BUSINESS
03/18/2013 12:50 pm ET | Updated Mar 18, 2013

Cyprus Bailout Explained, Here's Everything You Need To Know About Why Your Money Might Soon Be On Fire

Just when you thought it was safe: Americans who have been pumping money back into the stock market as it hit record highs got some unhappy news this morning: Europe is blowing up, again, and threatening to set all of our money on fire, again.

The European country at the epicenter of the mess this time is neither Greece nor Italy nor Spain, nor any other country that large numbers of Americans could find on a map. It is the country of Cyprus, of which a sizable portion of Americans have perhaps never heard. Now many of them are asking, what the heck is Cyprus, and why is it threatening to set my money on fire?

Sit back, dear reader, and let us do some 'splaining:

What the heck is Cyprus? Is that the hip-hop group I smoked a lot of weed to back in college?

Cyprus is a tiny island nation in the Mediterranean, closer geographically to the Middle East than to Europe, hanging out just offshore of Turkey, Syria and Lebanon. Its gross domestic product is $25 billion a year, or about half of the quarterly revenue of Apple. It has a population of about 1.1 million people, or less than a third the size of Los Angeles, where the hip-hop group Cypress Hill perhaps scored weed on occasion.

Wait, that sounds tiny. Why is Cyprus threatening to set my money on fire?

Like other European nations, Cyprus has a massive debt problem. Its banks are broke, and its banking sector is about 700 percent of Cypriot GDP. The country's government is already in debt up to its eyeballs and can't bail out the bloated banks. So about nine months ago Cyprus asked for a bailout from the European Union, the European Central Bank and the International Monetary Fund. At long last, this "troika" of geniuses agreed to a bailout, but with one fairly terrifying condition: About 6 billion euros of the roughly 16 billion euro, or $21 billion, bailout package would be paid by bank depositors -- people who have money in savings accounts.

That seems... wrong?

Sure does. And it's never been done before in Europe, because the idea of punishing innocent people who were just trying to save their money is so odious. In Cyprus' case it feels a little easier to punish the depositors, because many of them are unsavory Russian oligarchs. Nearly a third of Cypriot bank deposits are from non-euro-zone countries, and a lot of that is Russian money being held offshore to avoid taxes, a trick the Russians learned from hedge funds and Apple.

Still, making depositors pay for a bailout sets a terrible precedent, and the worry is that depositors at banks in Spain and Italy could start pulling cash out of those banks, which would be truly disastrous for a euro-zone that had only recently seemed finally on the road to stability.

This is all Germany's fault, isn't it?

Partly, yes. Germany hates bailing out anybody in Europe, much less sun-drenched island nations hosting tax-dodging Russian bank deposits. So they pushed for a tax on depositors, along with other relatively healthy northern European countries with bailout fatigue.

So is everybody freaking out about this or what?

So far, so good, actually, with one major exception: European bank stocks are down a bunch, because of the worry that, if European policy makers are willing to stick it to mom-and-pop depositors, then they will definitely be willing to stick it to bank bondholders. Banks could suffer ratings downgrades, which could make it harder for them to borrow.

Otherwise, though, financial markets are mostly calm. The Dow Jones Industrial Average, which last week was setting new highs nearly every day, was only down about 10 points around midday. European stocks were in worse shape, as you'd expect, but still not too bad: The Euro Stoxx 50 index fell only about one percent on Monday.

And so far, people aren't yanking their money out of banks in Italy, Spain, or anywhere else outside of Cyprus, so that's good. They seem to be believing the promises of policy makers that Cyprus is a special case.

Whew! So I guess there is nothing to worry about!

Actually, some very bad things could still happen. The Cypriot parliament needs to approve the bailout package, which is understandably being met with howls of outrage in Cyprus. If the parliament doesn't approve the bailout package, then Cyprus could default on its debts, and there is a risk that it could leave the euro zone.

Cyprus leaving the euro zone might not ultimately amount to much -- people once suggested that Greece could leave the euro zone without causing the end of the world. But then again it could also be disastrous, if financial markets start to worry again about which country might be the next one out of the union.

Has anybody thought of an annoying name for this extreme possibility?

Yes: Cyprexit.

Oh, good. So what happens next?

Cypriot parliament is set to vote on the bailout package on Tuesday, and in the meantime they're furiously trying to work out a way to at least protect smaller depositors, Reuters reports. Cypriot banks, which ran out of cash over the weekend, are closed until Thursday.

After the vote, the outlook is murkier. If Cyprus rejects the bailout, then financial markets could be thrown into chaos as investors worry about the repercussions of a Cyprexit.

On the other hand, if Cyprus does approve the bailout package and haircuts depositors, then it is possible that other Europeans with savings accounts, who are already jittery, might start puling money from their banks lest they face the same fate.

Meanwhile, whatever bailout package gets approved in Cyprus must also be okayed by the European countries doing the bailing-out, including persnickety Germany.

What should I be watching in order to know if my money is about to catch fire?

Most obviously, watch out for long lines at ATMs in Spain, Italy and elsewhere. That will be a very bad sign. Rising borrowing costs for banks and governments throughout Europe could also signal that the crisis is intensifying again.

Like I don't have enough to worry about, what with my March Madness bracket and all. Are there any other Cypruses out there waiting to make us miserable?

Hard to say, unfortunately. Trouble could arise in just about any country in Europe with a lot of debt, including in the "core" of Europe: France, Belgium and Luxembourg haven't been bitten much by the debt crisis yet, but still could be.

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