BUSINESS
03/25/2013 08:23 am ET Updated Mar 25, 2013

After Cyprus Bailout Deal, Europe's Problems Worse Than Ever

Cyprus may have been saved from disaster, but don't be fooled: Europe is still a hot mess.

In the middle of the night on the continent, officials managed to hastily stitch together a plan to rescue Cyprus and keep it from leaving the eurozone. The deal came just hours before a European Central Bank deadline that could have left Cyprus cut off from short-term capital, beginning the potential unraveling of the entire currency union. It also came just about one week after another hastily stitched-together bailout deal sparked outrage in Cyprus and around the region and created the need for desperate last-minute talks in the first place.

To paraphrase Winston Churchill, European policymakers always do the right thing, but only after exhausting every available alternative. As Quartz's Simone Foxman points out, this is no way to run a currency union, which together makes up the world's second-largest economy. And there are reasons to suspect this won't be the last bungled bailout.

The Cyprus debacle came about in part because the European Commission and the International Monetary Fund weren't on the same page about what to do with Cyprus from the start, the Financial Times reports -- an echo of their disagreements over helping Greece last year. This incident has left their relationship more fraught than ever, and it means we could very well get a repeat of the botched Cyprus bailout soon -- in Slovenia, or Italy, or who knows where else.

"The troika model has become dysfunctional," a European official told the FT, referring to the trio of the European Union, IMF and European Central Bank. This troika has been responsible for bailing out countries throughout the crisis. This is the wrong moment for it to break down.

Also further breaking down are relations between northern European nations, led by Germany, and economically troubled southern Europe, represented by Greece, Italy, Spain, Cyprus, et cetera. Suffering from bailout fatigue, northern countries took a harder line than usual with Cyprus -- an ominous sign for the next crisis.

Europe even managed to annoy Russia, by failing to include it in talks over Cyprus, even though wealthy Russian depositors in Cypriot banks were going to be shellacked in any deal. Annoying Russia almost never ends well.

"We suspect that the same regime that locks up a punk rock band for criticizing it, will find a way to express its dissatisfaction with the EU and Germany," Brown Brothers Harriman currency strategists wrote in a note Monday morning.

Also burned by this debacle: Small depositors in banks throughout Europe, who have to be thinking twice about what to do with their money. European policymakers can claim that their initial effort to shove small Cypriot depositors under the bus was a special one-off circumstance, but the principle of Thou Shalt Not Shove Small Depositors Under The Bus, sacrosanct throughout the developed world, was nearly violated. People don't tend to forget that sort of thing.

Europe still needs a banking union with inviolable depositor protection and procedures in place for winding down failing institutions. Banks the size of the troubled banks in Cyprus failed almost every week in the U.S. after the crisis without causing a ripple, thanks to the Federal Deposit Insurance Corporation. Europe needs its own version of the FDIC, but that is still a distant dream.

Europe also needs a fiscal union, where the stronger economies help out the weaker economies as a matter of course, and crisis decision-making does not involve a troika of government bodies parachuting in at the last minute every time. Europe today is often compared to the United States when it was knit together by the Articles of Confederation. The U.S. wouldn't have survived that model, and Europe's union can't survive in its current form. Sorting out a permanent solution was always going to be difficult. It is going to be a lot harder when everybody's angry with each other.

Financial markets will cheer the Cyprus deal Monday morning and in the days ahead, and with good reason: Disaster has been averted once again. But Europe will be back to frighten them again. The next crisis may not be solved so cleanly.

Update: In fact, the relief of financial markets lasted scant hours before things started to come unraveled again. European and U.S. stocks have been worsening all morning. The Dow Jones Industrial Average was recently down about 70 points, and the Euro STOXX 50 index was down about 0.7 percent.

The selloff was sparked by some alarming statements this morning: Dutch Finance Minister Jeroen Dijsselbloem, the leader of the Eurogroup finance ministers, brilliantly suggested Cyprus's bailout deal could be a "template" for future deals, leading everybody to freak out about the idea of depositors and creditors taking brutal haircuts in the future. Then a Cypriot lawmaker suggested Cyprus could still leave the euro zone. Rating agency Moody's warned that, given the dismal state of Cyprus' economy, an exit from the euro zone was still a strong possibility. Others suggested that, with recently imposed capital controls, Cyprus had all but left the euro zone already anyway.

So, yes, though the immediate crisis has once again been averted, little has been solved.

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