What's Wrong With The Cyprus Bailout

The draft proposal on the table to bail out Cyprus consists primarily of closing one bank--Popular Bank of Cyprus, also called Laiki Bank--transferring deposits of 100,000 Euros or less to another large bank called Bank of Cyprus, and freezing deposits exceeding 100,000 Euros.  The frozen assets, which evidently amount to somewhat over 30 billion Euros, will be used to fund Cyprus' share of the cost of the bailout (5.8 billion Euros).  How much frozen account holders will ultimately receive is unclear, since the funds for paying them out would have to come from bad assets of Laiki Bank--defaulted loans and the like.  The hit they will sustain apparently could be large.

At first glance, this revised bailout appears not unlike bank liquidations as seen in the U.S.  Account holders with insured deposits (i.e., at or below the $250,000 threshhold) are fully protected, and those holding excess balances are at risk, taking losses if the assets of the bank don't fully cover the nominal value of their accounts.  But the Cyprus bailout is different.

The process by which Cyprus and the EU got to where they are today was one of political fits, false starts, near collapses and last minute expediency.  The first proposed bailout included a levy on all deposits, a proposal which the Cypriot legislature roundly rejected.  After scrambling futilely for assistance from Russia, the Cypriot government bowed to the stern diktat of the European Union that depositors be tapped.  But both the EU and the Cypriot government wanted to protect insured deposits (those of 100,000 Euros or less), so the burden had to fall on deposits in excess of the insured amount.  And because Laiki Bank is suspected to be the bank of choice for a supposed den of money launderers, tax evaders and other scoundrels, the blade fell on its large depositors.  Large depositors at other banks were spared the guillotine.

 What's missing is the due process of law.  There isn't even a flimsy facade of legal due process.  This isn't an ordinary liquidation of a troubled bank.  Cyprus got into financial trouble, asked for a bailout, was told by the EU that a Cypriot contribution would be a prerequisite, and only then did Cyprus figure out who would pay the piper.  The ultimate resolution is politically driven, not the result of the application of established legal procedures. 

If the large depositors of Laiki Bank are iniquitous Russian oligarchs as some EU officials have hinted, one can't feel terribly sympathetic about their plight.  Legality doesn't seem to have played much of a role in the way many wealthy Russians acquired their riches.  But, ordinarily, modern nations seize property only in accordance with the rule of law.  If a bank depositor isn't proven to be liable, for one lawful reason or another, then he or she shouldn't be deprived of property. 

It wasn't Robin Hood, or even Jesse James, who absconded with the assets of large depositors of Laiki Bank.  It was the sovereign governments of the European Union.  When governments depart from the rule of law, capital will start exiting stage right.  Large depositors in any EU nation that's financially shaky will likely behoove themselves to move their capital to safer places.  The shaky countries may get shakier.  The EU tries to present the Cyprus situation as a unique, one-time problem.  But how many well-to-do depositors want to leave their money at risk, in case that's not true? 

The EU will enjoy a near-term rebound from the Cyprus bailout.  But longer term, it encounter trouble attracting the capital it badly needs to rebound from recession and fuel future growth.  And it may well find that dealings with one of its major energy suppliers--Russia-- will take sharper tone.  When the due process of law isn't applied, some people start thinking that might makes right.  And that would be unfortunate for Europe, given the history of the last century.