Yesterday the New York Times posted an article about a decision made by the European Union in October 2011 that began the unravelling of the banks in Cyprus.

The article reports:

“It was 3 o’clock in the morning,” recalled Kikis Kazamias, Cyprus’s finance minister at the time. “I was not happy. Nobody was happy, but what could we do?”

He was in Brussels as European leaders and the International Monetary Fund engineered a 50 percent write-down of Greek government bonds. This meant that those holding the bonds — notably the then-cash-rich banks of the Greek-speaking Republic of Cyprus — would lose at least half the money they thought they had. Eventual losses came close to 75 percent of the bonds’ face value.

The decision resulted in the country of Cyprus, with a gross domestic product of 18 billion euros, taking a hit of four billion euros. Laiki, also known as Cyprus Popular Bank, alone took a hit of 2.3 billion euros. This is not the sole cause of the banking collapse in Cyprus, but it is a major factor.

The article further reports:

As well as hitting Cyprus over its banks’ holdings of Greek bonds, the European Union also abruptly raised the amount of capital all European banks needed to hold in order to be considered solvent. This move, too, had good intentions — making sure that banks had a cushion to fall back on. But it helped drain confidence, the most important asset in banking.

“The bar suddenly got higher,” said Fiona Mullen, director of Sapienta Economics, a Nicosia-based consulting firm. “It was a sign of how the E.U. keeps moving the goal posts.”

The European Union did what it needed to do to protect itself–it did not look at the long-term consequences of its actions, and its actions were tilted toward the interests of the larger countries in the E.U.  Cyprus never really had a chance.

The article further reports:

After the Greek write-down, Cyprus compounded its problems by dithering on whether to seek a bailout from the European Union. At first, it appealed to Russia, which provided a 2.5 billion-euro loan in December 2011. But this money quickly ran out, and when Cyprus did finally go cap-in-hand to its European partners for a lifeline, it received a rude shock: Germany, already gearing up for an election this year, wanted not just budget cuts and other conventional austerity measures but a complete overhaul of Cyprus’s economic model, built around financial services for foreigners seeking ways to dodge taxes and, Berlin suspected, launder dirty money.

“They did not want the Cypriot model to exist as it did — they wanted Cyprus to stop being a financial center,” said Pambos Papageorgiou, a former central bank board member who is now a member of parliament and on its finance committee. “It was very brutal, like warfare.”

Mr. Papageorgiou complained that the European Union had shown “the opposite of solidarity” in its dealings with one of its weakest and most vulnerable members.

The role Cyprus played in harboring money from questionable sources is not unique and has occasionally in the past gone unpunished. I recently watched a documentary about the role the Swiss banks played in holding the wealth the Nazis confiscated from the Jews of Germany. Most of that money still sits in Swiss banks. There was no reason the banks of Cyprus would have assumed that their business model would face a day of reckoning.

The article concludes:

“We are looking at a very grim future for Cyprus,” said Michael Olympios, chairman of the Cyprus Investor Association, a lobbying group. “Even firm believers in European project like myself see now that it was a bad idea and that we should have at least stayed out of the euro.”

As jobs disappear and the economy contracts, Mr. Olympios said, faith in Europe will wither. “I used to be a believer. Not anymore.”

There is such a thing as giving a small people too much power. ‘Nuff said.