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Salmon: The Cyprus Precedent

NEW YORK ( Reuters Blogs ) -- I stuck my neck out in January, writing that Cyprus was "certain" to default. After all, the Europeans weren't willing to come up with the 17 billion euros needed to bail the country out, and EU economics commissioner Olli Rehn told The Wall Street Journal's Stephen Fidler that Cyprus would have to restructure its debt. But now the bailout has arrived, according to the eurozone, and -- in something of a shocker -- there's no default. Instead, 5.8 billion euros of the bailout is going to come directly from depositors in Cyprus' banks, in the form of what the EU is calling (as FT Alphaville notes) an "upfront one-off stability levy."

Don't for a minute believe that this decision is part of some deeply-considered long-term strategy that was worked out in constructive consultations between the EU, the IMF, and the new Cypriot government. Instead, it's a last-resort desperation move, born of an unholy combination of procrastination, blackmail and sleep-deprived gamesmanship.

The details aren't entirely clear yet: We're told that deposits of more than 100,000 euros are going to have to pay a tax of 9.9%, for instance, but it's not obvious whether that applies to all of the large deposit or just to the amount over 100,000 euros. And there's still a real chance (according to ekathimerini.com) that the Cypriot parliament could scupper the whole deal. But for the time being, everybody's going on the assumption that the deal will go through, that Cyprus will get its 10 billion euro bailout from the EU, and that everybody with a Cypriot bank account in Cyprus (a group that The Telegraph reports includes members of the U.K. military) will see their accounts taxed by at least 6.75%.

In January, I wrote that this wouldn't happen:

"The last thing that Cyprus or any other country needs is a bank run, which will leave the national balance sheet in the classic pinch where "on the left, nothing's right, and on the right, nothing's left." What's more, in many ways the precedent of forcing depositors to take a haircut would be even more damaging than the precedent of imposing a haircut on Greek bondholders: at that point there would be really no reason at all to have deposits in any Mediterranean country."

It might seem a little bit like shutting the stable door after the horse has bolted, but the lines in front of broken ATMs (noted in this Twitter exchange ) certainly suggest that there will indeed be a substantial bank run out of Cypriot banks when they reopen on Tuesday morning. (Cyprus's loss, here, is likely to be Latvia's gain, as this EurActiv article points out.) Cyprus has been relying up until now on its status as an offshore financial center, especially for Russians. That has bloated its banks with deposits (as the Coppola Comment blog notes), and if the deposit bubble bursts, the government has no money at all to bail out the banks. Cyprus's president, Nicos Anastasiades, said today in this statement that he was forced to choose this path because the only alternative was the collapse of Cyprus' two major banks, with "catastrophic" consequences. What he didn't say is that those banks aren't remotely safe yet -- not with the prospect of a massive bank run hanging over their heads.