Cyprus Is Drowning in an EU Spoon

The Wall Street Journal

U.S. bank bailouts have taken a beating. They were criticized for their excess, uneven distribution and preservation of a status quo that shortchanges the little guy in favor of "stability of the financial system" or, put another way, private gains and socialized losses.

And the bailouts do look pretty awful—until you compare them with what's happening in Europe.

To say the euro zone has bungled the crisis in Cyprus is an insult to bungling.

Cyprian banks are undercapitalized, so central bankers and politicians want to respond by taxing depositors. Isn't this something like fixing a car by taking away the tires? Even if you can get the engine to start, your chances of getting somewhere aren't too good.

Moreover, the so-called "bailout" of banks in Cyprus has most Europeans, fearing they might be next, checking Google GOOG +0.42% Maps for the fastest route to their own bank branch.

There's a Greek saying, roughly translated, that goes like this: "You drown in a spoon of water." The deeper translation, or at least the way some people understand it, is: "You make a simple job difficult."

That's the European Union.

In a few short days, the EU and to some degree the International Monetary Fund have completely unraveled the confidence stitched during the last four years. To go back to our car analogy, the EU is the only shop in town. And now everyone knows the sort of shoddy work it does.

It has been argued that the response to the financial crisis in Cyprus was an isolated case. Cyprus is an offshore banking haven, which makes it somewhat unique in that it holds billions in foreign deposits, mostly Russian. Cyprus also is a small country with close ties to Greece.

As a member of the European Union, Cyprus barely rates. Among the 27 member nations, it ranks 25th in population and area. It holds just four votes in the European Parliament, the same as Estonia and Luxembourg. And then there's unemployment in Cyprus, which was under 8% until 2011 and now stands at close to 14%.

Yet Cyprus is hardly a deadbeat. As recently at 2010, it outranked 12 EU members in gross domestic product per capita. Its government essentially balanced the budget in 2007 and 2008 after years of deficit spending, according to the International Institute of Finance.

Let me repeat that: Cyprus balanced the budget. Not once. Twice.

Strong growth during the middle part of the last decade cut government debt to 49% of GDP by the end of 2008 from 70% in 2003, the IIF said.

Anyone who has been following the story knows what happened next. Labor costs rose. Private-sector debt rose. Cyprus's banks were far too exposed to real estate in Greece. They held about $36 billion in Greek debt, much of it in housing, as recently as 21 months ago. It doesn't sound like much, but for a country with less than one million residents, it was 170% of GDP, according to the IIF.

Like many countries, the Cypriot government tried to spend its way out of the mess. For a while, it worked.

GDP growth exceeded the average of the euro zone in 2009. Cyprus faltered, but not a lot. As recently as last year, its GDP growth trailed the rest of the zone by just 0.5 percentage point.

Alas, Cyprus's ability to borrow dried up. Interest rates shot up to 7% from 4.5% in 2011. The country was left to the mercy of its European neighbors for help.

Given Cyprus's size and debt—$14 billion is needed to shore up the banks—this should be a gimme for European leaders. Spain, Italy, Portugal, Greece and Ireland are the real problems. Cyprus isn't even change for the parking meter when compared with them.

Yet the initial response is nothing but a sick joke. The EU is essentially telling Cyprus to leave the euro zone.

Sure, much of that deposit tax was aimed at Russians, but the Cypriots bank there, too. The EU has many more countries that represent a threat to the system than Cyprus, and you can bet the citizens of those countries are watching the draconian measures aimed at the tiny nation and saying: "We're next."

Cyprus is getting nothing from the EU. It should tell the union "nyet" and take the Russian loans. The rates are better and the partnership stronger.

Watching all of this unfold, it's hard not to appreciate our own bailouts. For all of their problems, they were at least swift and somewhat effective (sorry, Lehman Brothers Holdings Inc.). Had we used the European model, we'd be like that car without the tires: still speeding down the driveway.

So, thank you, Henry Paulson. Thank you, George W. Bush. I know it's a low bar, but it's better than visiting Moscow in March.

Write to David Weidner at david.weidner@dowjones.com