Earlier today, Cyprus reached a deal with the EU and the IMF to get its desperately needed €10 billion bailout package. The outlines of the deal are very broadly similar to the one floated last week and then voted down in Cyprus’ parliament, but with several notable twists: while depositors with less than €100,000 in savings would be spared, the larger depositors at the two biggest Cypriot banks would take bigger hits than they would have before. In addition, senior bondholders, which many had assumed were safe, stood to lose some of their money as well.It turns out the markets, which had been calm throughout the heated negotiations leading up to this morning’s announcement, weren’t all that pleased with this outcome. Exacerbating the market’s reaction were the poorly chosen words of Jeroen Dijsselbloem, the Dutch Finance Minister and President of the Euro Group, a meeting of the Finance Ministers of the Eurozone countries:
Speaking to the Financial Times and Reuters, Mr Dijsselbloem said the relative market calm in recent months, coupled with the lack of market panic following the decision to force private investors and depositors to pay for the bailout of two large Cypriot banks, allowed the eurozone to go after private money more aggressively when banks fail.
The Wall Street Journal reported that Mr. Dijsselbloem soon walked back his unfortunate words (on Twitter, no less!), saying that despite what he might have claimed in his interview, Cyprus was a unique, one-off case and didn’t set a precedent for European responses to future crises.But the damage was done: there was a selloff in the markets, especially in Europe’s banking sector. And though there was a limited recovery toward the end of the day, Mr. Dijsselbloem’s words can’t have been completely forgotten by investors and savers alike. As Felix Salmon noted, no matter what policymakers say and unsay, the game has subtly changed, and it could have real consequences for the rest of the troubled European periphery:
The chances of European banks being allowed to fail are higher now than they were pre-Cyprus. As a result, we should expect uninsured deposits to continue to flow from the periphery of Europe towards the center. Which in turn means extra pressure on Italian and Spanish banks, just when it’s least needed.
Solving Cyprus wasn’t going to be easy or clean no matter how the Europeans approached it. And it certainly can be argued that there was no other way for the Europeans to deal with this particular case. After all, bailing out a bunch of wealthy Russian depositors was not going to fly in Berlin or any of the other European capitals.But we’re far from being out of the woods here. The pain is only just beginning for Cyprus, and it could easily get intolerable in a hurry. Exiting the euro is not yet out of the question in some powerful Cypriots’ minds, and the real consequences of such an exit may not have been gamed out properly, given how cobbled together and last-minute the Europeans’ response has been thus far.[Jeroen Dijsselbloem, courtesy of Wikimedia Commons.]