The Cyprus Crisis Explained (Like You're an Idiot)

March 21, 2013— -- There's a lot of talk this week about Cyprus, that tiny island in the Mediterranean that no one really thought about until a debt crisis there started to shake the world's financial markets.

You've got questions. We've got answers. And we promise to talk really, really slowly.

Q: Wait! What's going on? I'm still getting caught up on Tiger Woods dating Lindsey Vonn. Where is this happening?

A: Cyprus. It's an island and a member of the EU, but it's also a tax haven. Think the Cayman Islands but in the Mediterranean. Those lax taxes have made it a popular place for rich Russians – oligarchs, businesses, and a few shady characters – to put their cash.

Q: That sounds lovely. Spring Break! But seriously, it sounds like they've got plenty of cash. So, what went wrong?

A: Well, the big Cypriot banks made a really bad investment. They lent money to Greece. When the Greek economy took a dive, the Cypriot banks took a bigger gamble, buying up Greek government bonds in the hopes of a bailout. Now they're broke. The banks owe more money than they have. In fact they owe more money than the country's GDP.

Q: Good thing they belong to the EU, right? Those Germans are pretty rich. Sounds like somebody could use a bailout.

A: Cyprus asked for a bailout. But the Europeans were not exactly excited about bailing out another country, plus a bunch of billionaire Russian oligarchs and criminals. So, they told the Cypriots they had better come up with money on their own. The only place Cyprus could find large amounts of cash were in people's personal savings accounts.

Q: You've got to be kidding me! They're going to raid people's savings accounts, like Bonnie and Clyde?

A: That was the plan. Tax everyone with a savings account between 6 and 10 percent and use that money to pay down the debt.

Q: If that were me, I'd just run to the bank and take out all my money before the government could get their hands on it.

A: That's exactly what happened this week. Fearing the government was coming for their cash, Cypriots ran to the bank. The government declared a national holiday and closed the banks, so everyone ran to the ATM outside the bank. There were restriction on how much cash could be withdrawn, but that didn't stop people from waiting in long lines to get what they could of their money.

Q: That's nuts. Isn't the responsibility of governments to insure those investments, not take them?

A: Yes. And that's exactly what has got people nervous around the world. Just like the FDIC in the U.S. insures investments the Cypriot government insured accounts there. That means they promise to make investors whole if the banks go under. They abrogated that promise. Banks are based on confidence, but it's going to be a while before anyone can confide in them again.

Q: So, that's it? The government is just going to take citizens' money?

A: The Cypriot legislature on Tuesday refused to pass a law that would have allowed the government to take that initial sum of 6 to 10 percent of investors' savings. But citizens aren't out of the woods yet. The president is expected to go back to the Europeans with a new proposal to pay back international investors that will also satisfy the parliament. Cyprus has until Monday to present the EU and International Monetary Fund with a plan.

Q: Well, at least I've got nothing to worry about. The U.S. economy has been strong for months. The Dow just hit an all time high. My 401k is through the roof. Spring Break!

A: Not so fast. Economists have anticipated that American markets will have to correct for all the rapid growth and Cyprus might just be the tipping point. Stocks have fallen and there are concerns that jittery investors will pull back even more. If the Eurozone debt crisis continues to spread and investors in other countries begin pulling their money from banks, we might all be in trouble.