A Broken Bailout In Cyprus: Foreshadows of a Broken Europe

BY YURI VANETIK

The Cyprus bailout deal is now official.

Together with the International Monetary Fund, representatives from the European Central Bank and the European Commission just ratified a final rescue package totaling about $13 billion. In return, Cyprian officials are now obligated to install a broad variety of austerity measures, including financial industry reforms and restrictions on private banking transactions.

This deal is a capricious, economically illiterate mess certain to prolong the island’s suffering. It empowers parasitic public officials to pay off sovereign debts by raiding the savings accounts of private citizens. And it also hobbles local industry with intrusive new taxes and fees.

Eurozone officials should have aimed to ensure that any new rules would, over the long term, make the Cyprian economy an attractive place for international investment. The bailout package does little to accomplish such a goal.

For starters, it includes a $9.8 billion “bail in,” largely financed by simply siphoning savings away from affluent private citizens. Depositors with more than $130,000 in Cyprian bank accounts will immediately see 40 percent of their money spirited away, with any additional 20 percent set aside as “buffer” in case public bureaucrats decide they need more.

Meanwhile, cash withdrawals are now indefinitely capped at $390. Daily business transactions are limited to $6,500. Moreover, there’s a $32,500 ceiling for commercial deals approved by the country’s central bank. This brazen spread-the-pain strategy might satisfy the neo-socialist sensibilities of euro zone officials. It might even achieve its ostensible purpose of preventing bank runs and keeping capital on the island.

But it’s a perfectly toxic cocktail from the vantage point of an international investor. Of course, it would have taken several years of sustained fiscal discipline and regulatory reform before anyone would seriously consider injecting financing back into Cyprus. But these new capital controls will snuff out whatever sliver of confidence may have still been left in the Cyprian banking system.

Banks are essential intermediaries of commerce. If they break down — that is, if they can no longer be trusted to honor and protect deposits — so does the market. Ergo, the incentives for international investment collapse.

What’s more, these capital controls are actually outlawed by the EU’s own founding charter. It explicitly states that “all restrictions on the movement of capital between member states and between member states and third countries shall be prohibited,” except in rare instances of “public security.”

This bailout sends the message that EU officials can’t be trusted to follow their own rules. They’ve injected even more uncertainty into the continental economy. The aid package also ratchets up the Cyprian corporate tax rate from 10 percent to 12.5 percent and raises levies on alcohol, tobacco and some other consumer goods.

Pre-bailout, Cyprus’ chief selling point on the international market was its advantageous tax treatment of bank deposits. Savers from all over the world socked their money on the island.

Those savings drove a sprawling, vibrant domestic banking industry, supporting tens of thousands of jobs, including lawyers, tax accountants, bankers, notaries, trustees, IT personnel, and hospitality and administrative staff. The bailout deal is guaranteed to permanently contract the island’s core industry and put these positions in jeopardy.

So, now that EU officials have smothered the Cyprian economy with capital controls and new taxes, how exactly do they expect Cyprus will ever grow out of this mess? Surely, the island nation can’t rely on perpetual handouts from Germany. International investors will have little interest in Cyprus. And the Cyprian government surely won’t jumpstart economic growth – it has already proven itself galactically wasteful and corrupt.

It’s high time for a head check in the European Union. Officials need to radically reformulate their conception of the proper role of government. Banks need to be seen for what they actually are — private companies. They should not be treated as pseudo utilities. They enter into voluntary exchanges with investors, creditors, depositors, and vendors. They deserve neither special treatment nor bailouts.

Meanwhile, public officials driving up sovereign debt should be held to account when that load breeds economic chaos. Public debts should be recouped with cuts in government expenditures. Meddling bureaucrats certainly shouldn’t be empowered to cover the tab they’ve racked up by stealing money from private citizens.

The essential elements for recovery are simple — a far-sighted national regulatory framework conducive to private entrepreneurship and investment. Unless European Union officials recognize this reality, their partnership is destined to fail.

Yuri Vanetik is a principal at Dominion Partners, a private equity real estate firm, and a Lincoln Fellow at the Claremont Institute. He also serves on the national boards of Gen Next (www.gen-next.org) and the Gen Next Foundation (www.gen-nextfoundation.org)