Cyprus Financial Crisis: A simple explanation

Up until a week ago, investors were in euphoria because stocks were reaching new all-time highs. On March 14, 2013, the Dow Jones closed at a record 14,539.14 — a level not seen since pre-subprime mortgage crisis of 2007. Philippine stocks, meanwhile, continued its upsurge, ending at its all-time best of 6,835.21 on March 7, 2013.

And then last week, the market reversed. After reaching a new all-time high, the Dow Jones slid and was unable to return to record levels. The Philippine Stock Exchange index suffered a decline and, as of yesterday, registered its eighth consecutive day of losses.

What happened, you ask? Blame it on the Cyprus financial crisis.

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Why AIG was bailed out but not Lehman Brothers

There is a theory in finance and economics called the “Big Bank Theory” which asserts that governments — through the Central Bank or the Federal Reserve (in the case of the US) — will not allow a “big bank” to collapse because the economic impact of such occurrence will surely be great.

That was exactly the rationale behind last week’s bailout of the American International Group (AIG) by the US Federal Reserve (Fed).

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