The Financial Times is getting closer to the heart of the matter.
The European Central Bank determined last week that the second largest bank in Cyprus, Laiki, was in such bad shape that they could not justify giving it any service as lender-of-last-resort.
So, the proposition given by the Eurozone to the government of Cyprus was either 1) do nothing, Laiki fails this week, and you are on the hook for 30B euros of insured deposits, or 2) agree to the haircut which covers a third of the bailout package we’re willing to give you.
BTW: There are discussions in the Cypriot government about convincing the Eurozone to accept a bigger haircut on large accounts, in exchange for a reduced haircut on smaller accounts.
FWIW: It’s hard to get perspective on this, because Cyprus isn’t that well known. It makes up just 0.2% of the Eurozone economy. That’s comparable to Vermont relative to the U.S. economy. But, with an out-sized banking system: something like all of New England’s financial system crammed into Vermont.
N.B. # 1: You could and should view this as a tax on wealth, and many people are describing it this way. Keep that in mind when you hear 99 percenters talking about taxes on wealth, financial transactions,and so on.
N.B. # 2: The word “bail-in” is being tossed around. A bail-out is when outside money is brought in to make your operation solvent. A “bail-in” is when money you’ve already put into an operation is permanently committed without you being able to get it out again: sort of like having your bonds converted to (worthless) stock, with the chance that you might get lucky.