By proposing a tax on bank savers in Cyprus as a condition for a financial bailout, the European Union strong-armed the government of Cyprus to shut down its financial system, Athanasios Orphanides, former governor of the Central Bank of Cyprus, told CNBC on Wednesday.
The Cypriot parliament has rejected those terms.
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"Confiscating profits in a banking system is not the way to deal with anything," Orphanides said in a "Squawk Box" interview. "If European governments do not want to continue to keep the European project together, then they keep forcing governments—in this case Cyprus—to look elsewhere."
Cyprus is now talking about getting some aid from Russia, whose businesses and citizens make up an estimated 20 percent of all deposits in the Mediterranean island. There's concern that when the banks open again in Cyprus there won't be enough money to keep up with the withdrawals.
Orphanides, a former Fed staffer who is now an economics professor at MIT, argued, "I don't think it would be a good idea to open the banks in Cyprus before this situation is resolved."
As a means to resolve this crisis in Cyprus, he said, "Under the circumstances, what occurs usually is that other countries through the IMF, for example, offer loans and those loans are re-paid."
"European governments instead blackmailed the government of Cyprus to shut down its financial system." He stressed, "We're not talking about making a gift to anybody."