New Cyprus Deal Approved Without Parliament OK

The troiska composed of the EU, European Central Bank and IMF have come up with a new rescue plan for Cyprus. The terms are not quite as dreadful as those proposed last week. That said, they are still pretty awful and guarantee a deep recession, a collapse of business confidence, a capital exodus and the death of the banking sector. Having seen a patient with a brain tumor, the great and good have decided decapitation is the right treatment. Best of all, the Cypriot parliament won’t get to vote on the deal.

The new deal will see a levy on all bank deposits above &euro:100,000. In the earlier package, those with less than that figure would still have faced a levy of 6.75% on their savings. Now, those are protected as per EU law.Deposits above that figure, though, will be subject of a hefty tax, and the banks’ bondholders will lose out (unlike in the previous arrangement). Laiki Bank will be split into a “good” bank and a “bad” one, and the good assets eventually will wind up at Bank of Cyprus.

When the banks reopen tomorrow after a week off, people will likely line up to take out whatever they have. Big depositors may well move their money out of the eurozone altogether. Cypriot branches of foreign banks are probably going to close, or at very least, reduce their size. As a result, no one is going to be able to get a loan for the next several months. That means businesses will close, people will lose jobs, and in general, the country is going to go through economic hell. EU Commissioner for Economic Affairs Olli Rehn admitted the “depth of the financial crisis in Cyprus means that the near future will be difficult for the country and its people.” That’s how a diplomat describes hell.

Meanwhile, the banking sector itself is in for a huge consolidation. Cyprus is no longer a safe place to leave money if one is trying to hide it from other governments. Huge capital outflows should start immediately. The deposits in the Cypriot banking system were 7.5 times the size of the nation’s economy. The shrinkage ahead will be almost indescribable in its scope and in the damage it will do to the real economy of the island.

The chairman of the Cypriot parliament’s finance committee, Nicholas Papadopolous, told the BBC the deal made “no economic sense.” He added, “We are heading for a deep recession, high unemployment. They wanted to send a message that the Cypriot economy ought to be destroyed, and they’ve succeeded in a large part – they’ve destroyed our banking sector.”

Unlike last week’s proposal, the parliament in Nicosia won’t get to vote on this deal. Reuters stated, “German Finance Minister Wolfgang Schaeuble said Cypriot lawmakers would not need to vote on the new scheme, since they had already enacted a law on procedures for bank resolution.” In other words, the powers that be found a way around the people most affected by the deal. Mr. Schaeuble also said this deal was “much better” from Germany’s perspective than last week’s.

Perhaps, that is so. However, the real winners here are the banks in London and New York. When the capital floods out of Cyprus (and Spain, and Italy?) because the banks aren’t safe, it is likely not stopping in Paris or Frankfurt. London in particular should benefit as it is in the EU yet outside the eurozone. Meanwhile, Chancellor Merkel’s insistence on austerity has claimed another victim, and her re-election chances have improved proportionately. Sanity can’t return until the Germans vote, if it can return at all.