Cyprus: from bad to worse

The taste left in one’s mouth by the Cyprus bailout episode just gets nastier and nastier. The latest putrid fact concerns the way the bailout was negotiated. I’m hearing from those close to the deal that it was the Cypriot politicians themselves (in other words not the Germans, Finns or the IMF) who initially suggested taxing small depositors.

That particular element of the bailout is, as you will have gleaned from my previous blogs here and here, the most toxic of all. It came as a total surprise to those outside the room when it was finally unveiled early on Saturday morning. A tax on deposits (or a haircut or a bail-in – they essentially amount to more or less the same thing) had been under discussion for some time, but the assumption had always been that small depositors below €100,000 would have been spared.

However when it emerged that in order to generate the necessary amount the Cypriot government would have had to impose taxes of 30%-40% on those high-level depositors, they started to consider taxing all savings instead. The Wall Street Journal has a good run-down on the negotiations here. The Cypriots were determined, according to those I’ve spoken to, to avoid imposing a tax of more than 9.9% on any depositors.  The most most damning quote on this comes from Peter Spiegel of the FT:

“The Cypriot president did not want to agree to a levy higher than 10 per cent,” said one top negotiator. “People were joking that he has only rich friends.”

The subtext is that the Cypriot government were indeed desperate not to ruin the country’s prospects as a tax haven for wealthy Russian investors – something which is bound to cause a major stink in Nicosia. Indeed, the President has since issued a stern denial, insisting the plan was foisted on him by Brussels.

Not that the aroma is getting any better elsewhere either. One of the supposed quid-pro-quos of having one’s deposits snatched through the tax is that you get the equivalent amount of shares of your bank in return. That’s designed to try to prevent a full-scale bank run. However, I am now hearing that if, for instance, you have deposits with Barclays in Cyprus, you will be compensated in local bank shares (quite which one is unclear – possibly Bank of Cyprus or Laiki possibly) – not Barclays shares. Predictable perhaps, but a seriously raw deal all the same.

The Cypriot Government appears now to be wavering over the initial plan, and is making noises that it may exempt small depositors after all. It’s an open question as to whether the damage is already done. My hunch is that it may be. Local savers’ faith in the banking system must have already been dramatically undermined as a result of this.