David Frum

03.27.13

The EU's Terrible Handling of Cyprus

Robert Shapiro, co-founder of the Progressive Policy Institute and a Clinton administration economic official, writes scathingly of the EU's handling of Cyprus:

Large depositors account for a tiny fraction of all Cypriot bank accounts, but more than half of all Cypriot bank deposits. It’s a pattern seen almost everywhere, including the United States. Here, bank accounts of $250,000 or more account for less than one-half of one percent of all bank accounts, but nearly one-quarter of total bank deposits. In normal times, our own deposit insurance limits the amount subject to its guarantee at $250,000. But when confidence in banks is fragile or failing, the government always steps in to guarantee all deposits. That’s just what the Treasury and FDIC did in September 2008, to prevent a run on American banks by large depositors that would have spread the crisis across the U.S. banking system. That unlimited guarantee remained in place until our financial system was stable and healthy again, ending only at the end of last year.

Eurozone leaders have ignored these basic tenets of deposit insurance. Instead, they have sent a troubling message to large European depositors: Even in a financial crisis, large accounts are no longer safe. So, the next time that global investors begin selling off Italian or Spanish government bonds, threatening the solvency of the banks holding those bonds, we could see a run by large depositors not only in Italy and Spain, but also across Germany and France. And that would set off a new financial crisis that could trigger a downward spiral across much of world – including us.

Moreover, it seems that unnecessary economic mistakes have become the new norm. Austerity programs for economies struggling with weak recoveries, both here and across much of Europe, are the most common example. That’s why the Eurozone, taken together, has been in a recession for nine months; why Britain’s GDP has declined in four of the last five quarters; and why even the German economy has been contracting since at least last October. And an extended downturn in Europe only increases the likelihood of renewed government bond problems in Italy or Spain which, given this mismanagement of deposit insurance in Cyprus, could spiral out of control.