Crafting the Cyprus Deal: A Road Filled With Blunders

People queue at an ATM outside a closed Laiki Bank branch in capital Nicosia, Cyprus, Thursday, March 21, 2013. The European
People queue at an ATM outside a closed Laiki Bank branch in capital Nicosia, Cyprus, Thursday, March 21, 2013. The European Central Bank says it will keep emergency aid for Cyprus' troubled banks in place at least until Monday but will have to cut it off after that unless an international rescue program is drawn up. (AP Photo/Petros Giannakouris)

It's almost like Brussels has a sort of policy amnesia. The role of the Troika in bailing out governments and banks is nothing new, but the solutions put forward by EU leaders to improve the Cypriot crisis seem to be founded on little foresight, and without regard for the tragic mistakes of the past few years.

Last week's solutions, which thankfully never materialized, proposed a governmental foray into peoples' savings accounts. In theory this was a fine solution. Lest the country's troubled banks stop receiving assistance, the European Central Bank demanded Cyprus to pony up $7.5 billion, an amount equivalent to 30 percent of the country's GDP. The math made sense on paper, but in reality much of the money behind those figures came from everyday people. It didn't matter whether that money was saved for someone's retirement, schooling, mortgage, or car payment. If last week's policy came to life, all deposits would have been diluted by at least 7 percent.

If the idea sounds ridiculous, frightening -- stultifying, even -- it's because raiding peoples' savings accounts is all of these. The late hours of Sunday night saw the eurozone leaders agreeing to a measure that leaves most deposits untouched, but it seems that they've now set a precedent: if a eurozone government needs extra dough, savings accounts are fair game.

But what's even more shocking is that last week's policy wonks discussed these measures despite the existence of a eurozone decision in 2008 to insure bank depositors up to 100,000 euros. So at the crux of it, last week's policy suggestion spits in the face of such financial guarantees. It gives people one more reason to distrust their banks and hoard their money at home. And when money lies under the mattress instead of in the bank, the banks have nothing to dole out in the way of loans. And there we are with people who can't take out loans and therefore buy a house or improve their business. We've come full circle in worsening our recession.

A recent opinion piece by Douglas Elliott, a seasoned investment banker, compares the behavior of the eurozone to that of an unfortunate soul playing Russian roulette. The currency union pulls the trigger by assembling some drastic measures at the last moment before economic doom. To everyone's delight, the bullet doesn't fire: whatever policy emerges happens to save the euro from collapse, and people blissfully move on. That is, until the next catastrophe when some housing bubble, or bank default, or government insolvency sounds the alarm. Then the eurozone can once again pull the trigger hoping that the bullet won't really be there. According to Elliott, it would have been so much easier to bail out the country's banks without too much fuss. That way they could have focused on reform and encourage what's really needed: growth.

Take a moment to imagine that you're back in 2010. All of a sudden, draconian demands instituted by the ECB sound eerily familiar. During that year, Greece, which in many ways is Cyprus' closest cultural relative, entered contentious discussions with the Troika. In exchange for funds to keep the government afloat, Athens passed drastic austerity measures, ones that kept the balances in check, but ultimately placed the burden on ordinary people. The cutbacks shrank the economy, elevated the poverty rate, and eroded the quality of life. The social toll of the economic cutbacks contributed to the rise of an extremist neo-Nazi party that now claims seats in the Greek parliament. The painful austerity measures restricted any possibility that Greece could climb out of the sort of habits that led it into enormous debt in the first place.

To be fair, Cyprus is in a much different place; this time the ECB is bailing out the banks rather than an entire government. But the lesson from Greece says that strict austerity without encouraging some modest growth is a recipe to prolong the European recession. I hardly see how last week's suggestion to raid peoples' bank deposits encourages the growth that Europe needs right now. Instead, it gives people reason to pull their money out of the banks, ultimately destabilizing the financial sector.

As proof that it vanquishes faith in the banks, look at what happened to the stock market on Monday. Investors exalted when they saw that Europe surmounted the Cyprus problem. But not long after, Jeroen Dijsselbloem, the leader of the finance ministers in Europe, put in his two bits: the recent Cyprus decision, he commented, is a model for any struggling eurozone economy. Taxpayers won't bail out the banks, but depositors and bondholders will. To say this so soon after the success of Sunday's eurozone deal was simply asinine and brazen. Mr. Dijsselbloem gutted what little faith people had left in the banks, sending the message that your money is safe nowhere. He softened his remarks later in the day, but it was too late. Newspapers in Athens and Madrid ran almost identical headlines that focused on the gravitas of the Cyprus decision and the precedent it lays for the future.* Investors cringed and stocks plunged on both sides of the Atlantic.

Personally, I never expected Cyprus to flourish in the years immediately after the Greek crisis. For a variety of cultural and historical reasons, Cypriot banks heavily exposed themselves to the Greek economy. And when the latter fell apart, it was only a matter of time before the tempest moved farther into the eastern Mediterranean. It simply demonstrates that we can expect a handful of economic hurdles in the future, if only because what happens in one country affects what happens in others.

As the Troika starts a new chapter after the recent acrimony in Cyprus, its leaders must seriously rethink the narrative they offer to the public. The importance of keeping state and bank budgets in check must carefully weigh against the need for economic growth and social stability. This most recent hurly-burly was unnecessarily tense, a climate that, according to Moody's, inflicted enough damage on Cyprus' large financial sector to be felt for years to come. Scaring people into a bank run is no way to encourage the sort of fiscal punctilio that the Germans want of the struggling southern Mediterranean countries. If they consider the misery of the Greek situation, they'll know not to turn that direction, and instead advocate simultaneously for growth and responsible spending.

If I'm correct, the responsible thing to do with one's money is save it. In most places, having a savings implies that a person has discipline, stability, and resolve. But in the eurozone, apparently, putting a savings in the bank isn't smart. It shows stupidity.

*My translation of the Greek and Spanish headlines are as follows: "Cyprus Agreement a New Prototype for Europe, Says Dijsselbloem," and "Eurogroup Leader Proposes the Cyprus Method For Other Countries"