Cyprus votes down--resoundingly--the bailout plan--now what?

03/19/2013 2:39 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The Cypriot parliament today voted down the proposed bailout of the country’s banking sector using a combination of EuroZone money and cash generated by a fee on savings accounts. This is despite changes to the deal that would have exempted accounts holding less than 20,000 euros from what was, initially, a 6.7% fee. The vote wasn’t even close with 36 No votes and 19 abstentions from government members of parliament.

The rhetoric in parliamentary speeches was heated and very anti-German.

These comments to Bloomberg TV from Athanasios Orphanides, a former government of the central bank in Cyprus, exemplify the more moderate rhetoric:

"What we are witnessing is the slow death of the European Project. We are in a situation that some European governments are essentially taking actions that are telling citizens of other member states that they are not equal under the law."

"What we have seen in the last few days is a very serious blunder by European governments that are essentially blackmailing the government of Cyprus to confiscate the money that belongs rightfully to depositors in the banking sector in Cyprus.”

What lies ahead after the vote by the Cypriot parliament?

EuroZone leaders and the Cypriot government can renegotiate a deal. The problem is that Cypriot banks need a huge infusion of cash--$18 billion—and that the economy of Cyprus is so small—about $18 billion—that the standard tools in this crisis—budget cuts and higher taxes—simply won’t work. The reason that the plan tapped saving accounts for 5.8 billion euros to begin with is that 5.8 billion euros is about 32% of the country’s GDP. Try getting that from austerity.

The solutions seem to be more money outright from EuroZone taxpayers (difficult when Cyprus has been portrayed in the German press as a haven for cash from the Russian mafia), an exit from the euro (horrifying as precedent given that Greece blackmailed the EuroZone into accepting Cyprus as a member initially and an exit by Cyprus would lead to threats (at least) of a Greek exit too), or some kind of bailout from Russia.

I think the last option is more likely than it seems. Russia’s Vladimir Putin is livid that the EuroZone didn’t even consult with his government before announcing this plan. Russian banks have lent 40 billion euros to Russian-owned businesses operating in Cyprus. Any plan that imposed capital controls—as a euro exit would—could lead to bank losses estimated a 2% of Russian GDP.

It’s unlikely that Russia would bail out Cyprus for free—even if Putin is mad enough to want to stick it to Germany and its allies in the EuroZone. But Cyprus does have significant reserves of natural gas and I could see a deal that used Gazprom, the government controlled Russian natural gas giant, to bail out Cyprus in exchange for part or all of those reserves. (Russian control of Cyprus’s natural gas would send a shock wave through European governments already worried about their dependence on Russian sources of gas.)

There’s not a whole lot of time to head off disaster. The current bank holiday is scheduled to end on Thursday. If banks reopen without a reassuring plan in place, bank runs across the country are virtually certain on Thursday. A big enough bank run in Cyprus would force the country to impose capital controls, which would, in turn, suck Greek and Russian banks into the crisis. (Big loans to Greek banks is how Cypriot banks got themselves so far into trouble.) And any withdrawal of bank deposits from Cypriot banks will just make it that much harder to prop up the country’s banking system.

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