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The Cyprus Bank Deposit Haircut: Could it Happen Here?

Wednesday, 20 Mar 2013 | 2:21 PM ET
The Bank of Cyprus headquarters in Nicosia, Cyprus.
Chris Ratcliffe | Bloomberg | Getty Images
The Bank of Cyprus headquarters in Nicosia, Cyprus.

What if Congress raided up to 10 percent of your bank account to bail out the government?

That's exactly what could have happened in Cyprus if its parliament had gone ahead with a proposal to tax depositors for a 5.8 billion euro bailout–the first of its kind in the ever-escalating euro zone debt saga.

"This is an extraordinary and extreme step," Adam Schneider, chief adviser at Deloitte Center for Financial Services, told CNBC.com. "If you're a company that needs cash, you sell assets, but you don't seize employees' cars in the parking lot."

"Now that this idea has been floated, it's reasonable to ask whether other countries with significant debt would consider this step," he added.

The United States, unlike its European counterparts, is the issuer of the currency in which its debt is denominated. This means that the U.S. cannot be involuntarily forced to default on debts or abandon its currency, unlike European nations that borrow in a currency controlled by the European Central Bank.

Still, that doesn't stop many from worrying that the U.S. debt burden is already too large.

A version of the Cypriot haircut has already happened here, said Sen. Tom Coburn, R-Okla., who sits on the Senate's banking committee.

"Congress' decision to steal from our entitlement trust funds is a Cyprus-like theft from programs like Social Security and Medicare," he said.

Washington politics aside, other experts firmly believe a Cypriot drama would never unfold in the U.S.

"The decision to confiscate insured deposits below 100,000 euros–that was a boneheaded decision," said Bob McTeer, former president of the Dallas Fed and CNBC contributor. "The rule of law would prevent that from happening in the U.S."

There are other fundamental differences between the U.S. and Cyprus. For one, the U.S. does substantial financing through its capital markets and is not as reliant on banking.

"In the U.S. the dog is the economy and the banking system is the tail," McTeer said. "In Cyprus it's the other way around apparently. The banking system was bloated relative to their overall economy."

Another key difference is that the FDIC has never lost money backing deposits. Although the banks had to borrow money during the financial crisis, the banks are better capitalized than they were before the crisis.

"Even take JPMorgan–they were able to absorb a $6 billion loss and still show record profits this year," McTeer said.

Part of the reason Cyprus even considered tapping into the savings of citizens and some Russian oligarchs–who have viewed the island as a tax shelter, until now–is that the country's debts exceed its ability to raise taxes, Schneider pointed out.

And unlike other euro zone nations, the U.S. can manipulate the dollar, and therefore, the value of its debts: "We can just print more. It's called inflation."

Even though Cyprus' parliament rejected the idea on Tuesday, the threat of financial chaos remains. The bank holiday initially imposed to prevent a run on banks could be extended through the weekend. And it is still unclear how the country will avoid a default even as its finance team courts Russia for funding.

What surprised some financial experts was not the rejection of the proposal, but the fact that parliament even considered such a formula.

"What we had was two or three days of tinkering and not two or three days of rejection," Schneider said. "That tinkering gets people concerned, maybe they'll come at it at a different direction–maybe 2 percent is OK."

Follow me on Twitter @Carney

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