Why Cyprus Matters

Mar 21, 2013
Originally published on March 21, 2013 10:25 am

Banks on Cyprus remain closed today. The Cypriot Parliament has rejected the terms of a bailout from the European Union. The finance minister is in Moscow looking for financial help from the Russians.

Cyprus has about as many residents as the Bronx. When you add up all the country's banks, they don't even match the 30th largest bank in the U.S. But people all over the world have good reason to be freaked out over what's happened there this week.

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We're going through another one of those weeks when the average person following the financial news could be forgiven for asking a simple question: Huh? We tell you that the change in banking on the tiny island of Cyprus has shaken the entire world financial market. What?

Zoe Chace of NPR's Planet Money team sorts out how that happened.

ZOE CHACE, BYLINE: Cyprus has reached the point that a lot of people have been worried about over the last year, the point where if you go to the ATM you're suddenly not allowed to take out your money.

MICHEL LOIZIDIS: You could see people driving up in their cars and just sitting there, you know, waiting to get in line.

CHACE: Michel Loizidis had to wake up early a few days ago just to get cash. But he was limited to a couple hundred euros. The rest of the money in his own account he was not allowed to touch.

LOIZIDIS: You couldn't go into the bank because they declared it a national holiday so we wouldn't have a run on the bank. So people just went to the ATM, withdrew their amount (unintelligible) went home and just sat in front of the television, wondering what was going on.

CHACE: What's going on is what many people are calling a dangerous escalation in the European debt crisis. And to understand why and why it matters, you have to know a little history. So, here's a Cyprus crib sheet. Cyprus is an offshore tax haven, a Cayman Islands of the Mediterranean, and it became a banking center for a lot of wealthy Russians - some oligarchs, Russian companies, parked tons of money in Cyprus. The problem is, the Cyprus banks took that money and put it in some very bad investments. In this case Cyprus, the land of Aphrodite, lent its money to Greece. Here's Jacob Kirkegaard with the Peterson Institute.

JACOB KIRKEGAARD: They took a huge bet on Greek government bonds because they thought presumably, well, they're going to be safe. They're going to be bailed out. Of course that was a huge mistake. This is what has sunk the Cypriote banks and now the Cypriote economy as a whole.

CHACE: The banks are broke. They owe more money than they have, and they're huge - several times bigger than the entire GDP of this little country. Cyprus looks for a bailout; European leaders say we're actually not that psyched to bail out a bunch of Russian oligarchs. Cyprus, you'll have to come up with some of the money yourself and we will give you the rest. So the Cyprus government looks around...

KIRKEGAARD: I like to refer to it as the sort of Willie Sutton rule. You go where the money is.

CHACE: Kirkegaard points out the only place where there's real money in Cyprus is in the savings accounts of these big banks. So the Cyprus government said to get our loan from the rest of the Europe, there is going to be some pain. Everyone with a bank account, we will take between six and 10 percent of your money. On the one hand, great idea. How else are they going to raise a couple billion euros? There are not enough people and businesses to tax on this tiny island. On the other hand, this sets a terrifying precedent, because the Cypriote government has broken a fundamental promise in banking. The Cypriote bank deposits, like bank deposits everywhere, were insured by the government. An insured bank account is the government saying even if this bank goes under, we will make you whole. Now Cyprus was saying never mind. In fact, we're going to take some of that money for ourselves. Thanks. Earlier this week, as the banks remained closed, the Cypriote parliament voted this down. But a bank is built on confidence - confidence that your money will be there when you want to go and get it. And the confidence in the Cypriote banks may have been lost with this move. It is for Michael Loidizidis and his friends.

MICHAEL LOIDIZIDIS: I've heard a lot of people that have said that as soon as they can take money out of the country, they will.

CHACE: Some people worry that this precedent will be on the minds of people all over Europe. Megan Greene is an economist with Maverick Intelligence. She specializes in the euro crisis. And she worries, what if a banking crisis flares up again in a larger European country?

MEGAN GREENE: People with their money in the banks will know that part of the toolkit now for bailing out countries is to force a loss on depositors.

CHACE: Or maybe there have been so many bailouts at this point that Europeans have learned to tell the difference between the rules that apply to an offshore tax haven and a much bigger, systemically important economy. Banks are scheduled to open up again next week in Cyprus. It's still unclear how the government plans to come up with the money that Europe is demanding for its bailout. Zoe Chace, NPR News. Transcript provided by NPR, Copyright NPR.