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What The Cyprus Crisis Means For Investors

cyprus sunset

I’ll give the European Union credit: at least they are creative at finding new ways to upset the world’s capital markets.

Instead of demanding the usual austerity measures of higher taxes and lower spending—and a potential haircut on speculative creditors such as hedge funds—the EU bailout negotiators insisted over the weekend on extracting a pound of flesh from the customers of Cypriot banks. Savers would see as much as 10% of their checking and savings accounts expropriated to help cover the cost of the bailout, and the levy would apply even to accounts insured by the Cypriot equivalent of the FDIC.

Ouch.

Needless to say, the news didn’t go over well in Cyprus; it led to a small-scale bank run as depositors rushed to get to their cash. It also didn’t go over particularly well in Russia. Cyprus is notorious as a haven for Russian funds of…ahem…questionable origins. Roughly a quarter of all Cypriot bank deposits are owned by Russians.

As I’m writing this, it appears likely that Cyprus’ parliament will shoot down the bailout agreement hammered out between the government and the European Union on the grounds that it isn’t fair to small local savers who assumed their deposits were protected by government guarantee. (Imagine any democrat or republican approving something like that here; it would be political suicide.)  The government is also reluctant to “soak the Russians” out of fear that it will destroy confidence so badly as to end Cyprus’ existence as an offshore financial center.  And I can’t say I blame them for not wanting to anger the Russian mafia dons or Russian President Vladimir Putin.  That’s not good for your health.

So what happens now?

Good question. My best guess is that the deal is slightly tweaked to allow the Cypriot government to save face but that the bailout goes through and the depositors get hit.  Politically, German Chancellor Angela Merkel and French President Francois Hollande cannot ask their taxpayers to come to the rescue of dirty Russian money, nor should they.

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