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Sunday, March 31, 2013

A vindication of Germany?

This article by Mats Persson will make a lot of people feel good, namely all those who have felt all along that the criticism of Germany's being the pariah of the EU was/is wrong. And, of course, excessively unfair, too.

Persson writes that 'there are three main factors driving Germany’s attempt to instil this, and none of them is about seeking domination'. Many people in the South march on streets showing Angela Merkel with a Hitler-moustache proclaiming the Fourth Reich. If they spent any time living in Germany, they would know that this is a farce. The idea of Germans' desiring political domination of other countries is about as far fetched as the idea that Germans will ever become a spendthrift, sun-loving people who prefer idleness and/or fun over high productivity.

I am Austrian and Austrians have their own hang-up with German attitudes of superiority ever since Bismarck kicked Austria out of the German Union in 1871 on the grounds that 'Austrians were not fit to be Germans'. However, I have lived in Germany from 1974-80 and, more importantly, from 2003-10. If there is one generalization one can make about today's Germans, it is their abhorrence of all alleged 'German traits' which may have contributed to the result of the 1930s. In the extreme, this can even mean the rejection of social values which are important for nation building simply on the grounds that they had been used by their ancestors in the 1930s. Nationalism being one of them.

A former German President dared to say in public that 'he felt proud to be a German' and he was clobbered by the country's politically correct elite. Given its history, no German politician should ever say something like that. It almost seemed like Germans liked themselves better when they could hate themselves.

Another former German President was praised by the country's politically correct elite for having said, in an official speech, that 'the Islam is part of Germany'. No one dared to ask him what he thought Martin Luther, Johann Wolfgang von Goethe and/or Immanuel Kant might have said about that.

A friend of mine, a very traditional and conservative German of the older mold, keeps telling me that Germany has become a zombie society. A society which denies itself the pursuit of all those values which have made up German history. He attributes that to the 1968-generation-mindset which, he says, nowadays pervades all walks of German public life. And, he concludes, a society which does not hold on to its historical values (or rather: disavows them) will spell trouble in the longer term.

So much for Persson's argument that Germans are not seeking domination. I think he is absolutely correct!

Still, I do not agree at all that Germany can walk away free and clear of responsibility from today's financial, economic and political crisis in the Eurozone. On the contrary, Germany (together with France as a co-equal partner back in 2010) set in motion the process which may eventually lead to a breakup of the Eurozone and cause irreparable damage to the EU.

In 2010, Angela Merkel coined the phrase which may go down into history as one of the more expensive phrases ever coined by a politician: "If Greece fails, the Euro will fail and if the Euro fails, the EU will fail". Nicolas Sarkozy seconded that erroneous line of thinking by adding "Angela and I will make sure that the Euro stays in tact".

I am not saying that they intentionally lied but they certainly were less than truthful. Merkozy had one primary objective from the start: to do everything possible that their overexposed banks would not fail. And instead of being truthful about that, they disguised their strategy under the heading 'help for Greece'.

The destructive consequence of that policy was that two problems which should have been dealt with separately were now mingled: the saving of the banks on one hand and the help for Greece (and others) on the other.

Just follow this arithmetic: suppose that the total cost of 'saving the South' was/is 1.000 units by now. It is no secret that only about 200-300 of those units really went to the South while the remaining 700-800 units went to the banks. The shareholders of those banks are still untouched; they have received substantial dividends in the meantime and the bank managements substantial bonuses.

My argument from the beginning was/is that those 700-800 units should have gone directly to the banks instead of via the South. Not in the form of loans but, instead, in the form of equity. Existing shareholders would have been appropriately diluted, certain managements could have been replaced and the tax payers would have gotten something in return - equity in those banks.

To be sure: not with the intention of more permanent nationalization of banks but, instead, temporary and partial nationalization with the objective of repairing those banks and selling them to new owners afterwards. This would only have worked with bank supervisory and management boards free and clear of political influence.

In conclusion: Germany (and its co-equal partner France at the time) cannot be vindicated from responsibility. No alternative strategy could have avoided the painful but necessary economic adjustment in economies which lost their competitiveness. However, that lost competitiveness alone could never have led to the result which we are seeing today and which might endanger the worldwide financial system.

Germany (and France) embarked on policies aimed at saving banks by saving the Euro. Forcing uncompetitive economies to become competitive was seen as the best (and only!) instrument. In the end, they may fail on all three of these objectives.

Saturday, March 30, 2013

National Bank & Eurobank - nothing like blowing up a big deal at the last moment!

I haven't followed the planned merger between National Bank and Eurobank in detail but it seems like this has been in the works for a very long time. Over a year perhaps? Of late, I was under the impression that the deal had been closed and was done.

Surprise, surprise! According to this article from the Ekathimerini, the Troika is now opposing this merger. Now, to create uncertainty virtually at the last minute of a merger process will really do the Greek financial sector some good as regards investors' or depositors' confidence!

Has the Troika not been around during all this time that the merger had been discussed and negotiated?

"Risk takers MUST remain risk carriers in a restructuring!"

I have pointed out before the potential nightmare which the implementation of the plans for the Cypriot banking sector is likely to trigger. This plan is full of preferential treatment elements and few things motivate smart lawyers as much as preferential treatment when there should be no preferential treatment.

All of this just makes it even more un-understandable for me why the Eurogroup did not even consider the proposal made by Lee Buchheit. His proposal was the standard approach to ANY financial restructuring, be that the debt of the Cypriot banking sector, the debt of the Greek state, the debt of a corporation, or whatever.

Buchheit's proposal rested on 2 major principles: (a) risk takers must remain risk carriers; and (b) if losses are to be taken, creditors/depositors should be given the choice to take them right away or to defer them into the future against the chance that, perhaps, the losses can be avoided in the longer term. As Felix Simon stated in his commentary: 'That’s it! That’s the whole plan, and it’s kinda genius. If you have bank deposits of more than €100,000, they will be converted into bank CDs, with a maturity of either five years or 10 years — your choice'.

As I have argued over and over again: the same principles should have been applied to the sovereign debt of Greece (Buchheit had recommended that for Greece. He ended up engineering Greece's lamentable haircut only because that was set as a condition precedent by the Troika).

The one counter-argument against such an approach is the famous but abstract argument of debt sustainability. That sounds like a very good argument but, in practice, it is close to nonsense.

Debt sustainability only matters when principal and interest of debt need to be paid in cash. Put differently, if principal or interest on debt never had to be paid, debt sustainability would be infinite. That 'debt' would then be called 'equity'.

To return to Cyprus: if creditors/depositors over 100 TEUR were given new CDs with 5 or 10 year tenors in exchange for their loans/deposits, those CDs would have had a value in the secondary market from the start. Those who didn't trust Cyprus for 5 or 10 years could have sold their CDs and taken a loss. The others could have held on to them and, if things went well, even collect interest at the end. No one would have been forced to take losses right away. And one could still have dreamed up additonal incentives like offering a bit of bank equity to the lenders/depositors or, as Felix Simon suggested, receipts of future gas revenues as collateral.

If EU authorities had followed the principle of 'risk takers must remain risk carriers in a financial restructuring', the Eurozone would financially be a much safer and more stable place today than it is!

Prof. Paul Krugman - a Greek script for Cyprus?

Prof. Krugman recommends in his blog that Cyprus should pursue the script which he had originally recommended for Greece, namely: allow a banking crisis, follow-up on it with sharp limits on bank wirthdrawals and then - with the panic argument against Euro-exit reduced - reintroduce a domestic currency.

Prof. Krugman concludes with the question: what exactly is the point of Cyprus' staying on the Euro?

I cannot judge Cyprus but I do recall that my original recommendation for Greece was quite similar to Prof. Krugman's. One small/giant difference: I recommended that Greece should hold on to the Euro. Why? Because my answer to the question of 'what exacly is the point of Greece's staying on the Euro' is - hold on before you continue reading because my answer might shock you when looking at the economic/political mess which the Euro allegedly caused in Greece - well, my answer why Greece should stay on the Euro is that the Euro means living standard for Greeks!

From the Greek standpoint and against the background of Greece's experiences with the Drachma, the Euro is a strong currency. The Greek Euro has the same international purchasing power as the German Euro. Admittedly, that is part of the reason why the Greek economy got into so much trouble because Greeks intensified importing instead of buying Greek products (thereby damaging the domestic economic value generation). But still: with the Drachma, Greeks could have never imported so much (that is: imported living standard) as it did with the Euro. Give up the Euro and you give up living standard.

My recommendation for Greece was a bit different. I argued that 'if a Euro-exit is the worst of all evils (which it would be) and if Greece cannot make it with the present Euro-structure (which it most likely cannot), then Greece must hold on to the Euro and simulate a situation – at least temporarily – as though she had returned to the Drachma'

As (temporary) measures I had recommended: special taxes on imports in order to make imports altogether 30-40% more expensive (on a staggered scale, however: 0% for priority imports; 100% for luxury imports); selective Free Trade Zones where internationally competitive business conditions are allowed so that new domestic production for import substitution (and for export!) can be started; and capital controls. I also suggested that, during the interim, a deposit freeze with only minimal withdrawals for personal use might be necessary. 

My proposal was detailed in this article which I had first published in Austria in the spring of 2010 and later re-published in this blog a couple of times. Not knowing the Cypriot economy, I cannot judge whether this script would work for Cyprus but I maintain to this day that it would still be the best script for Greece.

Friday, March 29, 2013

Laiki Bank is only a symptom. The problem is elsewhere!

This interesting article describes how the Greek tycoon Andreas Vgenopoulos built his Marfin Investment Group (MIG) to which the now defunct Laiki Bank had belonged. Please note that the article was published in June of 2012!

The story in nutshell: Greek wants to build Empire and become tycoon. For that he needs money. He realizes that it is easier to get money in the name of a bank than in the name of a company (or in his own name). He also realizes that it is easier for a bank to get money when it is domiciled in Cyprus instead of Greece. He gets hold of a bank in Cyprus and uses it as one giant sucking mechanism for money. He spends that money, in the name of the bank, to finance the expansion of his group based in Greece. He also spends money to finance himself and befriended partners to buy shares in his group so that the stock market value of his group explodes. Add to that a little corruption and the story is complete.

On the surface, there is nothing obviously illegal about the above practices except, of course, for the despicable corruptive part of it. But it could also been done without corruption. There is nothing illegal about a bank's financing the expansion of a group. There is nothing illegal about a bank's financing the acquisition of shares in a third-party company using those shares as collateral (provided, of course, that sufficent security margins are maintained).

You and I can, without any money on our own, open a bank and furnish it with an equity of, say, 100 MEUR. All we would have to do is to state in the bank's statutes that the equity will be paid up within 3 months. During these 3 months, we make a 100 MEUR loan to ourselves and put that money into the bank as equity. No cash moved. The bank now has total assets of 100 MEUR (its loan to us) and equity of 100 MEUR. No debt; no leverage. On the surface, triple-A quality. Then we start raising funds in the name of the bank and lend these funds to whoever we want (including ourselves and/or our other corporate enterprises).

There are only 3 reasons why this would normally not work: banking laws, banking regulations and the observance/control of the latter.

If a bank makes a loan to its owners, the bank is reducing its equity. If the bank makes a loan to a series of seemingly third-party companies which are secretely under the control of its owners, the fact that it is reducing its equity is covered up. But, at the end of the day, it is still lending to its owners and, thereby, reducing its equity.

Please note that, on the surface, everything would appear quite proper: the bank's books balance; the bank's loans seem well-structured; the bank's management tells credible stories about the marvels of their growth strategy. The bank may even pass EU stress tests with flying colors.

The whole system stands or falls with supervisors/controllers of banks doing more than just making sure that the i's are dotted and the t's crossed. Put differently, if supervisors/controllers only make sure that the i's are dotted and the t's crossed, literally unlimited malpractice can take place behind the facade of balanced books.

I have written ad nauseum that, in the case of Greece as a country, no one (neither in Greece nor at the EU level) seems to have been concerned about the application of the enormous funds which entered the country. In Cyprus, it seems that no one at the EU level spent any amount of time to understand how the Cypriot banking sector applied all those billions and billions of funds which it attracted.

In Greece, the EU had almost 10 years to look at the country's Balance of Payments and to monitor the staggering increases in foreign debt of both the public and private sector (banks). In Cyprus, they had over a year to shed light on what the Cypriot banking sector was really doing. Still, the Eurogroup took decisions in the last couple of weeks which would suggest that they had absolutely no idea as to what the Cypriot banking sector was doing. Apparently, they had done nothing for at least a year and then they gave the new President a couple of weeks to come up with a solution.

It is simply mindboggling to observe how little competence the Eurogroup and EU politicians have in the area of setting incentives for growth in the real economy. It is even more mindboggling to observe how little competence the Eurogroup, EU politicians and - above all - the monetary experts at the ECB have in the area of seeing through the operations of a banking sector. All they seem interested in is that the books balance.

If the Eurozone were a multinational corporation, its top management would have been fired a long time ago. Some of them might even have been brought to court for illegal practices. And none of them would have found a new job due to their lack of economic, financial or commercial competence.

Thursday, March 28, 2013

John Mauldin hits the nail on the head!

The widely read American financial expert John Mauldin (www.mauldineconomics.com) made the following summary of Cyprus, the Euro, European banks, etc. in his latest newsletter. It has got to be one of the best pieces I have read so far!





You Can’t Be Serious
By John Mauldin | Mar 27, 2013

I admit to being surprised by Cyprus. Oh, not the banking crisis or the sovereign debt crisis or the fact that its banks were eight times larger than the country itself or even the fact that the banks were bloated with Greek debt that had been written down. I wrote about all that a long time ago. What surprised me was that all the above was apparently a surprise to European leaders.
While there is much to not like about what European leaders have done since the onset of their crisis some five years ago, they have demonstrated a prodigious ability to kick, poke, and massage the can down the road, to defuse crisis after crisis, and to indefinitely postpone the inevitable. They have demonstrated a remarkable ability to spend taxpayers’ and others’ money in order to keep Europe and the euro more or less in one piece. At every step they have been keenly intent on maintaining trust in the system. That they have been successful in keeping a majority of citizens in favor of the Eurozone and the euro, even in countries forced to endure serious austerity, must be recognized.

However, the shock in Cyprus reveals an absolute lack of preparedness in dealing with a problem that had festered for several years. By now it should be no surprise to anyone that sovereign nations can default, that banks can go bankrupt under the weight of defaulted sovereign debt, and that banks can be too large for some countries to bail out. That a clear and consistent response to Cyprus should have been worked out in the halls of Brussels and the ECB seems so, well, reasonable. Clearly, the large depositors in Cypriot banks, the majority of whom were Russian (according to Financial Times reports) thought the Eurozone had a plan. In fact, the apparent assumption, bordering on religious faith, that Eurozone leaders would not allow depositors in Cypriot banks to lose one euro, is almost touching. This snafu is going to have repercussions that spread far beyond this tiny island nation. Let’s look at a few of the implications.

When we woke up to the Eurozone pronouncement that all depositors in Cypriot banks, no matter the size of their deposits, would take a loss my reaction was somewhat akin to John McEnroe shouting, “You can’t be serious!” to a line judge whose call he infamously questioned.

While there was no official deposit guarantee in place in Europe, the implicit guarantee was €100,000, a number that had become all but sacred during the recent banking crisis. To wake up and find that European leaders not only did not consider this protection to be implicit but also planned to demand losses from all depositors, was quite the shock. I think this may have been the single worst “call” by European leaders since the beginning of the crisis in 2008.

Let’s look first at what actually transpired. Cypriot banks held deposits of roughly €68 billion, four times the size of the total national GDP, while the total size of the banks was roughly eight times GDP. The “Troika” seemed to feel that Cyprus needed €17 billion in bailout money to be able to handle the crisis. But after finding hundreds of billions for Greece and Spain, they were only able to offer tiny Cyprus €10 billion (€10 billion is the equivalent of offering the US $8 trillion, give or take a few euros, just to keep it in perspective), and demanded that depositors in Cypriot banks be levied for most of the remaining €7 billion. They offered a formula by which small depositors would lose somewhat less than 10% and large depositors somewhat more (the actual number varied day by day).

The Cypriot parliament totally rejected the Eurozone proposal. Not one vote was cast for the deal. And when you look at the numbers, as any politician does, you can see why. This is an island of 1.1 million men, women, and children. There are (were) 370,000 bank accounts, with 360,000 of those containing fewer than 100,000 euros (per Dennis Gartman). In the recent presidential elections in Cyprus, there were 445,009 voters and a voter turn-out rate of 81%. Thus, a huge majority of voters had accounts with less than €100,000 in them. Call me cynical, but I think any politician could figure out which side of this fence to land on.
It now appears that “only” €5.8 billion is needed for the bailout, so the 10,000 or so accounts holding more than €100,000 will be docked an average of €580,000. “The tottering banks hold 68 billion euros ($88 billion) in deposits, including 38 billion ($49 billion) in accounts of more than 100,000 euros – enormous sums for an island of 1.1 million people, which could never sustain such a big financial system on its own.” (NBC World News).

On the surface it looks like large depositors will lose about 15%. And if the Financial Times is right (and the betting line is heavily on their side), a significant majority of that money is Russian. Much of the remainder is tax-haven money (more on that later). “Not so bad,” you might think; “things could be worse.”

Well, actually they are worse. Some EZ officials suggest that the losses of large depositors could range up to 40%, and the Cypriots themselves suggest 30%. That is because if you are a Greek bank with a Cyprus branch your deposits are exempt from the levy. The logic behind that decision is just too arcane to explain in a brief letter that prides itself on rational explanations. Which is another way of saying that I actually couldn’t understand it myself. But then, I’m just a country boy from West Texas, not a European financial wizard.
Things keep spiraling down in the Eurozone. One of the founding principles of the Eurozone was that a euro anywhere within the zone would be as good as one anywhere else. Euros would flow freely. All for one and one for all.

Except that now euros in Cypriot banks are no longer equal. Not only are they going to be “taxed” (or whatever euphemism they end up choosing – they’re still debating that one – but if it were your account you might call it theft), but deposits will be subject to capital controls. Reports coming out of Europe this morning suggest that banks in Cyprus will stay closed until at least Thursday. It is not clear when you will actually be able to take your money and leave the sunny shores of Cyprus.

Cypriot banks will remain closed until Thursday, the government announced on Monday night, as President Nicos Anastasiades acknowledged that the country had come “a breath away from economic collapse” before its last-minute bailout.  Speaking after he agreed a €10bn international rescue that includes the restructuring of the island’s two biggest lenders with losses for bigger depositors, Mr Anastasiades also said capital controls would be imposed but as a “very temporary measure that will be gradually relaxed”.

We will eventually learn what time frame a Cypriot politician has in mind when he says “temporary.” And Mr. Anastasiades may have been speaking optimistically to the press. Other Cypriot politicians were rather less sanguine. From Dennis Gartman this morning:

They (bank depositors) knew for certain, however, that they were going toface massive losses when Mr. Averof Neofytou, the deputy president of the ruling Disy Party, said that those large depositors “Will [have to] wait for many years before they see what percentage they will get back from their savings – 30 percent, 40 percent, 50 percent, 60 percent, it will be seen….”

Basel III standards require European banks to increase their deposit ratios. This European response to Cyprus is going to make that harder for banks in smaller European countries to accomplish. Very tiny Luxembourg has banking assets 13 times the country’s GDP. Yes, I know that Luxembourg’s banks are the very epitome of solid banking and that the majority of those assets are loans to central banks and other credit institutions, but there is no way on God’s green earth that Luxembourg as a country could even begin to think about backing its banks. Of course, everyone knew that before this crisis, but if you are the treasurer of a large corporation, how soundly do you sleep at night after Cyprus? And God forbid you have an account in one of the peripheral countries. In the case of Ireland, the lesson was that the money would be found to back the banks, even if taxpayers suffered. But now? New rules for new times. And then you open The Financial Tim es this weekend and read (emphasis mine):

The chairman of the group of eurozone finance ministers warned that the bailout marked a watershed in how the eurozone dealt with failing banks, with European leaders now committed to “pushing back the risks” of paying for bank bailouts from taxpayers to private investors.
Jeroen Dijsselbloem, president of the eurogroup, was speaking after Cyprus reached its 11th-hour bailout deal with international lenders that avoids a controversial levy on bank accounts but will force large losses on big deposits in the island’s top two lenders.

Evidently, Jeroen interprets the term private investors to mean depositors with over €100,000 in a bank. That has to be unsettling to anybody who has diligently saved for decades and is now retired and depending on those funds for sustenance. And for corporations that run a payroll account through a bank? The thought that you could see a lifetime of work building a business go down in an unelected bureaucrat’s blink of an eye would keep me up at night. I do not think most corporate financial types see their deposits as an “investment” in the bank.

One of my favorite reads is Kiron Sarkar (who variously lives and writes daily in London, Ireland, and India). I talk and correspond frequently with Kiron. He is a retired but very senior investment banker with deep European political and business connections in many countries. As we say in Texas, he is “wired.” (You can subscribe to his letter at http://sarkargm.com.) He shot out a special note on the rather incendiary comments of Mr. Dijsselbloem. I have seen other comments similar to these (but less well-said), expressing various levels of disbelief about the timing of Dijsselbloem’s remarks, but here’s what Kiron had to say:

Reuters quotes the Chairman of the EZ Finance Ministers, Mr Dijsselbloem, as having said:
“If there is a risk in a bank, our first question should be OK, what are you in the bank going to do about that? What can you do to recapitalise yourself? If you can’t do it, then we will talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalising the bank and, if necessary, the uninsured deposit holders.”
He is also reported as having said, “It will force all financial institutions, as well as investors, to think about the risks they are taking on because they will now have to realise that it may also hurt them. The risks might come towards them”. These are very likely to be personal remarks, rather than an EZ finance minister’s policy statement, but these comments suggest:

·         Uninsured depositors in EZ countries may well be bailed in in the future, ie Cyprus is a precedent;
·         EZ countries with large banking sectors will have to reduce their size and restructure;
·         EZ countries are seeking to shift risks away from the public sector and onto the banks; and
·         Bail-ins will reduce the need to use the ESM funds to recap banks, a policy which was proposed just under 1 year ago.

These are INCENDIARY remarks, especially given the timing and debacle over Cyprus.  What happens to Malta? Slovenia is in trouble. Luxembourg has a massive banking sector, though it is an AAA-rated country. All 3 are in the EZ. I realize that Mr. Dijsselbloem is new to the job and has little to no experience of the financial services sector (why was he appointed, you may well ask), but to make such comments, especially at this time, is the height of irresponsibility. The comments Reuters reports seem accurate, as the FT carries similar quotes.

At the end of the day, Mr Dijsselbloem is, of course, right; but to say something like this, especially at this time, well …

[Now this is the key paragraph and takeaway. Read twice. – John]
Essentially, why will anyone keep more than E100k in any EZ bank – indeed, why deposit any amount in certain EZ banks, as the value of the EZ  bank-deposit guarantee is worthless in a number of cases, as a number of the peripheral EZ countries can’t afford to pay up. I repeat, the EZ bank deposit “guarantee” is not a joint and several responsibility across the EZ; it is the responsibility of individual EZ countries.

If these comments are not withdrawn/clarified, the weaker EZ banks in the troubled countries, in particular, are going to come under severe pressure. Even if withdrawn/clarified, this is yet another self-inflicted wound. The euro has declined materially since these statements by Mr Dijsselbloem were published by Reuters and the FT.

The euro has declined to US$1.2873 at present and continues to weaken. The European banking sector is being hit – no surprise. The peripheral countries (Spain and Italy) are also being hit, in particular. Bond yields of the safer countries are declining, unsurprisingly, whilst the yields in the EZ peripherals are rising. Italy and Spain look to be under pressure. A number of you may now understand why I am so negative on the EZ. 

As I noted, Basel III makes it more necessary than ever for Eurozone banks to retain depositors, but this action on Cyprus will make getting large deposits more difficult for many banks. Note that less than 4% of depositors account for almost 60% of the deposits in Cypriot banks. Banks need those large depositors if they are going to grow their capital base to the required standards.

This unfortunate business underscores one of the most significant problems in the Eurozone, which is the lack of a collective deposit-insurance scheme. I wrote pessimistically about that topic over a year ago when European leaders promised they would create a Eurozone-wide deposit-insurance mechanism. That initiative has gone nowhere, primarily because the Germans have opposed it. (Ironically, so did Cyprus.)

Let me state this very clearly: if something as seemingly straightforward and necessary as deposit insurance cannot be achieved, then how can there be any hope for deeper fiscal union? And fiscal union will be necessary before all is said and done if the Eurozone is to survive.

It is not just tiny Cyprus or even Spanish banks that will be looked at with growing worry by large depositors. Let’s examine this note from David Stockman on European banking, and in particular French banks:

BNP-Paribas is the classic example: $2.5 trillion of asset footings vs. $80 billion of tangible common equity (TCE) or 31X leverage; it has only $730 billion of deposits or just 29% of its asset footings compared to about 50% at big U.S. banks like JPM; is teetering on $500 billion of mostly unsecured long-term debt that will have to be rolled at higher and higher rates; and all the rest of its funding is from the wholesale money market , which is fast drying up, and from repo where it is obviously running out of collateral.

Looked at another way, the three big French banks have combined footings of about $6 trillion compared to France’s GDP of $2.2 trillion. So the Big Three French banks are 3X their dirigisme-ridden GDP… By contrast, the top three U.S. banks which are no paragon of financial virtue – JPM, BAC, and C – have combined footings of $6 trillion or 40% of GDP.  The French equivalent of that number would be $45 trillion for the U.S. banks.  Can you say train wreck!

It is only a matter of time before these French and other European banks, which are stuffed with sovereign debt backed by no capital due to the zero risk weighting of the Basel lunacy, topple into the abyss of the shadow banking system where they have funded their elephantine balance sheets. And that includes Germany, too. The German banks are as bad or worse than the French. Did you know that Deutsche Bank is levered 60:1 on a TCE/assets basis, and that its Basel “risk-weighted” assets are only $450 billion, but actual balance sheet assets are $3 trillion? In other words, due to the Basel standards, which count sovereign and other AAA assets as risk free, DB has $2.5 trillion of assets with zero capital backing!

This is all a product of the deformation of central banking and monetary policy over the last four decades and the destruction of honest capital markets by the monetary central planners who run the printing presses. Furthermore, this has fostered monumental fiscal profligacy among politicians who have been told for years now that the carry cost of public debt is negligible and that there would always be a central bank bid for government paper. Perhaps we are now hearing the sound of some chickens coming home to roost.

Yes, yes, I know: “John, how can you even think that French debt could be at risk?” But if you look at France’s income and balance-sheet statements, as if France were a stock rather than a country, you might not be so sure. Might I suggest that a good trade would be to be long German government debt, short French debt? Essentially, this is a bet that France will be worse off than Germany in the coming years, which seems like a good wager right now. And in a French debt crisis (well within the realm of possibility) that trade could work both ways! Just saying …

We will wrap up with this note that just hit my inbox from Louis Gave. (I am up late, as usual, and Louis writes from Hong Kong, where it is early). Remember that Louis is French as you read this.

So we now know that, in Europe, big depositors are the first in the line of fire to ensure that small depositors do not suffer losses. Needless to say, this raises the question of who wants to be a big depositor in a weak bank in a country undergoing a secondary depression?...

EU policymakers are probably not evil henchmen set on destroying the financial industry (even if it often looks that way from the City of London). The more likely explanation is that EU policymakers are simply ignorant of how financial markets work. For example, the fact that the two largest Cypriot banks’ London branches have remained opened through the past week, allowing large depositors to take out millions of euros, hints that Europe's policymakers are simply clueless when it comes to how financial markets work. This also means that whatever pound of flesh the EU thinks it will be getting by wiping out the large depositors could turn out to be on the light side.

Or, for a second example of cluelessness, what could rival yesterday's declarations by the Dutch finance minister that the Cyprus bailout set a new “template” on how to deal with bust banks, namely make the rich depositors pay for the little depositors? What large depositor in a troubled bank in a country going through a secondary depression will want to stick around for that deal? We would venture that the next time that "solution" is applied, the eurocrats will find that the large depositors will not have waited around to get fleeced. In fact, as mentioned above, it might not even work this time (i.e., Cyprus), let alone the next one.

Going one step beyond the ignorance of how financial markets work, what seems profoundly shocking is the lack of recognition of this ignorance. Place yourself back in the fall of 2008. As the financial crisis was unfolding, the likes of John Mack, Jamie Dimon, John Thane and other banking heads were asked to meet at the New York Fed, the US Treasury or even the US Congress on a regular basis to explain what was unfolding (and what they planned to do about it). Meanwhile, how many times have the heads of Santander, Intesa, SocGen, Deutsche Bank, etc., been called in to explain what was going on, or for them to give their views on what should be done? If asked, perhaps these CEOs would have said that:

a) European banks are much more dependent on deposits than their US counterparts.
b) Owners of large deposits are likely to be more risk averse and much more active in moving their money than small retail savers (for whom moving money from one country to the next presents high costs and almost insurmountable hurdles). And this for obvious reasons: a 40% haircut on $1,000 is unpleasant but it's not going to change anyone's life. But a 40% haircut on a pensioner's life savings of $500,000 will have a huge impact—and a 40% haircut on any middle-sized company's $10mn payroll will be enough to bankrupt the business. In fact, this simple reality brings us back to Mark Twain's advice that it is always better to tax poor people as there are so much more of them—unfortunately, Europe keeps going the other way, with devastating consequences.
c) For these reasons, regulators and governments have never in living memory allowed big banks to default on their depositors, regardless of the wording of formal deposit insurance contracts. If this implicit guarantee is now removed in Europe (and it sure looks like it has been), then we should expect a big shift of large deposits out of the banks and into government bonds or credit market instruments.
d) This will prove very problematic, especially given the new Basel III regulations which encouraged a funding model whereby banks should rely more on deposits and less on bonds.
e) As savings shift out of banks and into credit markets, the "German bank" model based on bank-financing of industrial companies and long-term creditor-debtor relationships will inevitably erode, to be replaced by the Anglo-Saxon model credit-market financing along with the short-termism which it implies.
In other words, the law of unintended consequences is at work: the eurocrats will end up with exactly the opposite of the financial system they wanted. Either that, or the European banks will end up having to be nationalized in great numbers. These two possible outcomes seem to be the logical consequence of the EU's very unfriendly financial sector policies.

Louis is right. If you are a large depositor, you HAVE to be thinking about what country your deposits are in and how safe the actual bank is. Even if a bank is seemingly safe, is that any comfort? Is there any evidence that the depositors in Cyprus are better off being in one bank than another when the entire country’s banking system has seemingly failed? Was every bank in Cyprus bankrupt at the same percentage rate? Who’s to say, if BNP Paribas has problems, that a few finance ministers in Brussels would not demand that Societe Generale and Credit Agricole should be penalized, since they are in the same country? What is the logic here? Or is Cyprus a one-off because most of the losses are Russian and who really cares about those commies anyway? Except that the next time, comrade, it might be your bank account that is deemed expendable.

If you run a family office, large corporation, or just your own small pension account, you are not exercising reasonable prudence if you are not asking yourself, what are the risks as of today? You’re calling European friends and trying to figure out what the new rules are. Who made these decisions and why?

After spending hundreds of billions and not flinching from potentially printing perhaps trillions of euros to shore up the periphery, the Eurozone leaders now balk at a mere €5.8 billion and raise questions about their whole enterprise? Over German politics? You can’t be serious.
This may one day rank up there with “Let them eat cake” in the politically tone-deaf department. Merkel may have risked the entire euro experiment over local politics, after writing such large checks in prior situations. The Eurozone response to Cyprus indicates serious ignorance of how financial systems operate. Trust is an ephemeral thing. It is hard to build and maintain and can be so easily squandered. I suggest you go back and read (if you have not) the recent posting in Outside the Box of Dylan Grice’s masterful essay on trust.

Last-second insert, which I haven’t done in years, but this seems important:

As my editors and tech staff are literally ready to send this letter out, reports are starting to come across my desk that Russian depositors are finding ways to get money out of Cyprus, through branch banks in other countries. The ECB has supposedly told Latvia not to take Russian-flight money if they expect to join the Eurozone. Haircut estimates are ranging to 50%. If a lot of Russian money actually goes, it could be closer to 100%. I offer a few links, one from Reuters and one from ZeroHedge. I see some other reports and can’t completely separate rumor from fact, but Reuters is usually reliable and has a policy of multiple sources.

No one knows exactly how much money has left Cyprus' banks, or where it has gone. The two banks at the centre of the crisis – Cyprus Popular Bank, also known as Laiki, and Bank of Cyprus – have units in London which remained open throughout the week and placed no limits on withdrawals. Bank of Cyprus also owns 80 percent of Russia's Uniastrum Bank, which put no restrictions on withdrawals in Russia. Russians were among Cypriot banks' largest depositors. (Reuters)
So, while one could not withdraw from Bank of Cyprus or Laiki, one could withdraw without limitation from subsidiary and OpCo banks, and other affiliates? Just brilliant. (Zero Hedge, citing the above Reuters quote)

If this is true (and Reuters makes it sound real), so much for sticking it to the Russians. This could escalate into something ugly. I rather think this weekend’s Outside the Box will be on this still-brewing crisis. The Europeans are looking more and more like the Keystone Cops, in addition to being merely clueless. (And watching Jeroen Dijsselbloem trying to take back his words at this late moment is amusing. The Dutch are normally so disciplined. It just gets stranger, and if it was not so sad and scary it would be funny.)

The problem we have been discussing is not just a problem in Europe. In a general sense, it is the problem of banks that are too big to be allowed to fail. It is time to rein in the size of large banks before the next crisis. BAC and C are not just too big to fail, they are too big to effectively manage. If banks want to get larger, they should pay more deposit insurance to offset the implicit guarantees they get from taxpayers to cover losses beyond the ability of an FDIC to underwrite. I would go so far as to increase the capital requirements of banks as they increase in size, giving an incentive for management to break them up into smaller (and more manageable) pieces. The number of top experts, economists, and bankers who agree with me is rising, as this recent post from my friend Barry Ritholtz over at The Big Picture demonstrates.


End of newsletter

Tuesday, March 26, 2013

All easy - only bank resolution, deposit cuts and capital controls need to be implemented...

I cannot jump on the bandwagon of praise for the Cyprus decision because I see a potential nightmare ahead when I think of its implementation. Yes, it sounds good when regular savers are saved and when profiteers suffer some damage. But how is that going to work in practice? All depositors below 100 TEUR are regular savers and everyone else is a profiteer? All customers of most banks are regular customers but those of the two largest ones are profiteers?

To be sure, I have argued since the beginning that those who knowingly take risk in banks have to be called upon first when banks are to be rescued. This group begins with shareholders and moves on to semi-equity holders, interbank lenders and other 'professional market participants'. Depositors come last but even among depositors one should differentiate between 'professional market participants' and the others. And no one should ever play around with deposit insurance.

And, I hasten to add, it is good that this was finally recognized in Cyprus but it should have been recognized 3 years ago, beginning with banks in Germany, France & Co!

Here is an example given by a Cypriot university professor on German TV last evening which shows the potential nightmare very well:

A Cypriot takes a 300 TEUR loan from the Laiki Bank to finance the building of a house. That loan is deposited in a 'building account' from which all construction costs are paid. On day 1, the full 300 TEUR are in that account as 'deposit'. Overnight, the Cypriot loses 200 TEUR of those 300 TEUR while his loan remains at 300 TEUR. Makes sense? No, it doesn't, but that's going to happen the way I understand the planned implementation.

I think it is utterly wrong to take the figure of 100 TEUR (or any figure, for that matter!) to differentiate between regular savers/customers and profiteers. The differentiation is absolutely necessary but it should be made along the lines of deemed risk awareness of the depositors/customers.

Basel-2 has created the language of 'professional market participants'. Banks have 1-2 page questionnaires to be filled out to determine whether a customer is a 'professional market participant' or not. 'Professional market participants' are those who are deemed to know what they are doing. If a customer's account shows that several cross-currency swaps or other derivatives were transacted, that customer can be deemed to be a 'professional market participant'. If the account shows that a customer is transacting regular commercial business, it is not a 'professional market participant'.

The reason why this is more critical in Cyprus than elsewhere is that, apparently, Cypriot banks are much more funded by deposits than is normally the case. Normally, one gets quite a critical mass if one only aims at shareholders, semi-equity holders and interbank lenders. That critical mass is apparently not there in the Cypriot banking sector. Therefore, it is of utmost importance to differentiate among depositors in a way that is fair, just and - above all - makes sense!

Bank resolution - There better be a very good explanation/justification why there is a difference between the two large banks. Why one bank will be resolved and the other bank strengthened. Why the depositors/customers of one bank receive worse treatment than the depositors/customers of the other. I am sure some very smart lawyers are already out there chasing potential new clients...

Capital controls - If it is true that large sums of money could leave bank accounts (and the country!) during the current bank holiday, there better be an immediate investigation with the threat of enormous penalties. Happenings like this would totally undermine the credibility of everything which the government tries to achieve!

Is the Euro the primary culprit?

Hans-Olaf Henkel is a semi-retired, very prominent German with many, many experiences in business and otherwise. Since he has spent much of his career with an American corporation (IBM), his mind is noticeably shaped by common sense.

Henkel tends to swim against German mainstream thought (and he is a strong swimmer!). He has criticized Germany's handling of the Euro-crisis from the beginning. His major argument is that the Euro in its present form is the wrong currency for several countries and the sooner that is recognized and admitted, the better. Henkel is not really in the blame-game. He doesn't praise the North for being so responsible nor blame the South for having been profligate. He simply takes aim at the Euro and analyzes what the Euro has accomplished.

In his latest article, Henkel lists, using the example of Cyprus, 3 points why the Euro is more or less a weapon of mass destruction:

1. 'The anti-German protests in Nicosia help our Euro-savers to hide the consequences of their actions from the public' - These protests create the impression among German voters that their government is successful in protecting German interests (why else would Cypriots protest?). Henkel says the opposite is true. The German government has made things worse through its policies. This is why the German government literally needs the protests from austerity-hit countries to calm down the domestic voters.

2. 'The Euro forces German politicians to poke their noses into domestic affairs of other countries' - When German politicians take influence on the Cypriot pension system, it is not because 'Germans would like to rule the world' but, instead, the Euro drives them to do that. German politicians felt it necessary to tell the Greeks to privatize their national railroad when they would not dare to privatize their own national railroad. They get involved in national tax systems and wage/salary structures. Because they see that as their mission? No, because the Euro forces them to do that. 'A currency which presupposes that, of all countries, Germany gives orders to others cannot promote peace'.

3. 'The result of the Euro can be witnessed on the island of Cyprus. The Turkish part in the North, without the Euro, is doing quite well. The Greek part in the South, with the Euro, is collapsing'.

That certainly is food for thought!

Monday, March 25, 2013

Prof. Paul Krugman on capital controls

Prof. Krugman writes the following in his NYT commentary:

"Now what? I don’t expect to see a wholesale, sudden rejection of the idea that money should be free to go wherever it wants, whenever it wants. There may well, however, be a process of erosion, as governments intervene to limit both the pace at which money comes in and the rate at which it goes out. Global capitalism is, arguably, on track to become substantially less global. And that’s O.K. Right now, the bad old days when it wasn’t that easy to move lots of money across borders are looking pretty good."

I am reminded of the proposals I had made for Greece at the outset of the crisis: implement special taxes on imports, implement capital controls and perhaps even implement a temporary deposit freeze with only minimal withdrawals for personal use. All clear violations of some of the 'EU freedoms'.

The state would have had more revenues from the special (and specially targeted!) import taxes (or imports would go down, preserve domestic liquidity and perhaps even stimulate economic activity through import substitution) and about 80 BEUR could not have fled the banking system, and certainly not abroad.

A classic trade-off between religiously defending dogmas versus being practical about solutions.

Back to debt/equity swaps?

The worst thing which can happen to a bank's creditor (be that a lender or depositor) is that his claims are 'shaved' as part of a haircut. Why? Because he gets nothing in return.

In a previous post, I have argued why a debt/equity swap (which was insinuated in the first proposal for Cyprus) could really be a good idea. Obviously, if the equity one gets in exchange for loans/deposits is worthless, the idea is not much better than getting 'shaved' right away. But who is to tell that equity which appears worthless today will never regain some value?

It seems that debt/equity swaps are now indeed part of the current proposal, and that is good!

Not knowing their balance sheets, I cannot tell why one would restructure the largest bank through debt/equity swaps and not the second largest. Some creditors who will lose money with the latter are certainly going to ask that question in court.

The other question which I cannot answer without knowing the banks' balance sheets is why it should not be possible to transform the short-term risk of a bank run on the part of large depositors into an organized and orchestrated process to reduce bank assets in order to pay out depositors. Given the magnitude of the large deposits, it can't be that the banks used them all to fund loans. We know that a lot of them were used to fund the investment in now illiquid Greek bonds but I have to assume that the banks also invested in other, more solid and liquid asset categories. When an investment fund is called upon to pay out investors, it doesn't borrow money for that. Instead, it sells assets.

No particular praise is in order for doing away with the charge on deposits under 100 TEUR. First, there was no choice but to do this and, secondly, the long-term damage of having originally proposed it is irreparable.

To essentially close the second largest bank may be a good idea, or may not be. That would depend on how large the good bank would be after the bad bank is carved out. The most important point, though, is equitable treatment of risk takers in similar categories. The more inequitable it may turn out to be, the higher the risk of endless law suits.

Obviously, if one's intent is to shrink the Cypriot banking sector, there is no faster way to do it than to close the second-largest bank...

Sunday, March 24, 2013

Thinking of Cyprus and remembering Greece

As incredibly wise men and women meet in Brussels to find a solution to the Cyprus problem, I am reminded of the proposal which I had made for Greece at the outset of the crisis.

STEP 1: Reschedule maturities of all sovereign bonds and other sovereign debt with existing creditors way into the future. A couple possible ways: (a) add, say, 10 years to every current maturity; or (b) multiply the current tenors by, say, 3 (i. e. an outstanding 10-year bond would become a 30-year bond); or (c) replace all existing bonds/debt with 3 or 4 categories of new bonds; etc.

Consequences of step 1: Original creditors remain creditors (i. e. 'risk takers remain risk carriers'); no new debt is required to repay maturing debt; long 'breathing-space' as regards the refinancing of debt.

STEP 2: Implement interest capitalization in such a way that, in sum, cash interest expense is capped at, say, 5% of government expenditures (the remainder being capitalized).

Consequence of step 2: Enough of a burden for the budget to assure discipline but not so much as to suffocate justified spending.

STEP 3: Reschedule the entire foreign debt of other public sector companies, other private companies and, above all, of all banks in similar fashion.

STEP 4: Obtain commitment from foreign banks that suffient trade finance lines for Greek banks are kept open.

Comments on steps 3 & 4: always following the principle that 'risk takers remain risk carriers'.

STEP 5: Negotiate with IMF the Fresh Money financing requirement of the budget deficit.

No haircut. No deposit cut. No cut whatsoever.

The IMF would be the principal actor in this scenario and assure 'behind the scenes' that all creditors involved go along with the proposal.

Results for Greece? There would still have been an IMF-program with austerity and all that. The big difference would have been that, from the start, the debt situation of the sovereign, of other public sector companies, of private companies and, most particularly, of the banks would have been regularized. Thus, there would have been peace and quiet to work on all the other things that required working on.

Essentially, this is what Lee Buchheit is recommending for Cyprus.

Thursday, March 21, 2013

"Round Trips to Cyprus" - Prof. Paul Krugman

I wish I knew more about Cyprus, its economy and, above all, its financial sector. That's why I don't write about Cyprus (except for the recent 'stupidest and most potentially destructive Eurogroup decision since this crisis began three years ago', as Prof. Varoufakis correctly called it in his blog).

I wonder if those who write about Cyprus really know that much about its economy and, above all, its financial sector. Articles appear from time to time which bring to light entirely new aspects where one wonders why they haven't been brought up by those who took decisions and justified them.

For example, the Cypriot financial sector is unisono being described as 'overblown'. That is probably correct but there was a recent article which showed that if the Cypriot financial sector is overblown, you ain't seen nothing yet until you look at Luxemburg.

The Cypriot financial sector is unisono being described as being home to enormous amounts of black money from Russian oligarchs and that much of that money was invested in Greek bonds. Thanks to Prof. Krugman, I now know that Cyprus has being doing more with Russian money than only buying Greek bonds.

In his latest blogpost titled "Round Trips to Cyprus", Prof. Krugman explains that Cyprus is the single largest foreign direct investor in Russia! Here is what he writes:

"Still trying to wrap my head around the Cyprus situation; what makes it so interesting (as in “may you live in interesting times”) is the role of the island as a tax, regulation, and law enforcement haven.

It’s not just about the Russian connection, but that connection is really huge. Here’s another metric: Cyprus is, according to official figures, the largest single foreign direct investor in Russia — this from an economy roughly the same size as metropolitan Scranton PA. What’s that about? The FT explained it a while back:

This link occurs through CIS [Commonwealth of Independent States] commodity-based shell companies that deposit transactional balances of their CIS-based legal subsidiaries engaged in oil, mineral, and metals exports, often involving transfer pricing and other tax minimization strategies. The Central Bank of Russia classifies Cyprus as the largest single source of FDI in the Russian Federation, with a total of $41.7 billion in cumulative inbound FDI into Russia’s non-financial sector between 2007 and 2010 (over 2.7x German levels)… Cyprus is also counted among the top FDI investing nations in several Central Asian countries (likely Russian capital reinvested via Cyprus, a process known informally as “round-tripping”).
And a key aspect of the current mess is that the Cypriot government isn’t willing to give up this business. That’s why solutions like converting large deposits into CDs haven’t been on the table; once round-tripping Russians know that they can find their money trapped for long periods, they’ll go find another treasure island.

My guess is that in the end Cyprus can’t reclaim the round-tripping business — and once it decides that it can’t, a resolution will become much easier. But they’re not there yet."

Well, that adds an entirely new perspective to the situation. How many other new perspectives might there be out there which should be considered before taking rash decisions about this, that or the other?


PS: and here is another blogpost from Prof. Krugman with a lot of sensible stuff.

Go ahead, EU-elites - continue to ignore advice!

I vividly remember the frustrations I felt early on in the Greek crisis when I observed how arrogant and financially incompetent EU-politicians rejected advice from people who had extensive experience with sovereign external payments crises. William R. ("Bill") Rhodes often recounted how he had offered advice to EU-elites (and to Mr. Papandreou, for that matter) and how he was told that the Eurozone was something special and could not be compared with prior financial crises, possibly in emerging markets.

The IMF must be having celebrations. Up until Greece and the Eurozone, the IMF was always in the front row of sovereign external payments crises. They always unfolded their standard program and they were always hated by people suffering from IMF-imposed austerity. I understand that Mr. Papandreou originally, and correctly so, wanted to go to the IMF but his EU-colleagues bullied him out of that idea. The result? Mme. Lagarde can today attend meetings more or less as a relaxed observer who offers advice and tries to help. Instead of being blamed as in the past, the supra-national IMF appears today as the objective mediator and the national governments get all the heat. Well done, EU-elites!

Lee Buchheit is credited world-wide as possibly the most competent lawyer on issues surrounding sovereign debt crisis. He helped Russia in 1998 and Mr. Papademos could not have pulled off history's largest sovereign debt haircut without Mr. Buchheit.

Mr. Buchheit has now made a proposal for Cyprus. It consists of a grand total of 3 pages. As my American bosses used to tell me early in my career: "It's not the length; it's the content!" Well, these 3 pages include all the content one requires to solve the Cyprus problem. Felix Salmon made a good analysis of the Buchheit-proposal on Reuters.

So, here we go. Today, Cyprus is expected to announce 'Plan B'. If this plan follows the framework outlined by Mr. Buchheit, we will have seen the precedent that, for the first time, at least some EU-politicians accepted the advice from those who know what they are doing.


PS: I just read on Twitter that the Head of the Eurogroup, Jeroen Dijsselbloem, accepted responsibility for the Eurogroup's wrong decision. Well, that would be a first step toward 'Plan B'.

Monday, March 18, 2013

Hats off to Cypriot IT-specialists!

Anyone who has ever worked in a large corporation knows how tedious a process it can be to get internal IT-departments to develop new software. Not so in Cyprus. Within less than 24 hours, so I understand, the IT-departments of Cypriot banks developed and implemented new software which blocked funds in the amounts specified by the Eurogroup's decision. Wow!

This reminds me of Greece where, allegedly, the judicial process can almost be eternal. However, when it came to arresting and judging a journalist for publishing the Lagarde-list, they got that done in a hurry.

This just goes to prove that 'where there is a will, there is a way'.

How about applying the will to things which are more constructive than disowning small depositors and/or jailing journalists?

Crossing the Rubicon...

A day has passed since I published my first assessment of the Cyprus deal and I am even more concerned about the most terrible precedent which has been set by the Eurogroup. No, I don't mean the precedent of having customers contribute to the bail-out of their bank. That makes eminent common sense. Barack Obama was rightfully blamed for letting some customers of AIG (such as Goldman, Deutsche, etc.) so easily off the hook.

The most terrible precedent is the messing around with deposit insurance, with a law which guarantees that deposits up to 100 TEUR are safe. It would have been bad enough if Cyprus alone had messed around with that law because then the rest of the Eurozone could have said that this was strictly a domestic Cypriot decision. Here it was a decision of the Eurogroup imposed on Cyprus. Chancellor Merkel had the good sense last night to repeat on TV how correct she thought this decision was.

The Cypriot storm may well blow over in the next few days. What will not be forgotten, not only by Cypriots, Greeks et. al., is that the Eurogroup, in extreme situations, will not shy away from messing around with legal deposit insurance. From now on, that will also be in the back of the minds of savers in Northern countries. Who knows? Their banking systems might hit trouble one day and what then?

Simon Nixon of the WSJ also criticizes this terrible precedent but takes a more relaxed view on it. He thinks there is a chance that the storm will blow over and, after all, Cyprus is a singular case. Maybe yes, maybe no.

Eamonn Fingleton of Forbes makes a damning assessment of Germany and considers the Cypriot decision worse than the Lehman decision. With regard to the messing around with a deposit insurance law, I would agree. With regard to the remainder of his conclusions, I am more reserved.

Either way, there was a time when the expression 'post-Lehman' entered the dictionary of finance. I would predict that we are now entering a 'post-Cyprus' time.

Sunday, March 17, 2013

A new instrument - here come debt/equity swaps!

The deposit tax on Cypriot banks was originally introduced as an 'upfront one-off stability levy'. Subsequently, it was announced that those tax-paying depositors would receive in exchange shares of their banks in an equivalent level. In short, a debt-equity swap.

A debt-equity swap can be a very good idea provided that it is voluntary. Bonds, interbank loans and deposits are liabilities of a bank. If liabilities are exchanged for equity, ceteris paribus, the equity base of the banking system is strengthened overnight. The stability levy, so I understand, is expected to generate about 5 BEUR. After the debt-equity swap, the equity base of the Cypriot banking system would be strengthened by about 5 BEUR. I don't know how large that equity base is now but 5 BEUR more equity should make a substantial difference to the strength of the Cypriot banking system.

Things are different when a debt-equity swap is imposed by law. It may still be legal if the law is legal, but nevertheless. The key question with an imposed debt-equity swap, which may still be a prudent thing to do, is who gets hit by it.

The present proposal hits ALL depositors and those depositors are differentiated by more/less of 100 TEUR in deposits. Whoever thought of that wasn't thinking well.

When it comes to an imposed hit, any differentiation must be made on the basis of risk awareness of those who could be hit. Shareholders should have the greatest risk awareness because in a capitalist system, their money is strictly risk capital. And then there are funders of a banking system who are considered as 'professional market participants' (this is an official Basel-2 term). Typically, they are bondholders and interbank lenders. Finally, certain depositors can also be considered as 'professional market participants': an anonymous company, for one, should be considered as a 'professional market participant'. A regular depositor, that is a human being with a first and last name who invests his savings and considers himself protected by a deposit insurance law up to 100 TEUR, is NOT a 'professional market participant'.

By definition, a debt equity swap hits the shareholders because their equity will be diluted. It only hits the 'professional market participants' if they are specifically targeted. The plan for Cyprus does not specifically target them. Instead, the plan also hits regular savers who had considered themselves to be protected, up to 100 TEUR, by the deposit insurance law.

This mistaken differentiation, not the imposed debt-equity swap per se, is the enormous error underlying the Cypriot plan. There is no way of telling what sort of consequences this terrible precedent may have (even in countries which are not yet affected by the crisis)!

I am not an expert on Iceland but what I have read about it, the Icelandic government essentially said to those creditors of their banking system which were 'professional market participants' the following:

"We have never understood what our banks were doing. Since you are 'professional market participants', we assumed that you knew what they were doing and that you were happy with it. However, we always understood what our savers were doing. They were putting their savings into banks in the confidence that they would be safe. Thus, we'll protect the savers and you, the 'professional market participants', will have to fill the hole".

Austrian banks, for example, lost a couple of BEUR in Iceland. Served them right! Why did they transport Austrian savings to Iceland when they didn't understand what Icelandic banks were doing with the money?

In my opinion, the Cypriot government/parliament should approach the deliberations of the new law in the following way:

"The Troika requires the customers of our banking system to provide an upfront one-off stability levy of 5 BEUR. Since those customers will receive shares in their banks, this is a debt-equity swap. We agree that it is fair to impose such a debt-equity swap on bank customers as their contribution to the problem. We do not agree with the Troika's 'definition of customers'. We will exclude regular savers, that is official depositors with first and last names, from this debt equity swap altogether. Instead, we will increase the levy on all 'professional market participants' so that the 5 BEUR volume is reached. That is fair, equitable and, most of all, it is the will of the Cypriot people".

To me, to do that would absolutely be the sovereign right of Cyprus, and it would make sense. The real question is how the Eurogroup would react to that!

Friday, March 15, 2013

Where are the Greek media, for crying out loud?!?

Over one month ago, I wrote this article about a most remarkable new investment, Systems Sunlight. My conclusion was a fairly aggressive one, namely:

"Let me phrase it politely: When public discussion goes overboard about what did or did not happen with Greek statistics back in 2009; when Greek brainpower dissects the question of whether the IMF had used the right multiplier; when members of the Greek intelligentsia write almost dissertations explaining that Greece can do nothing on its own in the present situation just like Ohio couldn't do anything on its own during the depression - well, when all such things are happening but no one finds time to spread positive news if and when they occur and to show how opportunties are used successfully, then one shouldn't be too surprised if surveys show that Greeks no longer have a future perspective."

The reader Sebastian Schröder has now alerted me to this article which appeared, of all places!, in DER SPIEGEL. It is, in a nutshell, an exhilerating praise of something which is happening in Greece.

Where in the world is the Greek media when they report, in seemingly infinite detail, everything which is or goes wrong in Greece but when it comes to something which could have a positive signal effect for everyone, well --- there is virtually nothing!

Thursday, March 14, 2013

Foreign investment necessary? Heck, yes!

The Ekthimerini writes in an editorial: "It will be particularly difficult, if not outright impossible, for Greece to get back on the road to growth without foreign investment." I would like to explain, once again, why it will be impossible for Greece to get back on the road to growth without foreign investment.

A credible source informed me that the Geek economy, since Independence, ALWAYS needed finanical stimuli from abroad in order to function well or reasonably well. I cannot judge that but it sounds plausible. During the first 10 years of the Euro, the Greek economy received (net) 10-15% of GDP in foreign funds annually and yet, unemployment did not go significantly under 10%. This is evidence enough that the Greek economy, in its present structure, can only employ its people when there is net fund flow from abroad.

The following items are the most important instruments for foreign funds to enter the country:

1. Loans and other financial liabilities
2. EU grants and subsidies
3. Remittances by Greeks working abroad
4. Foreign investment

Item (1) has the disadvantage that it carries interest and needs to be repaid. Items (2)-(4) have the advantage that the don't carry interest and they don't need to be repaid.

EU grants and subsidies are, hopefully, already being used to the maximum. Remittances by Greeks working abroad were the most important source of foreign funding from 1950-74, but they have declined (and become very small) since then.

That leaves foreign investment. Full stop.

The trick with foreign investment is to find the 'right' foreign investor. Anything which only smacks of financial investments for short-term profit must be avoided. Multi-nationals which come and go are also unattractive in the long run.

The 'right' foreign investment comes from investors who have a long-term commitment to the country; who bring know-how in addition to capital and who want to grow their business in Greece (and perhaps through Greece in the region).

Anyone who is in a position of influencing public opinion and sentiment is, in my opinion, obligated to bring the above message across to Greeks; continually and convincingly!

Wednesday, March 13, 2013

"Worry more about the real world instead of the paper world!"

This is a good interview on Charlie Rose. His guest is Jeremy Grantham, co-founder and Chief Investment Strategist of GMO, a fund managing over 100 BUSD. At about minute 51 in the interview, Grantham says the following:

"What debt does is that it distracts us from the real world. Debt is an accounting rule. It's paper. The real world is the quantity and the quality of your people. And the quantity and the quality of your capital spending. Are you building new machines? Are you being inventive? Are you training your people? Is your High School system delivering the same education as it used to relative to the South Koreans; relative to the Norwegians? No, it's not. We should worry more about the real world and less about the paper world."

Amen!

Tuesday, March 12, 2013

A 'politically explosive finding'. Really?

This article describes the 'politically explosive finding' that Italians may be wealther overall than Germans. I have no idea whether or not that finding reflects reality. I guess there is really no way to accurately make such comparisons.

But there is one indisputable fact: when foreign debt enters a country, something happens with it. Part of it may leave the country to finance a current account deficit. Other parts may again leave the country as bank deposits in Switzerland & Co. But a certain part always remains in the country and is recycled via the budget to the country's residents.

What all these processes have in common is that money enters a country as debt and is converted into private equity while the public debt remains.

From 2001-10, 283 BEUR entered Greece as foreign debt (net). The current account deficit accumulated 197 BEUR during this period. So there is another 86 BEUR which went either into domestic private wealth or into bank accounts in Switzerland & Co.

If the foreign debt were to be forgiven, that private wealth remains private wealth.

PS: during my time in Argentina (1980s), the general rule of thumb was that the foreign financial holdings of Argentines were at least as high as the country's foreign debt.