(Reuters) - Cyprus's parliament overwhelmingly rejected a proposed levy on savings in banks as a condition for a European bailout on Tuesday, throwing international efforts to rescue the latest casualty of the euro zone debt crisis into disarray.
The vote in the tiny legislature was a stunning setback for the 17-nation bloc; lawmakers in Greece, Portugal, Ireland, Spain and Italy have all accepted unpopular austerity measures over the last three years to secure European aid.
With hundreds of demonstrators facing riot police outside parliament and chanting "They're drinking our blood", the ruling party abstained and 36 other lawmakers voted unanimously to reject the bill, bringing the Mediterranean island, one of the smallest European states, to the brink of financial meltdown.
EU countries said before the vote that they would withhold 10 billion euros ($12.9 billion) in bailout loans unless depositors in Cyprus, including small savers, shared the cost of the rescue; the European Central Bank had threatened to end emergency lending assistance for teetering Cypriot banks, which were hard hit by the financial crisis in neighboring Greece.
The demonstrators were unbowed: "This is a great decision for Cyprus," said Andreas Miltiadou, a 65-year-old pensioner among the crowd. "The voice of the people was heard."
Make no mistake, the road ahead is difficult.
The Cypriots may be crushed.
But telling the IMF, the ECB, the EC and most especially Germany that they will NOT stand by placidly while the powerful devour them was an important message to send to those in the corridors of power.
And some of them may be getting a little of that message.
Reuters describes the euro zone finance ministers as "stunned" by the backlash against the bailout.
They thought that they could push the 6.75%/9.9% levy through and no one would say or do anything much to stop them.
Instead that move initiated a firestorm.
Felix Salmon lays out two ways this could go:
The best-case scenario here is that the vote by the Cypriot parliament is a “phoney war”, in Dan Davies’s words: “A vote on which the government abstains is like opening with two hearts at bridge. It’s a bidding convention, not a serious plan.” Cyprus and the EU will go back for another round of negotiations, with Cyprus trying to front that it has a great offer from the Russians, and the two sides will come to a compromise which doesn’t involve taxing insured depositors. The banks will then reopen, the Russians will pull a large chunk of their remaining money out of the country, the ECB will provide all the liquidity that the Cypriot banks need, and Cyprus will muddle through in an austere kind of way.
The worst-case scenario — call it #CypriOut — is that talks just break down entirely, with no plan acceptable to both the Eurogroup and the Cypriot parliament, while the Russians ultimately decide that they don’t want to throw good money after bad. In that event, Cyprus ends up with a chaotic default and devaluation — think Argentina 2002, only on an island which is already fractured along intractable ethnic lines.
The cost of CypriOut to the ECB and to Europe as a whole would be substantial, both in euros and in precedent. If you think that taxing deposits is a bad precedent, just wait until you see what happens when the world learns that a country can leave the eurozone after all. So a lot of people are going to spend a lot of effort trying to avoid it. And judging by recent European history, some last-minute deal will manage to get cobbled together somehow. But this whole situation is horribly messy — it reminds me of the Argentine political chaos in March 2001, a few months before the country finally defaulted.
Salmon says they probably will get the last minute deal here that staves off chaos, but unfortunately for the EU, this seems to be the only way they can do things and it isn't going to work forever.
There are only so many last minute, cobbled-together solutions they can pull off before they finally CAN'T pull one off and the shit REALLY hits.