Cyprus: A Lesson for Regular Investors

While the current Cyprus "crisis" in Europe may not be particularly relevant to investors here in the United States, there is a significant lesson to be learned.

The island nation has a population roughly the same as Jacksonville and has an economy smaller than Shreveport, Louisiana.  Cyprus was the richest of the ten countries that joined the European Union in 2004. In 2008, it dropped its currency, the pound, for the euro.

Being a member of the EU and the euro zone benefited both Cyprus and foreigners eager to invest there. It made the country more attractive as a place to do business. It particularly lured wealthy Russians, who appreciated the country’s strong protection of property rights beyond Moscow’s reach and its 10 percent corporate income tax rate (Europe’s lowest), not to mention the balmy weather.

The problem—again, a familiar one—was that Cyprus’s two biggest banks couldn’t manage the flood of deposits. Cypriot regulators fell short as well.   Starting in 2007, the Central Bank of Cyprus, realized excessive deposits could cause bubbles and inflation in the domestic economy, so they limited the share that could be lent domestically.  In theory, it was a good idea, except the two biggest banks—the Bank of Cyprus and the Cyprus Popular Bank—simply shoveled the money westward into loans in Greece. Greek government bonds were particularly attractive because they offered higher yields at supposedly zero risk—since everyone knows sovereigns don’t default, right?  Well we know what happened there.

The lesson here is by simply chasing yield or the highest paying investments, you open yourself to increasingly more risk.  There is a reason certain investments pay high interest - the quality of the underlying bonds are less than ideal.  If you can accept that your principal may be at risk, then it might be a suitable investment for you.  But for the rest of us, riskier assets only deserve a small part of any diversified portfolio.

Derived from Multiple Sources

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

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