While Cyprus is small in terms of size within the European Union (population of just over one million), it was significant because it had a large banking center concentrated in their two banks (Bank of Cyprus and Laiki Bank). Right now the banks are broke for a variety of reasons. For example, the small island nation held a significant amount of their neighbor’s(Greece) private and public debt. These investments lost 76% of their value.
Original Proposal for Bailout
This proposal included a tax on all deposits to the tune of about 6.5%. A $1,000 deposit would lose $65. It violates all banking standards for having deposits within the insurance limits (for us it would be like having a loss on your savings even though it was FDIC insured.)
Even though this option was changed because of a revolt by the Cypriot Parliament, the fact that it was even brought up is a precedent. Experts looking at the impact to the European Union feel the mere suggestion that depositors could lose money because of bank problems destabilizes the entire system.
Would you trust putting your money in a bank that has problems if you might lose some of your savings (think Italy, Spain, Portugal)? Many analysts believe depositors in other European nations will start withdrawing money from banks, further crippling the financial system of the European Union.
Unbelievably, what they ultimately did was to “tax” (loss of money) deposits of over €100,000 to the tune of approximately 40% at the Bank of Cyprus and 80% at the Laiki Bank! The value of the stock for bank is zero. Shareholders lost their entire investment.
Capital controls are also in effect. Money is frozen from being taken out of the banks. Thousands of small firms are unable to access their operating funds.
One Cypriot said he had a trading account of €400,000 at Leiki and it was frozen. He is unable to pay for the consignment of Egyptian shoes.
Checks may not be cashed; credit card use abroad is limited. This creates a two-tier Euro. Would you take a check written on a Cypress bank even though it is a “Euro,” the same as one from Germany?
According to the chief economist of High Frequency Economics, Carl Weinberg, the European banks are undercapitalized with no way to recapitalize. In the U.S., we had TARP as a public policy to prevent our banks from undercapitalization. There is no such approach available to Europe. Needless to say, he is bearish on Europe believing they are headed for a depression.