Monday's Market: How Cyprus Will Play Out

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At this stage, anything that's written about the outcome of the Cypriot situation is still speculative, as the Eurogroup working group that includes finance ministers from the 17 eurozone countries met in Brussels from 6 p.m. local time (1 p.m. ET) to hammer out an agreement with Cyprus. I'd expect negotiations to continue into the early morning hours. If you haven't been following the news, here's what you need to know about what will probably happen next.

Cyprus needs to come up with EUR 5.8 billion to receive EUR 10 billion in aid from the troika (the European Union, the International Monetary Fund, and the European Central Bank) to recapitalize its banking system. The plan developed last weekend -- which called for a levy on all bank depositors to pay for Cyprus' contribution -- collapsed after it was unanimously voted down by Cypriot lawmakers.

Time's up!
Cyprus has one more shot at this, as the European Central Bank gave the nation a Monday deadline to reach an agreement with international lenders; failing that, the ECB will withdraw its emergency liquidity -- which is the only thing that has been keeping the Cypriot banking sector afloat for months.

These are the broad strokes of a new agreement, as reported earlier today:

  • All uninsured depositors (i.e., those with an account that exceeds EUR 100,000) at the Bank of Cyprus, one of the country's largest lenders, will suffer a penal haircut. The reports I have seen refer to either a 20% or 25% levy.

  • Uninsured depositors at other banks in Cyprus -- whether Cypriot or one of the 26 foreign banks operating in the country -- will suffer a 4% haircut.

  • Cyprus Popular Bank (known as "Laiki"), the country's second largest lender, will be wound down. Laiki has now limited ATM withdrawals to EUR 100.

What does all of this mean for U.S. investors? If we wake up tomorrow morning with an agreement in place, the effect on U.S. indexes, including the Dow Jones Industrial Average (DJINDICES: ^DJI  ) will, in my opinion, be negligible -- this outcome is largely discounted in Friday's closing prices. That is as it should be -- I think this is the most likely option. Cypriot lawmakers will (hopefully) have realized that they have run out of road, there are no good outcomes available, and a bad outcome is still preferable to a catastrophe. Should they choose collective suicide, however, the fallout would probably hit the shores of the U.S. stock market, and investors should expect a bumpy ride on Monday.

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