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What is the euro zone doing?

I understand why Cyprus is rejecting the terms of the European Union's bailout. What I don't understand is why the European Union is offering these terms. Why would they choose to bail out Cyprus in a way that is almost custom-designed to undermine one of their proudest and most important achievements?

(Simon Dawson/Bloomberg)

Let's consider this from the American perspective. Imagine that, until 2008, we didn't have national bank insurance. If you put your money in a Vermont bank, and the bank went down, your money might well be gone.

Now imagine that in 2009, as a result of a series of huge bank runs caused by the financial crisis, we passed banking insurance. We created the Federal Deposit Insurance Corp. Every bank deposit up to $100,000 was completely insured by the federal government. And lo, there was much joy and celebration in the streets, because finally, at long last, the American banking system was truly safe.

But here we are in 2013. Connecticut still isn't recovered from the housing crisis. They need some kind of federal bailout. And so the federal government says fine, they'll bail out Connecticut, but part of the money will come by taking 5 percent out of every single bank account in the state. That way, all those hedge funders who do their banking in Connecticut will have to pay up, too.

How does that not completely and utterly destroy the banking insurance system? Can the answer really be, "Your deposits are safe and fully insured, unless the federal government decides to arbitrarily take money out of them?" And if that is the actual deal being offered, then isn't the banking insurance worthless? Why would you bank in the euro zone rather than, say, the United Kingdom?

That, as far as I can tell, is what's happening in Cyprus. The euro zone will bail out Cyprus only if Cyprus will agree to take some 6 billion euros, strap them to a missile, and launch it directly at the currency union's deposit insurance system. That strikes me as a far costlier solution than simply ponying up the 6 billion euros needed to save Cyprus. The fact is that Cyprus is a tiny country with a tiny economy. Saving it in such a way that you undermine the banking system of the entire euro zone seems insane.



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Brad Plumer · March 19, 2013

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