An angry Cypriot menacingly parked an excavator outside his bank last Saturday, ready to smash through the doors in protest. Others demonstrated outside Parliament through the weekend and Monday. All were showing their fierce opposition to the European Central Bank plan which will confiscate 6.75%-9.9% of Cyprus's bank deposits in exchange for a bank bailout.
As unfortunate as this situation may be for the people of Cyprus, why is this tiny Island with just over a million people making front page news across America? The direct seizure of people's money from their bank accounts is alarming, and some worry that it will set a dangerous precedent in Europe or even here in the United States. David Zervos, the head of market strategy at New York-based Jefferies bank, declared that this event amounts to "a nuclear war on savings and wealth." Despite the shock and disgust at Cyprus's blatant confiscation of private property, the painful reality is that Cypriots got off easy compared to our own bank bailout, which continues to this day.
In response to the sub-prime mortgage meltdown in 2007, our Federal Reserve slashed interest rates to near zero, an unprecedented move. These rates determine both the rate at which banks can borrow as well as the rates that banks pay to your savings accounts. If you have been wondering why your savings account yields a paltry half percent (at best), it's because this policy has been providing banks with cheap capital at your expense.
Specifically, the interest rate on bank deposits was 5.46% before the Fed began cutting rates in October 2007, according to FactSet Research. Today, the rate stands at roughly .25%. Had you kept your money in the bank through that time, the lost interest on your deposits would total approximately 33.4%. If Cyprus has declared a nuclear war on savings and wealth, we have secretly been waging war by pouring radiation into the water supply.
The slashing of the savings rate affects not only your bank account, but your pension savings as well. The crisis has pushed many pension funds to the brink of insolvency and has led to a desperate search for better yields. Bond markets and dividend paying stocks have already been bid up to bubbly highs, so investors are chasing even riskier assets to meet return requirements. As the Wall Street Journal reported earlier last week, this desperation has led pension funds to pile into risky real estate assets.[i] Coming off the heels of a mortgage crisis, this should set off alarm bells.
It gets worse. The Federal Reserve has tripled the money supply since the beginning of the Great Recession[ii] in another measure to pump up otherwise insolvent financial institutions. Our inflationary policy carries the risk that we could significantly lower the value of our dollar even further. In other words, when you finally spend the money that hasn't been accruing any interest, it will buy even less than before.
If Cyprus passes the bailout vote, depositors will be angry to see less money in their bank accounts when they re-open on Thursday. If you check your own bank account this Thursday, nothing will have changed. Unfortunately, the tricks our government has pulled to keep it that way have left you worse off than the Cypriots. Neither scenario is desirable, but in this case, it may actually be better to get punched in the gut than kicked in the back of the head.
More questions on Cyprus Savings Raid (Mar 16, 2013):