Could the U.S. Do Like Cyprus and Seize Bank Deposits?

Cyprus financial crisis banks insured deposits
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Just when we all thought it was safe to stop worrying about the eurozone, another country's banking system blew up and stopped the Continent in its economic tracks.

This time, the victim was Cyprus: a tiny Mediterranean island not far from Greece, whose two biggest banks were facing insolvency if Europe didn't come to the rescue. And yes, a last-minute rescue plan was arranged. But rather than simply bailing out the banks with EU taxpayer money, as had been done previously, the European Union initially decided to "bail in" the creditors -- that is, make people with money deposited in the banks take some of the hit for the rescue.

Initially, part of this hit was going to be against insured depositors -- ordinary savers whose accounts were insured by the European Union up to €100,000. Had the plan gone through as proposed, they would have faced a one-time 6.75 percent tax on their accounts.

However, there was such local and international uproar against the notion that ordinary citizens could have their bank accounts raided by the government that a new bailout plan was devised. This one protected insured depositors but still left those with various levels of "unsecured debt" -- i.e., very large deposits -- in the country's two biggest banks on the hook.

The mere fact that Cyprus attempted to raid insured accounts has left a bad taste in people's mouths around the world. And it has led some people to ask: Could that ever happen here in America?

Let's play pretend with the U.S. banking system

Imagine if the U.S. found itself in Cyprus' situation, with a failing banking system and no way to save it except by accepting the terms of whatever rescue plan was handed down by foreign governments or multinational organizations.

Finding that hard to imagine? It's no wonder.

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That's because, unlike EU members, Washington isn't subject to any superseding government. No outside force can dictate terms to it. And if the U.S. banking system does get itself into trouble (as it did in when the housing bubble burst and tanked the markets), we're still not in danger of running out of money to pay off our IOUs.

Unlike eurozone nations, we have our own currency. We can just "print" more of it until our debts are covered. So you can rest assured -- if the government needed money to prop up endangered banks, it surely wouldn't need to reach into your savings account to find it.

True, there are dangers associated with flooding the market with dollars, inflation being one of them. But the fact remains that the U.S. literally can't run out of money. For Cyprus, and other countries that have had to take European Union bailout money because there was no other place to turn, this is one of the major downsides of not having a separate currency.

Our ability to print money isn't the only stop-gap against a Cyprus situation. We also have a long-standing deposit-insuring agency: the Federal Deposit Insurance Corp.

We've Got You Covered

The FDIC was established as part of The Banking Act of 1933, in part as a response to the thousands of bank failures that occurred in the U.S. in the late 1920s and 1930s. (At FDIC-approved financial institutions, single depositors are covered up to $250,000 per owner, joint depositors are covered up to $250,000 per co-owner, and even IRAs are covered up to $250,000 per owner.)

No depositor has ever lost a dollar on insured deposits under the limits since the depositor guarantee was written into law in 1933. Without first changing the law, no American president or other member of the federal government could unilaterally tax the accounts of insured bank depositors to "bail in" failing banks. (Interestingly, the FDIC and the Bank of England have floated the idea of a policy that could, in theory, legalize such bank account haircuts, turning the Cyprus experiment into a U.S. precedent. But at this point, it's only a White Paper, an ivory tower exercise.)

And if you think there was an uproar over Cyprus trying a move like this, imagine the uproar the American press or Rep. Nancy Pelosi would create in response to a similar move.

We've Got a Well-Established Blueprint

The European Union and corresponding eurozone haven't been around for that long. There isn't much history in the eurozone as an entity, and the economic rule of law is still shaky in some of these smaller countries, like Cyprus.

Since the financial crisis, they've been putting out fires left and right on a case-by-case basis with varying levels of consistency and success. And that's what the Cyprus rescue was: a poorly thought out, ad hoc response that panicked markets and citizens everywhere.

Luckily for us in the U.S., we have history and established laws on our side. These two things, along with the flexibility having a separate currency provides, is why what happened in Cyprus can't happen here.

John Grgurich is a regular contributor to The Motley Fool. Follow his dispatches from the bleeding heart of capitalism on Twitter @TMFGrgurich.