Can it happen to us?

Can it happen to us?
Weekly CEO Commentary 3-25-13
Tim Phillips, CEO—Phillips & Company

One of the nice things about managing money professionally is if you’re intellectually curious, it provides for ample opportunity to learn new things all the time. Case in point: Cyprus. I have heard the name of the country before, and that's about it. I do enjoy seeing the Cypriotic (my term) experts roll forth with their infinite knowledge on something they probably knew nothing about. That's an illness in our industry and a topic for later.

The real question for me and likely you as a saver with money in a bank is: Could what happened in Cyprus happen to us?

What happened

The roots of the problem in Cyprus came down to some key points:

1) The financial sector is a large portion of the Cypriot economy, and a significant portion of the deposits aren’t domestic savers, but rather foreigners who sought to park cash overseas. CNN reports that “Nearly a third of the money in Cyprus' banks is Russian, and the country's 10% corporate tax -- half that of Russia's -- meant Russian firms had been using it as a tax haven since the early 1990s.”

Source: Central Bank of Cyprus

2) Cyprus was also damaged by the crisis in Greece. Cypriot banks held large positions in Greek debt, which ultimately turned out to be toxic assets.

3) Cyprus also has a great deal of political uncertainty. The country still suffers from the after-effects of a civil war in the 1970s, which has left an active UN Peacekeeping Force on the island to this day.

So in all likelihood what happened in Cyprus can't happen to us...exactly.

With the bailout agreed to, it looks like large savers will lose some of their deposits in the form of a tax, in exchange for continued EU support for the country. Originally, the terms were set to be a 6.75% levy on depositors under 100,000 Euros and 9.9% above that amount, but now the Cypriot government can adjust those figures (to try to spare small depositors) as long as they raise 5.8 billion Euros in total.

Larry Elliot, the economics editor at European newspaper The Guardian, also reports that, “The shakiest of the Cypriot banks – Laiki – will be closed. Deposits of more than €100,000 – amounting to €4.2bn in all – will be placed in a ‘bad bank’. That means savers will only get a fraction of their savings back and the deposits could, in theory, be lost entirely.”

Implications for US savers

Unfortunately, US savers have also lost money on cash savings during the 2008 financial crisis—something that was thought to be unthinkable before then. Little known to the investing public was the “breaking of the buck” of the Reserve Primary Fund, a money market fund that in theory should stay at a value of $1 per share, but actually lost money for investors during the 2008 crisis—something that is not supposed to ever happen.

On another side of things, US savers are getting punished right now by extremely low interest rates. Over a 5 year period of time, who is better off: a Cypriot saver with a small haircut, or a US saver with near zero interest rates?

BankRate.com shows an average annual rate on a US 5-year CD is 1.34 percent. The European Central Bank does not keep data on 5-year fixed deposits (the European equivalent of a CD), but shows that a 1-year fixed deposit in Cyprus has a rate of 4.53 percent.

If a Cypriot saver loses 10 percent up front due to the tax, and assuming that they can roll their 1-year fixed deposit over at the 4.53 percent rate for five years, they would still break even with their capital loss and eventually outpace an American saver.

The government isn’t putting a tax on US deposits, but savers have been hurt nonetheless by minimal returns.

If you have questions or comments, please let us know as we always appreciate your feedback. You can get in touch with us via Twitter, Facebook, or you can email me directly. For additional information on this, please visit our website.

Tim Phillips, CEO – Phillips & Company
Alex Cook, Investment Analyst – Phillips & Company