Cyprus is a small country, but the prospect of a Cypriot bank
bailout made international headlines because of a disturbing
proposal by European Union: It suggested Cyprus should pay for part
of the bailout through a seizure of a portion of the country's bank
deposits.
The proposal could not have done more to increase anxiety about
the
safety of banks
, and to heighten tensions between the haves and have-nots of
Europe.
The bailout proposal
At first blush, the proposal seems outrageous: The government of
Cyprus would seize a portion of all bank deposits on the island to
help finance the bailout. However, it becomes easier to understand
when you realize that this is no ordinary banking system.
Cyprus has less than a million inhabitants, yet it attracts a
disproportionate amount of bank deposits because it provides an
offshore shelter for foreigners (in this case, largely Russians)
who want to hide their assets from their own governments. Cypriot
banks have been so attractive to foreigners that total deposits
equal roughly eight times the island's Gross Domestic Product.
In one sense then, you could say that many of those who would
pay the levy on Cypriot deposits were people who were trying to
game the financial system in the first place. That may or may not
be justified, but the bigger problem is that the notion of deposit
seizures raises global doubts about the banking system -- exactly
the kind of panic that bailouts are designed to avoid.
Lessons from Cyprus
The solution to this bank crisis is still to be determined, but
already there are at least three lessons that can be gleaned from
it:
-
Asset seizures destabilize financial systems.
Free market advocates preach over and over again that there are
long-lasting negative effects on investment when countries
nationalize corporate assets or otherwise arbitrarily seize
property. It's ironic, then, that the economists of the European
Union should make a proposal that amounts to something
similar.
-
It's never a good idea to let people see the sausage
being made.
All this worldwide angst and market disruption occurred not
because these deposit seizures actually took place, but simply
because they were proposed. It was probably premature to
publicize something that had not yet been agreed to, because it
triggered a run on the banks and a great deal of ill feeling
without ultimately raising one penny toward the bailout.
-
People -- including Americans -- may want to rethink
offshore deposits.
All savings accounts are not created equal. From the Cayman
Islands to Cyprus, offshore accounts have been popular for
everything from political reasons to tax evasion. However,
leaving the stability and
regulatory protections of the American financial
system
can have consequences.
Bank savings accounts are supposed to be the ultimate in stable
and secure places to put money. With one proposal, the European
Union has forced people the world over to question that
assumption.