Lessons from Cyprus: Euro Crisis Poses Grave Dangers to EU Unity

Photo Gallery: The Pain of the Cyprus Bailout Photos
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Part 2: Deep-Seated Mistrust across Euro Zone

The anti-European mood in the south, in turn, has spurned the euro-skeptics in the north. Many Germans, Finns and Dutch long felt that Mediterranean countries were incapable of economic reform. As proof, they can now point to Italy's election winners, Beppe Grillo and Silvio Berlusconi, both of whom are publicly contemplating a withdrawal from the common currency.

There is deep-seated mistrust in all of Europe, but the suspicions run particularly deep between the Germans and the Cypriots. For months, the euro-zone leaders sought a solution for the debt-ridden country, but in the end the country still lacked €5.8 billion of the €7 billion it was supposed to contribute to its own bailout.

One of the primary hurdles is the Cypriot conviction that they are more victims of the crisis than they are perpetrators. After all, the main reason their largest banks are in trouble is that Europe ordered a debt haircut for Greek government bonds, many of which were held by Cypriot banks.

Now they feel like laboratory rats, say the Cypriots. They are convinced that the kind of bank account levy conceived of for depositors in Cyprus would never have been attempted on any other euro-zone member state. The prevailing feeling is that because Cyprus is small and weak, Europe felt it could get away with it.

The Cypriots were quick to assign blame. A cartoon in the Cypriot daily O Phileleftheros portrayed Merkel, Schäuble and International Monetary Fund (IMF) President Christine Lagarde as Huns with their swords drawn. A journalist with the same paper referred to as "fascist" Schäuble's characterization of the Cypriot business model as "no longer sustainable."

The German finance minister has become a symbol of the almost insurmountable differences between the Mediterranean country and Germany. "Unfortunately, the mutual perception of our countries is totally distorted," complains a Cypriot diplomat who lived in Germany for a long time. "Nowadays the German public only associates us with money laundering, the Russian mafia and oligarchs."

Victims or Perpetrators?

No Cypriot disputes that the island is a safe haven for foreign capital from around the world. They are convinced, however, that their country's business model differs only slightly from those of other financial centers like Ireland, Luxembourg and Great Britain. Island residents find it outrageous that Schäuble views Cyprus's low-tax model as a failure while a number of German companies profit from precisely that model. For instance, of the 80 foreign shipping companies in the port city of Limassol, 36 are German and only three are Russian.

"Many see Cyprus as nothing but a problem island that is bringing down the euro zone," says Andreas Athinodorou, who runs a tax and corporate consulting business in Nicosia. Last Wednesday, Athinodorou received more than 200 emails from concerned investors who "wanted to know whether their money is still safe with us, and yes, I was able to reassure them," he says. The "Cypriot business model," with the lowest corporate tax rate in the EU, will remain in place for now, says Athinodorou.

But that is precisely what Germany wanted to prevent. Berlin sees the Cypriots not as innocent victims but as being largely responsible for their current predicament. It is, after all, true that Cypriot banks lured billions into the country with low taxes, attractive interest rates and lax regulation -- and much of that money came from dubious sources. Cyprus was known for the fact that no one wanted to know exactly where the money had come from.

Late last year, a report by the BND, Germany's foreign intelligence agency, attracted attention when it portrayed Cyprus as a hub for money laundering. Wealthy Russians in particular were attracted to the favorable conditions and invested billions in Cyprus, often circumventing the Russian tax collector. According to the BND, 80 Russia oligarchs have sheltered their money on the island.

But citizens of other countries, especially Great Britain, also value Cypriot discretion. There is about €70 billion deposited in savings accounts with Cypriot banks. More than half of that, €39 billion, is in accounts with balances in excess of €100,000. European leaders were anxious to trim the island's banking sector to tolerable levels as quickly as possible. But Nicosia was keen to keep its financial industry intact.

Rigidity in Berlin

That desire goes a long way toward explaining President Anastasiades' stubbornness during the negotiations. To protect his banks and their major foreign investors, he initially opposed the Euro Group's plan to introduce a mandatory levy on savings deposits to bridge the funding gap. Ultimately, he acquiesced, but insisted that small deposits also be levied, only to claim afterwards that the hardliners from Germany had supported the inclusion of ordinary savers. In fact, it was Anastasiades who had insisted that large investors be protected as much as possible.

European leaders were astonished when, last Tuesday, not a single member of the Cypriot parliament voted in favor of the bailout package that included the one-time levy on deposits: 6.75 percent for accounts worth between €20,000 and 100,000, and 9.9 percent for those above that level.

Veteran European politicians also attribute the failure of the deal to the rigid position of the German government. "Other countries also have legitimate interests, which isn't sufficiently appreciated in Germany," says Luxembourg Foreign Minister Jean Asselborn. "We also accept that Germany sells a disproportionate number of weapons. In return, Berlin could show a little more understanding for the special situation of smaller countries."

Meanwhile, Berlin rejects all blame for the debacle, saying that those who don't want to be rescued simply cannot be helped. The ESM and the IMF cannot contribute more than the proposed €10 billion in bailout loans, says Berlin, arguing that this is the only way to achieve a debt level of 100 percent of GDP by 2020, as the IMF requires.

For this reason, the troika and the German Finance Ministry also discarded the Cypriots' proposed solution last week, which was to establish a bailout fund, using government and church property as collateral, which could then issue bonds independently. But critics unanimously agreed that the construct would simply amount to Cyprus taking on additional debt. "The proposal is worthless," sources associated with the troika said bluntly.

The Haves and the Have Nots

Instead, the ECB stepped in last Thursday, acting with unprecedented severity in giving a member state an ultimatum. Had Cyprus not submitted to the EU bailout program, the ECB would have cut off funding on Tuesday. To reinforce the threat, the ECB promptly froze its liquidity aid at the current level of €11.4 billion.

Even Southern European countries, normally in favor of generosity, agreed with the hard-line position. And the threat worked, with the Cypriot parliament and other leaders working tirelessly to come up with a deal.

Still, the real loser in the Mediterranean game of poker was the euro zone. Once again, leaders have demonstrated their inability to balance the interests of the currency union "haves" with those of the "have nots." Depositors, for their part, learned that legal protections on their savings accounts are not as concrete as they thought. And international financial markets learned that the term "systemically relevant" is extremely relative.

German Chancellor Merkel has likewise not emerged unscathed. In much of Europe, her image is that of an overbearing, heartless know-it-all who cares little for the suffering of average people. And at home, voters were likewise less than impressed. In the most recent public opinion polls, her Christian Democrats have lost two percentage points of support.

BY SVEN BÖLL, CHRISTIAN REIERMANN, MICHAEL SAUGA, CHRISTOPH SCHULT, ANNE SEITH and DANIEL STEINVORTH

Translated from the German by Christopher Sultan

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1. Eurozone won
Kofi 03/25/2013
The Eurozone made clear that rogue states cannot game the rules. Brussels is no oriental bazar.
2. Two euro's.
yiannaki 03/25/2013
Please do give the South of Europe a Seuro they can devaluate. And when they don't need that anymore (evidence based) they can have the Neuro again. Don't try to press oil out of water.
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