How German fears of underwriting Russian oligarchs pushed Cyprus to crisis

Could the tiny economy of Mediterranean Cyprus, in urgent need of a bailout package, pull the whole eurozone back into crisis?

The answer, it became clear in the past few days, is yes. And the responsibility lies with the eurozone’s strongest economy, Germany.

For months, eurozone finance ministers have been debating how to help Cyprus, whose banks, exposed to large amounts of bad Greek debt, are in dire need of recapitalization. Cyprus is the fourth eurozone country to apply for financial aid from the European Union, the European Central Bank (ECB), and the International Monetary Fund (IMF), after Greece, Portugal, and Ireland.

It is also by far the smallest, and the amounts needed to keep it afloat are relatively modest, around 10 billion euros ($13 billion). So, late last week the ministers at a meeting in Brussels finally decided on a bailout package.

But for the first time, at the insistence of the German government, private account holders were being asked to shoulder a part of that bailout, around 5.8 billion euros ($7.5 billion), through a special levy on their savings.

“The German taxpayer is willing to help Cyprus,” says Michael Fuchs, a member of Parliament for Chancellor Angela Merkel’s Christian Democrats. “But the Cypriots have to help themselves and pay a tax on their deposits.”

An ashen-faced Nicos Anastasiades, president of Cyprus, told his fellow countrymen in a televised statement that it was either this deal or state bankruptcy. Under the deal, people with more than 100,000 euros in their accounts would have to pay a 9.9 percent tax, while people with less than that would pay 6.7 percent.

Cypriots' reactions were shocked and angry, the more so when they realized that over the weekend accounts had been frozen and transactions were impossible. Banks were closed today for a national holiday and officials said they would remain closed until Thursday to prevent panic reactions amongst customers.

Today, the Cypriot parliament was meant to approve the bailout deal. The vote was postponed to Tuesday though when it became clear that President Anastasiades would face defeat. MPs are particularly unhappy about the fact that holders of small accounts should be taxed too. Angry protests in the streets of the capital, Nicosia, lay the blame with Germany’s government.

But German Finance Minister Wolfgang Schaeuble made it clear in an interview on German television today that for him it was not important where the Cypriots raised the money – as long as they did raise it.

There are two reasons for this unusual conditionality. First, German politicians and many of their European colleagues suspect Cyprus to be a tax haven and a money-laundering site for Russian oligarchs. Of the 68 billion euros stored in Cypriot bank accounts, around 20 billion ($26 billion) belong to Russian account holders. A report compiled last year by the German secret service, the Bundesnachrichtendienst, claims to have found evidence that Cypriot banks or Russian bank branches based in Cyprus are used to launder illegal money.

The second reason is that Germany’s ruling coalition of conservatives and liberals is facing general elections in September, and politicians fear accusations they are sacrificing German tax money to bail out Russian billionaires. “There is a lot of, let’s say, difficult money in Cypriot accounts,” says Mr. Fuchs. “We want this to be taxed.”

The question now is what the rest of the eurozone – and indeed the international financial markets – make of the deal. The verdict seems to be a general thumbs-down. Shares in Europe, particularly those of banks, were down today.

And economists warn the Cypriot example could set a risky precedent. American Nobel prize winner Paul Krugman called it a “dangerous solution” that could cause mass withdrawals in countries like Greece and Italy. And Peter Bofinger, a member of the so-called council of wise men advising the German government on the economy, said in an interview with German magazine Der Spiegel, “From now on Europe’s citizens really have to worry about their money.”