Cyprus: deserted island

Editorial The Guardian, Friday 22 March 2013 22.17 GMT

Four and a half years ago, the American Treasury secretary was worn down by rescuing reckless institutions, and so decided to get tough with one. Its name was Lehman Brothers

Four and a half years ago, the American Treasury secretary Hank Paulson was worn down by rescuing reckless institutions, and so decided to get tough with one. Its name was Lehman Brothers, and the world is still living with the consequences. The problem was not that his concerns about indulging companies that took dangerous risks were silly; they were well founded. No, the problem was that in his impatience to impose some discipline on an unruly system, he lost sight of the reality that all financial order is based upon the foundation of the banks being able to honour their debts. Watching Europe's bumbling response to the crisis in Cyprus this week, it has felt as if the lessons of 2008, or something very like them, are having to be learned over again.

Since Lehman, we've grown familiar with the phrase "too big to fail". In responding to a small island, a mere quarter-percent drop in the euro zone ocean, the continent's institutions initially acted as if following a dangerous corollary – too small to care. There are disputes about whether President Nicos Anastasiades was following orders, in proposing to rescue banks by helping himself to a chunk of every deposit within them, including those below €100,000 which Europe had previously sworn would be safe everywhere. But even if the idea had a Cypriot genesis, Brussels and Frankfurt should have known that the Cypriot people would never wear it, and yet the plan was pushed all the way to parliament in Nicosia where, attracting zero support, it collapsed and died. Once again, in connection with a currency supposed to bind a continent together, the democratic will of a southern nation has been considered as an afterthought. Far too late, it was remembered that all economic arrangements rely on consent, but at least a scrap of the trust has now been rescued by the apparent shared understanding that any levy will now respect that promised €100,000 guarantee.

The crucial question, however, is whether the scrambled rethink this weekend will be bold enough. On Cyprus's part, capital controls are reportedly under consideration, an extraordinary departure within a single currency zone. As with Mr Paulson's reluctance to stand behind Lehman's dodgy dealings, the reluctance of the Germans to stand behind stricken Cypriot financial institutions is understandable: they have grown bloated; they have acted imprudently; they have relied too much on funds from Russian tax-dodgers, whom bizarrely the Russian state has been defending all week. German politicians are doing no more than respecting the will of their own people in trying to ensure that all this does not go unpunished. But again, as with Mr Paulson, they need to stop and do a commonsensical check on the consequences of being bloody-minded about extracting a price – in this case €6bn – which could soon look paltry in the scale of things.

For if the doors of Cypriot banks were to open on Monday without this thing being resolved, Europe as a whole should wake up scared: for panic can be contagious. If the consequence, as is possible, were the island to slip out of the euro and Cypriot pounds being printed, then the spell of the single currency's permanence would be broken for good. The consequences would even go beyond Europe. Since 1970, of 147 banking crises tracked by the IMF, none have imposed a blanket loss on all depositors. The next year, Richard Nixon broke the dollar's link to gold, since when the value of money has been underpinned by nothing but the word of government. We live with the uncomfortable truth that there is never enough money in the vaults to pay every depositor, largely because we trust the authorities to see to it that – when the pinch comes – the cash would be there. That promise may only ever have been implicit, but it does not follow that there would not be grave consequences from the world seeing that it can be broken.

Cyprus: deserted island | Editorial | Comment is free | The Guardian