The Washington PostDemocracy Dies in Darkness

Why the new Cyprus deal sows the seeds of the next European crisis

Europe called a mulligan.

Ten days ago, they arrived at a deal to rescue Cyprus in part by taking money out of depositors’ accounts in the country’s banks. The reaction was an unpleasant one, with the precedent of seizing money from European banks even for small depositors whose deposits are theoretically insured prompting new tremors of worry about the euro currency union.

They tried again this past weekend, with the same characters meeting in the same conference center in Brussels and hammering out the same issues. The new deal they came up with is a cobbled together thing that fixes some of the most glaring problems of the earlier one. In particular, people with deposits in solvent Cypriot banks will no longer face the tax on their deposits. Even at the problem banks, Laiki and Bank of Cyprus, people with less than 100,000 euros in deposit will face no losses, consistent with Europe’s bank deposit guarantee.

But the cost of protecting smaller depositors is that those with large deposits at the two problem banks are looking at huge losses—40 to 50 percent, not the 9.9 percent in last week’s deal. Much of that money are deposits of wealthy Russians, who will be none-too-pleased with seeing their savings evaporate. Don’t expect simmering diplomatic tensions between Russia and Western European nations to go away anytime soon.

So is the Cyprus crisis (Crysus?) averted? It depends on what you mean by crisis, and what you mean by averted.

The Europeans have found a way to bail out Cyprus that navigates the various imperatives they faced. Germany’s upcoming elections make Angela Merkel’s government reluctant to undertake open-ended bailouts. The IMF doesn’t want to throw good money after bad by giving emergency lending to a country that will never be able to repay it. And the European authorities don’t want to undermine their communal bank deposit guarantee scheme before it has even really gotten going.

The question was always who would be stuck holding the bag. Cypriot taxpayers, Germany and the other stronger nations of Europe, or the depositors with big accounts in Cypriot banks (the list includes wealthy Cypriots, Russians, Brits, and other international savers).  The answer, overwhelmingly, has turned out to be the last of those, which is how the “troika” negotiators of the European Commission, IMF, and European Central Bank navigated the constraints they were facing.

But to make it stick, Cyprus will have to implement capital controls, in order to prevent mass withdrawals from its banking system and an associated economic collapse. Already, people with accounts at the still-closed Bank of Cyprus and Laiki are reportedly limited to withdrawing 120 euros a day from ATM machines, down from 260 euros last week. It is clearly aimed at preventing people from withdrawing their money as cash and then taking it out of the country. When the banks reopen, there will presumably be major restrictions on electronic transfers of euros in Cypriot banks.

It’s hard to overstate what a profound violation of the idea of a unified currency area this amounts to. It is a rejection of one of the fundamental goals of European economic unity. There is no such thing as a currency union in which capital cannot flow freely; if Americans with accounts in New York were prohibited from transferring their dollars to California, the United States wouldn’t really be much of a currency union at all.

Financial markets rose on the deal—the German stock market was up 0.5 percent Monday, for example. And it is true that the deal over the weekend solved the immediate problem Europe was facing. Given the cul de sac in which Europe, and Cyprus, found itself, there may not have been better options. But now, more than three years into the Eurozone crisis, a new Rubicon has been crossed, and the possibility of another bad turn have reappeared.

If you are a depositor in a European bank, you now have every incentive in the world to move your money somewhere safer, or even to keep it in cash, the minute you detect any hint that your nation could end up in the same place Cyprus did. The next time there is a banking panic in Europe, it will move much faster, and be much harder to control, than those of the recent past, as depositors try to get ahead of future losses and capital controls. And that's a scary proposition indeed.