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Cyprus Is a Game Changer for Investors: Jacob Kirkegaard

Daily Ticker

All eyes are once again on Cyprus, a small Mediterranean island nation with just over a million people and an economy smaller than any state in America. This afternoon  (evening in Cyprus) the parliament in Cyprus rejected a tax on bank deposits that would  have raised enough funds for the smallest Eurozone member to qualify for a financial bailout.

U.S. stocks fell on the news, leaving global financial markets vulnerable to further declines. What happens next is anybody's guess. Will Cyprus be forced to leave the Eurozone, or will there be another plan to help Cyprus raise the funds needed to qualify for a buyout?

Earlier today The Daily Ticker spoke with Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics. He said the plan for Cyprus to tax bank depositors made sense because it “goes where the money is." The Cypriot banking system is about eight times the size of its GDP, with approximately 136 billion euro ($176 billion) on deposit. Now where can Cyprus find the money it needs to qualify for a bailout?

Related: Why the Cyprus Bail-In is a Bigger Deal Than You Think

The plan that Cypriot legislators voted down today would have taxed Cypriot bank deposits of 20,000 to 100,000 euros at 6.75% and accounts over 100,000 euros at 9.9%. It was a revised version of an earlier plan to tax all deposits below 100,000 euros at 6.75%.

Cyprus has to raise 5.8 billion euro ($7.5 billion) in order to secure a 10 billion euro bailout ($13 billion) from the troika of European lenders: the European Union, ECB and IMF. No word yet on whether the troika will relent on that requirement in any way.

Related: Suddenly Things Are Going "Terribly Wrong" for the Big Banks

A government official told Reuters earlier Tuesday that the latest bank tax bill would  likely fail to pass the Cypriot legislature, but when the news hit, stocks fell anyway. Before today's parliamentary vote, Kirkegaard said a final deal for Cyprus will pass “sometime this week” and when it does it will represent a game changer for how the European Union will deal with banking crises in the future.

“Until now there’s basically been a standard precedent that all bank bondholders are going to go free and will get their money back,” said Kirkegaard. “Those days are over. Going forward, investors in European bank bonds—not necessarily insured depositors--should expect to be 'bailed in' in future crises anywhere in the European union." That means depositors will be hit up for funds.

In the meantime Kirkegaard advised investors to monitor the retail deposit levels of all European nations to gauge if the crisis in Cyprus is spreading; although, he didn't see an “immediate contagious effect.” Stay tuned.

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