Europe’s leaders run out of credit in Cyprus

By Gideon Rachman
March 18, 2013

European leaders must surely know that they are taking a big risk with Cyprus. The danger is obvious. Now that everybody with money in Cypriot banks is being forced to take a hit, nervous depositors elsewhere in Europe might notice that a dangerous precedent has been set. Rather than run even a small risk of an unwanted financial “haircut” in the future, the customers of Greek, Spanish, Portuguese or Italian banks might choose to get their money out now. If that starts to happen, the euro crisis will be back on again – with a vengeance.
The people behind the Cyprus plan hope that the risks of contagion are small. They reckon that the Spanish banks are on the mend, and that Greece too has pulled back from the brink. There is no reason for depositors to draw lessons from the peculiar case of Cyprus, whose banks are stuffed with Russian money.

Maybe so. And yet EU leaders have got these kinds of calculations badly wrong before. At a summit in Deauville in September 2010, they announced that the holders of sovereign bonds in bailed-out countries would lose some of their money. The result was a severe worsening of the euro crisis, as investors began to demand much higher rates to lend to risky-seeming countries, such as Italy or Spain.
So why – after all the painstaking efforts to put euro-humpty back together again – have European leaders taken such a gamble in Cyprus? The answer is that they too are out of credit – political credit.
This credit shortfall takes different forms in northern and southern Europe. For leaders of nations such as Germany, the Netherlands and Finland, there was a sense that their voters and parliaments just would not approve another bailout – unless heavy penalties were attached.
Cyprus is a small place, and so the amounts of money needed to shore the country up are relatively small – “just” €17bn. The problem is that Cyprus is also a particularly clear-cut example of the fundamental deficit in trust between northern and southern Europeans. Ever since the crisis began, the German media has been full of stories of southern corruption. German voters have been encouraged to believe that their hard-earned money is going to shore up fundamentally rotten countries.
Cyprus is a particularly big problem because its banks have a well-earned reputation for being a haven for dirty money from Russia. The amount being “round-tripped” through Cyprus – as it goes in and out of Russia – does suggest that the Cypriot banking laundry has been spinning wildly. Hitting depositors with more than €100,000 looks like an effective way to target illicit Russian money. The baffling and dangerous decision also to tax small depositors shows the extent to which sympathy has run out – even for the “little guy” in southern Europe.
In theory, Angela Merkel, German chancellor, and other European leaders could have told their voters that they had to bite the bullet – and bail out Cyprus, without demanding a price – because the alternative is risking a European bank-run that eventually leads to bank failures back home. But the likely reaction would have been even more voter anger and incomprehension.
Cyprus’s rulers also had very little political credit left in the rest of Europe. Many EU leaders had been deeply reluctant to admit Cyprus into the union in 2004, without a peace settlement that reunified the island. But Greece had threatened to veto the entire enlargement of the EU – blocking Poland, the Czech Republic and the rest – unless Cyprus was admitted. Reluctantly, EU leaders succumbed to this act of blackmail. But the whole episode left a bitter taste, particularly when Greek Cypriot voters rejected the Annan peace plan. As a result, when Cyprus ran into trouble the well of sympathy was fairly shallow.
The bigger problem remains, however, the gap in trust and political cultures between northern and southern Europe. Back before the crisis, when things were going well, it was considered politically incorrect, even xenophobic, to suggest that standards of probity in public life vary widely across Europe and that this is a problem for an organisation dedicated to “ever closer union”.
Now, however, it is apparent that this lack of convergence in trust and political culture is at least as important as a lack of economic convergence. It is also true that the Germans, the Dutch and the Scandinavians have their own problems with corruption in public life, and that the caricature of the whole of southern Europe as corrupt and lazy is grossly unfair.
And yet it is a fact that tax-evasion is rife in countries such as Greece and Italy. That has always made it hard to persuade northern voters to bail out the south.
Even casual observation confirms that attitudes to public money vary widely. A couple of years ago, I was invited to a meeting of all Dutch ambassadors from around the world. Lunch was a not terribly appetising array of sandwiches and crisps, eaten standing up. I suspected that, even though the public finances of Italy or Greece were in worse shape, their ambassadors were eating better.
It is a trivial anecdote. But it is the kind of cultural difference that explains why the northern Europeans have now said “basta”, when it comes to the Cypriot banks.
Unless Europe can create a real convergence in standards in public life, then the resulting gap in trust could ultimately break up first the euro – and the EU itself.