Eurozone chaos

When Clemens Fuest, president of the Centre for European Economic Research in Mannheim, read the news about the agreement between Cyprus and the banks, he first thought the report was a hoax.

"In Europe, there are clear rules for restructuring banks," Fuest said earlier this week at an event organized by the Hanns Martin Schleyer Foundation. The rules, he pointed out, establish clear liability. Bank owners are first in line to bear liability. When their equity is exhausted, then banks' creditors, including owners of bonds and bank accounts, have to pay next.

Deposit protection

In general, bond holders are liable first because they receive higher interest rates in good times. Savings account holders with a credit of up to 100,000 euros are protected under the deposit protection fund - at least that's what the European Union promised.

But the Cypriot deposit protection fund itself could become insolvent, in which case small savings account holders could ultimately incur some losses. "But the law actually requires taking a course of action that has equity owners pay first and then investors," Fuest said.

Finance ministers in the eurozone hoped to shorten this path significantly by jumping to the last people in line, requiring bank customers with deposits of up to 100,000 euros pay a levy of nearly 7 percent. Politicians tried to sell the plan by referring to it as a tax.

A person could land in court for trying to pull off such scheme in other areas, Fuest said. "In my opinion, allowing such an arbitrary approach is a scandal," he added.

Levy on bank deposits

Although Fuest said private creditors should be called on to help rescue a country, he added that Cyprus' attempt to do so has failed and will discredit the participation of private investors.

Achim Wambach, director of the Institute for Economic Policy at the University of Cologne, was also critical of the politicians for unnecessarily yanking the anchor they set themselves to secure deposits. He said the 6 billion euros the levy would generate was "a small sum in the entire bailout" and not enough to justify abandoning established liability rules.

The finance ministers have, meanwhile, backtracked and are now recommending that Cypriot government not touch bank deposits under 100,000 euros. But plenty of trust has already been destroyed, the experts said.

"What should Spaniards be thinking right now?" Wambach asked. "Spanish banks are in the euro rescue program. But investors still face no commitment."

Wambach admitted, however, that if he were a Spaniard, he would be plenty nervous and would try to transfer money to another country or hide it under his pillow.

Greek banks also have serious concerns at the moment. After the parliamentary vote, the Euro Group is now longer obligated to keep its promise of a bailout of up to 10 billion euros. The collapse of Cypriot banks would, however, pull down the recently rescued Greek financial institutions.

Plenty of fear

That's why economist Wolfgang Franz said action needed to be taken.

"Measures for supporting the Greek banking system must be considered and relatively quickly," he said, adding that the effects on the rest of the eurozone would be bearable.

While Franz reckoned with Cyprus' bankruptcy, Fuest said he doesn't expect the country to be allowed to decend into insolvency. The fear of contagion, Fuest added, is so great that Cyprus could ultimately spark a wildfire in the entire eurozone. Hoping for a better deal as negotiations continue, parliamentarians in Nicosia, he said, may well have bet on that fear.

Fuest said if he were a member of the Cypriot parliament, he may have voted the same way.

"The blackmail potential is huge," he said. "With 99 percent certainty, we can expect more negotiations and more concessions. I wouldn't be the least bit surprised if in the end everyone is rescued and big investors throw back their heads in laughter."