By JAMES KANTER, NICHOLAS KULISH and ANDREW HIGGINS - March 18, 2013
BRUSSELS — A plan to rescue the tiny European country of Cyprus, assembled overnight in Brussels, has left financial regulators, German politicians, panicked Cypriot leaders and a disgruntled Kremlin with a bailout package that has outraged virtually all the parties.
In the end, a bailout deal that was supposed to calm a financial crisis in an economically insignificant Mediterranean nation spread it wider. Word of the plan unnerved markets across Europe, raised fears of bank instability in Spain and Italy and sent pensioners into the streets of the island’s capital, Nicosia, in protest.
As markets tumbled and the Cypriot Parliament fell into turmoil, salvos of blame were hurled back and forth across the Continent.
Officials scrambled to explain what went wrong and how best to control the damage of what Philip Whyte, a senior research fellow at the Center for European Reform, called a “completely irrational decision” to make bank depositors liable for part of the bailout. The deal flopped so badly that finance ministers who came up with it shortly before dawn on Saturday were on the phone to each other Monday night talking about ways to revise it. Whatever the outcome, the dispute is a vivid demonstration of why Europe, which until recently was congratulating itself on having weathered the worst of the financial storm, has trouble making decisions with so many different interests represented at the table.
Politics, both domestic and international, get in the way of economics and make it difficult for wealthy countries to line up behind a plan to help the smallest ones. The northern European nations have grown so weary of bailouts for their southern neighbors that they were intent on exacting a hefty contribution from their latest supplicant. Germany in particular, with parliamentary elections looming in September, was set on driving a hard bargain.
A wild card in this instance were the Russians, who have deposited billions in Cypriot banks, extended a $3.25 billion line of credit to Nicosia in 2011 and were in negotiations to help out Cyprus once again. Cypriot leaders apparently were so concerned with keeping their wealthy offshore Russian customers happy that they pushed their own citizens to pay even more than some of the lenders were demanding.
The Russians reacted angrily to a so-called stability tax on deposits in Cyprus, and at being left out of the negotiations. On Monday, Russia’s minister of finance, Anton Siluanov, warned that Russia might not extend the existing credit line because the Europeans had not consulted authorities in Moscow about the deposit levy plan. On Sunday, one Russian official was reported by the Interfax news agency as advising Russians to withdraw funds from Cyprus, saying the banking system was untrustworthy.
The all-night discussions began Friday and ran for 10 hours, ending shortly before dawn on Saturday. Cyprus needed to come up with billions of dollars to help cover the costs of the bailout of the country’s financial sector, or its European allies said they would leave it to face the prospect of collapse alone.
Each of the major stakeholders, which included the International Monetary Fund, the European Central Bank and euro zone finance ministers, entered the room with a conflicting goal. Protecting the small-time saver was at the top of no one’s list. The result was a compromise solution everyone is now unhappy with, officials say, one that stands to cost ordinary Cypriot depositors 6.75 percent of their savings.
The Germans and their northern European allies wanted to exact a maximum contribution from Cyprus to ensure the deal could pass their recalcitrant, bailout-weary parliaments at home. A confidential report by the German foreign intelligence agency, known by its German initials as the B.N.D., was making the rounds, one that painted the island as a haven for money-laundering. The stigma attached to helping the Cypriots — and the political cost in an election year — was rising rapidly.
The I.M.F. was dead set on keeping the debt at what its number-crunchers considered a sustainable level. The Cypriots, meanwhile, wanted to spread the pain around.
After midnight, negotiators thought they had a proposal that could work: a one-time “tax” of 12.5 percent on depositors with $130,000 in the bank and milder but still painful cuts of around half that or less for everyday account holders — the pensioners and laborers who thought their money was protected.
The proposition, worked out by small group of finance ministers, including those from Germany and the Netherlands, and the European Central Bank, was taken to a different room in a sprawling, Brutalist Brussels office mocked by some as the Kremlin and shown to Nicos Anastasiades, the newly elected president of Cyprus.
The president, who had left initial talks in the hands of his own finance minister, flatly rejected the offer. He insisted, according to European officials, that large depositors must not face a levy higher than 10 percent.
This meant that small savers would have to take a bigger hit, but it did soften the blow on Russians and others who, looking for a safe place to park their money, have turned the tiny Mediterranean island into a financial center known for not asking too many questions.
What happened next sealed the deal, which now appears to be coming apart amid strong protests from ordinary Cypriots. Jörg Asmussen, a German member of the executive board of the European Central Bank, told Michalis Sarris, the Cypriot finance minister, that stopgap financing for Cyprus would be cut off this week if no agreement was reached.
Mr. Asmussen’s message “really did sharpen the thinking of Mr. Anastasiades,” said a European official with knowledge of what happened during the talks but who spoke on condition of anonymity because they were conducted in private.
“The Cypriot president understood clearly he faced the collapse of his banking system and disorderly exit from the euro area,” said the official.
What emerged was a deal that took a bite out of average savers, one that made sense in the wee hours between the dealmakers. In the light of day, as Cypriots tried desperately to pull their savings out of A.T.M.’s, it looked like a threshold that many experts say should never have been crossed.
“The result is a likely bank run in Cyprus alongside financial and sovereign instability in the wider euro area,” said Mujtaba Rahman, a senior analyst with the Eurasia Group who has followed the European debt crisis.
At several points along the path that led to the decision on Saturday morning, the European Commission, the union’s policy-making arm, tried to warn that imposing losses on bank accounts could be a recipe for panic — and not only in Cyprus.
In the weeks leading up to the meeting on Friday, Olli Rehn, Europe’s commissioner for economic and monetary affairs, told a representative of the Eurogroup of finance ministers that the levy should probably be set at 2 percent, and certainly at a level no higher than 5 percent, across all types of deposits.
The European Central Bank also had reservations about levying higher taxes, but the Germans wanted $9.2 billion from depositors, officials said. That was an enormous contribution for a country the size of Cyprus.
Imposing the tax on all bank deposits in the country was, in part, a move “to stop money being put into smaller packages or to have it sliced up” so that wealthier depositors, including Russians, would be able to avoid the tax, said one diplomat, who spoke on condition of anonymity because the talks were held behind closed doors.
The Cypriots insisted that they couldn’t “go beyond a one-digit number for higher deposits,” said another official familiar with the discussions. “From there its simple mathematics if you don’t want to go above that.”
Mr. Rehn then went to Mr. Sarris with slightly revised numbers lowering the rate on larger deposits, right up against the threshold at 9.9 percent. The contribution from depositors had come down to $7.6 billion, leaving the rate on smaller holdings at 6.75 percent.
With few options, Mr. Anastasiades accepted the new terms.
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