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Cyprus: Europe Violates the Sanctity of Insured Deposits

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Europe has crossed the red line of the sanctity of insured deposits by making them subject to a partial confiscation.

It is pure extortion of bank deposits that the European Union has asked Cyprus to proceed with.

This action has huge long-term and short term consequences. Mohamed El Erian , from Pimco, expressed the same concerns in his blog post. The same applied to a blog post by Paul Krugman.

Some consider it to be worse than the management of Lehman Brothers.

Europe Provokes a Run on the Banks

As it became clear that a 6.75 percent to 9 percent levy would be imposed on deposits, Cypriots run to their banks to get some cash only to find that, before the measure was even approved by the Parliament, the Cypriots could not withdraw money from their ATM machines. While most governments have done everything to avoid a run on the bank, the European Union has provoked this run and made it impossible for the banks to service their clients.

This is stunning and unheard of: There is no precedent for such a brutal action against bank depositors. It is worse than expropriation, for which there is a quid-pro-quo of fair compensation.

Bank Deposits Must Be Protected

Bank deposits have been, throughout the entire financial crisis, the reason why taxpayer money was used to bail-out banks. It is the core of confidence of the public in banks. In the banking regulation efforts, everything was done to avoid the contamination of core banking by trading activities, and deposits were considered sacred.

For the European Commission to declare war on deposits is turning its back on everything that it tired to do to create a stable financial system in Europe. Whether it is legally or ethically justifiable, is highly questionable, but that does not seem to have even been considered by Brussels and Nicosia. It is an absolute shame.

The Consequences of This Action Could Be Dramatic

Over the past two years, the difficulties of several countries in difficulty has been compounded by substantial withdrawal of money from their banking system. The worst case was Spain where month after month, billion of euros were withdrawn from Spanish banks and transferred to safer banks.

Now that it becomes clear that the European Union will not hesitate to tax deposits, we can expect that any country that is threatened by a bailout will face massive withdrawal of deposits, making the situation worse, and even unmanageable.

The European short-term action for Cyprus will boomerang in Italy, Portugal or Greece and compound the difficulties of those countries.

Is It Intentional or Stupid?

Whether this action is actually intentional or stupid does matter. If it is intentional, Europe has put the most lethal bomb under its entire banking system. Apprentice sorcerers since the beginning of 2010, when the Greek crisis erupted, Europe needs to called to publicly explain how and why it did approve such brutal and inhuman action and took the risk to threaten the deposit base of its banks.

It is too easy to hide behind the new Cyprus Prime Minister who desperately needs the 10 billion euros promised by Brussels. The Member States who approved that package last week are guilty, unless proved otherwise, of one of the most dangerous move in the history of the financial crisis.

However, stupidity could always be part of this drama: Europe has accustomed the world with dysfunctional decisions whose consequences it did not understand.

Markets understood immediately the threat and the Euro started tumbling in Asia this Sunday evening. Fresh turmoil is expected in Europe as it opens on Monday morning.

Backtracking this Monday will not change the fundamental question: where is Europe when it comes to protecting retail deposits? Is there no sanctity of retail deposits? The Heads of State and Government and their Finance Ministers are called in for a serious explanation: how could they have approved a decision that infringes the European Directive that provides for a 100,000 euro minimum bank deposit guarantee?