The headline in today's Journal is "Merkel's Hard Line, Vilified In Nicosia, Cheers Germany". Some quotes:
"Cyprus lives off a banking sector with low taxes and lax regulation that is completely out of whack. As a result, Cyprus is insolvent and no one outside of Cyprus is responsible for that…We've taken measures in all countries to protect ourselves against contagion effects."
--Wolfgang Schaueble, Finance Minister
"Merkel has nothing to lose in Cyprus."
--Ulrike Guerot, European Council on Foreign Relations
Germany is happy about the Cyrpus banking crisis because it will punish Cypriot sinfulness. I guess the sin is that the eurozone is no place for an offshore banking center/tax haven, which is debatable. But that decision should have been made before Cyprus was admitted into the eurozone. Now its banks have EUR 50 or 60 billion in euro-denominated deposits which Germany wants it to default on. The Journal says that "one reason that Berlin is taking such a hard line on Cyprus now is that it sees the country's crisis as a unique opportunity to end its reliance on tax refugees". This is punishing shoplifting with the death penalty.
Germans are very skilled at making things and being thrifty. They are economically admirable in every way except one: they have never accepted modern capital markets. They have resisted anglosaxon capitalism for forty years, and they still don't accept it. Germany (like France) believes in intermediated financial markets which can be controlled by the authorities in order to ensure financial stability. They don't trust independent market actors like hedge funds, US investment banks or rating agencies. You can make an argument that they are right, but it's way too late. They lost that battle and global finance is now substantially anglosaxonized.
A large percentage of European capital flows today are disintermediated, especially cross-border. And anyway, foreign banks are no more controllable than hedge funds. The creation of the eurozone by itself substantially reduced the power of national authorities. Consequently, the European capital market is now more powerful than the European national authorities. Germany doesn't like this for good reasons, but it is a fact that she can't change. Causing Cyprus to default is not a good way to deal with this issue.