Which brings us to the real issue: The European monetary union was never a real union. Nor does it seem to be moving in that direction.Yes, these 17 countries share a common currency, a common market and common rules. They give voice to a common purpose.But people still think of themselves as German or French or Cypriot first, not European.Their actions are at odds, as well. Despite Europe's social democratic foundation, decisions are still made by governments (in general, Germany's) on the basis of what's good for the nation-state, not the whole.Banks in Cyprus remain closed until the authorities can arrange for security to deal with an onslaught of angry depositors.A mass exodus would be no surprise, even without Paul Newman.Baum, author of "Just What I Said," is a Bloomberg View columnist.