Why a Tiny Island Is Shaking Global Markets

On a day in which there were no major economic releases, blue-chip stocks are nevertheless broadly lower. With roughly an hour left in the trading session, the Dow Jones Industrial Average (DJINDICES: ^DJI  ) is off by 59 points, or 0.4%.

The biggest catalyst in the market today is news that Cyprus, a tiny Mediterranean island smaller than the state of Connecticut, has agreed with the European Central Bank and the International Monetary Fund upon the terms of a bailout. As The Wall Street Journal reported, the deal ends a week of "financial panic that threatened to see the small island nation become the first government to leave the euro zone."

Under the terms of the plan, Cyprus will receive 10 billion euros from the international bodies in exchange for the country's agreement to shut its second-largest bank and impose "steep losses" on deposits in excess of 100,000 euros. The reality that this was a pyrrhic victory was not lost on the island's finance minister, who observed that "It's not that we have won a battle, but we really avoided a disastrous exit from the euro zone."

While Cyprus probably shouldn't matter in the whole scheme of things -- as my colleague Morgan Housel noted this morning, "Its annual GDP equals what Apple earns in profit every seven months" -- the terms of the bailout have nevertheless sent shockwaves through the international banking establishment, sending shares of even American lenders such as Bank of America (NYSE: BAC  ) and JPMorgan Chase (NYSE: JPM  ) lower today.

The reason, as I discussed over the weekend, is that it calls the sanctity of deposits into question. Since the Great Depression, deposits in most of the Western world, including Cyprus, have been considered safe thanks largely to government-provided deposit insurance. Here in the United States, we have the aptly named Federal Deposit Insurance Corporation to thank for that.

But as Simon Kennedy of Bloomberg News observed, "The island nation’s rescue sets precedents for the euro zone that may stick in the memory of depositors and bondholders alike as investors debate who will next fall victim to the debt crisis." The implication, according to Kennedy, is that investors of all stripes may become more "skittish" and that "bank runs and bond market selloffs become more likely the moment a country applies for a new rescue." The net result, in other words, is potentially heightened instability and volatility.

Of course, for opportunistic investors, this isn't necessarily a bad thing, as it may present buying opportunities not otherwise available -- one of which may well be Bank of America, the second-largest bank by assets in the U.S. Click here now to download our comprehensive report on the bank, which details three reasons both to buy and to sell the mega-lender today. 


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