Why Cyprus Matters

To American policymakers working through the sequester, Cyprus’ 10 billion euro bailout must sound like a rounding error. Context is key: the amount equals nearly half of Cyprus’ annual GDP. Euro-watchers first warned that the disjointed political path to the bailout agreement  — including a proposed tax on all Cyprus bank deposits — adds to the potential market uncertainty likely to greet future crises. A second warning holds that the EU may overcorrect in its stance towards moral hazard in its banking system; after tolerating too much for too long, it might allow too little. True as these arguments are, they risk obscuring other important messages in the crisis. Two key ones are getting buried in the post-crises analyses: First, the persistent threat posed by banks and national financial services sectors that grow larger than the GDPs of their countries – and therefore grow “too big to fail”; second, the cumulative stress of national debt and banking crises on the EU’s identity.

Deposits in Cypriot banks involved in the crisis totaled $87 billion — over three times the country’s annual GDP. As Sony Kapoor wrote in the Guardian, Cyprus, like Ireland and Iceland before it, had a disproportionately large banking system in relation to its overall economy. Individual banking institutions with assets that are overly large relative to national GDP, and national banking sectors that comprise an overly large portion of a national economy, both pose risks. Cyprus has relied on its banking sector to drive economic growth; the crisis leaves it looking for alternatives. In their book 13 Bankers, Simon Johnson and James Kwak noted that one result of the U.S. response to its recent financial crisis — that “our big banks have only gotten bigger” — increases the likelihood of a future financial crisis requiring substantial government intervention. The U.S. financial sector is a large component of the economy, but there area other major sectors to spur its recovery. Cyprus specialized in financial services, and apart from tourism, has no other bedrock sectors on which to build an economic recovery.

Also writing in the Guardian, historian Timothy Garton Ash examined the impact of the crisis for those who would, or would not, like to see a more “federal” Europe. Events within Europe’s national economies are demanding “European” responses. Ash argues that the Cyprus crisis is the latest reminder that the EU, despite broadening the reach of its collective policies,  still operates as a collection of 27 national economies and political systems. “Every one of the Eurozone’s 17 and the EU’s 27 national leaders thinks first of their national politics, media and opinion polls. Tempting though it is to say: ‘We have made Europe, now we must make Europeans’, the truth is that in this respect we have not made Europe.”

The assumption of state debts was a key step in the creation of U.S. federal governance. One key lingering question is the role that addressing the debts of its member nations may play in “making Europe.”