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WHY DID CYPRUS NEED A BAILOUT? Cyprus built its economy in recent years by becoming a financial center, much the way Ireland and Iceland before it did. Its banks offered Internet accounts to foreigners, were renowned for their service, provided substantial privacy to clients and had very low taxes. It worked so well that Cyprus' banking industry ballooned to nearly eight times the country's gross domestic product at the height of the boom. In December, it was still more than seven times Cyprus'
euro17.5 billion GDP. Russians -- looking for warmer climes, lower tax rates and shared culture in the form of Orthodox Christianity
-- are thought to hold the majority of those accounts, with about euro20 billion in the island's banks. But Cyprus' banks held a lot of Greek debt and suffered significant losses when they took a writedown of those bonds as part of the Greek bailout. Much of Cyprus' bailout money will be used to recapitalize Cypriot banks to prevent them from collapsing. Like other eurozone countries, Cyprus has also seen its deficit and debt explode as growth has ground to a halt. And with the banking system so large, the government wouldn't have been able to bail it out even in a healthy economy. WHAT WILL THE REACTION BE ON MONDAY? Cyprus may be on holiday Monday, but the rest of the world will go back to work. Kirkegaard says that the decision to tax tap depositors indicates that the European Central Bank is confident that the risk of a bank run elsewhere in the eurozone is low
-- and by excluding Greek branches of Cypriot banks, they have reduced the possibility even further. Bond markets may react a little since bondholders were also tapped. Bank stocks will probably fall and they'll see their borrowing costs rise since this deal signals that other eurozone countries may call on bondholders if their banks run into trouble. But Heather Conley, director of Europe program for the Center for Strategic and International Studies, says it's hard to know the far-reaching implications of this one-off deal. The "exceptions" created to solve Europe's debt crisis are adding up, she said. And some investors may look at this late-night, three-day-weekend deal and see what she saw: a dress rehearsal for a country dropping out of the euro.
[Associated
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