Cyprus the Nation and the Cypriot Banking System were insolvent. It was a mess. The system (they are intertwined) relied on ELA (Emerging Lending Agreements?) from the ECB. That is how they were being financed.
They paid high rates on deposits. Depositors assumed they had insurance for up to at least the €100,000 of guarantees, though it looks like it was guaranteed by the government, so a circular non-functional system.
One way or the other, without some real wealth transfer, losses were going to have to be taken.
What people didn’t expect was for all depositors to be hit. The original plan was to levy a tax of 6.75% on deposits below €100,000 and 9.9% on those above. There are already talks about changing that plan.
There are two mitigating circumstances that can contain this situation.
Cyprus is small. It really doesn’t represent a meaningful portion of EU economic activity. If Greece never felt “European” to many, Cyprus seems even more disconnected.
People were going to lose money one way or the other. If you don’t like the way it was handled, that is a problem, but without a direct wealth transfer, someone had to take losses. Default could have been messier, and in the end, the decision to create an arbitrary number to hit depositors with may be unfair, but it might be better than they would have had otherwise.
That will be the spin on the positive side. I don’t find either particularly compelling but they are mitigating circumstances.
The EU is NOT the US
Before going into the great ramifications of what happened, it is useful to highlight the difference between the U.S. and Europe. In the U.S., we came up with $60 billion of taxpayer money to help victims of Hurricane Sandy. We didn’t question the need to build in areas near the water. The desire to keep trees over power lines to make things more beautiful. Heck, we were busy spending this money while facing a fiscal cliff and staring sequester in the face.
The EU could have cut a check for €5 billion or so here and avoided this. They probably could cut a check for $60 billion and solve a lot of problems. But that is not how Europe thinks. For all the talk about keeping it together, there is more concern about self-preservation at each country than there is about unity.
For all the talk about “bailouts”, the nations that have “backstopped” the other countries have all made money. The ECB has been paid in full on every loan they made and every bond they bought. They have received every interest payment due. Ditto for the EFSF. So don’t get too excited about the “sacrifices” Germany has been making.
Germany has made a lot of money from lending and backstopping lending to the various countries that were “bailed out” and demand many changes to those countries. We gave $60 billion for hurricane relief and encouraged people to recreate rather than change.
The ECB is NOT the FDIC
There is a real risk, that the resolve of the ECB will once again be tested.
Going after deposits might make economic sense, but it is dangerous. We have a Fed and the FDIC to discourage runs on banks. At some level, we have decided that having a run on a bank is a bad idea. When our crisis hit, the FDIC didn’t complain that it was short funding (which it was). The FDIC, instead increased the amounts it covered. The FDIC also created a program to let banks issue bonds with FDIC backing to expand their borrowing capacity. The Fed intervened in the commercial paper market because it was creating a stealth run on the banks. Companies were drawing down on revolvers, or considering it, because they were scared that the CP market would shut down and the banks would not honour their drawdown requests.
So in the U.S., we did everything we could to prevent a run on banks and to make depositors comfortable. It was a tough battle, but one that we fought. Europe has just done the opposite.
Europe has made a mockery of what little deposit insurance they have. Messing with depositors, especially in what seems like such an arbitrary fashion is just bad business. Individuals react badly. Individuals that see individuals reacting badly are often too poorly informed to know their neighbour is acting irrationally, and do the same thing. Soon enough, the irrational action is the rational action because everyone else is doing it.
So the first problem that Europe faces is depositors need to be concerned, especially in countries where the sovereign is in trouble and banks have relied on ELA.
I am not sure how you fix this in the short term. Any client that I have that has money in a bank that has received ELA money, or a country that is in trouble, I would say pull it out! NOW! Why keep it there? Is the Bankia “spiderman towel” enough of an incentive to risk being subject to some “grand plan”? Bankia is a mess. Spain relies on EU help for its banks. Bankia was giving away spiderman beach towels to attract depositors. After seeing what happened in Cyprus, take your money out, go to bed bath and beyond and buy your own beach towel.
Seriously, I cannot imagine a single business, hedge fund, family office, or wealthy individual who doesn’t take a close look at his or her deposits. Why keep any more than the bare minimum to function?
Greece has shown some signs of stabilizing, but I cannot think of a single reason to keep money in a deposit at a Greek bank. Even with whatever depositor insurance there is. Take it, take it out now.
And I’m not being alarmist. I’m not saying the banks WILL do this. I am saying there is a risk that it MIGHT happen, but you don’t get paid enough to take that risk. There are so few barriers to moving money, why would you keep it there? It is simple. No cost to move, and little reward for the risk you are currently taking.
Remember all the talk about “PanEuropean Banking Union”? It reminds me of the old joke, “how do you know when a lawyer is lying?” “His lips are moving.” Any time Europe creates Pan anything, it never happens. Remember all the stimulus spending?
So, before I digress (and I was about to) the risk of money shifting out of banks is real and the EU has little to stop it. If the EU can’t win with the message that “Cyprus was unique and this is better than the depositors deserved” then we will see pressure on the weakest banks in the weakest countries.
The ECB is NOT the Fed
Up until know I have demonstrated that there is a chance that it is contained because the spin works.
Even a run on the weakest banks in the weakest countries probably isn’t bad for global markets. It might be disastrous for the people in those countries, and I don’t mean to be callous, but it may remain reasonably contained. These banks are already shunned and aren’t viewed as being particularly important. If Greece and Portugal collapsed further, the markets, particularly in the U.S. could ignore it reasonably well. After all, the Fed is pumping $85 billion a month into treasuries and mortgages.
The risk is if investors start selling Spanish and Italian debt. These bonds have had a great run and I have argued for a couple weeks are overvalued on fundamentals alone. They each have their own political uncertainty and the economies are still somewhere between awful and heinous.
This is where it gets a bit ugly in a hurry. If bond yields start to go higher (and I think they will, if not within the first day by the end of the week) and then a few things start to happen
- Investors clamor for OMT to start and are finally convinced that it doesn’t exist. That it is a plan that needs to be implemented that no country has asked to set up yet.
- Rather than begging for OMT, Spain and Italy throw down the gauntlet and demand support without “ongoing” conditionality. The word “machismo” comes to mind, but don’t think that either country is ready to accept conditionality at this stage.
- While the EU and Wall Street (or the City) start blabbering about technocrats, a grassroots movement against the EU grows, and the realisation dawns on the markets, that even if Italy wanted OMT, there is no one in power to negotiate it
- Finland says it has had enough
- German politicians start pounding the table that enough is enough and Germany cannot support such flagrant spending and doubt grows whether Germany and Merkel can remain in charge of the “bailouts”
- The ECB and ESM look impotent in their ability to act quickly, actually, act at all
- Not only do “crazy fringe” bloggers talk about subordination, but everyone realises that once the ECB starts buying bonds (if they ever do) the promise of not subordinating other holders is a joke. The leopard doesn’t change its spots, and the ECB DOES NOT LOSE, NEVER, NOT EVEN A LITTLE, IT WON’T EVEN ACCEPT PURCHASE PRICE, ONLY PAR, so don’t think that once the ECB intervenes, that the most likely path isn’t all other holders being subordinated.
That flow of events causes the Euro to drop to 1.20? Causes European Bourses to drop 10% or more? How does Nikkei respond once the Yen stops depreciating? How does the global economy react to this?
OK, that was an attention grabber. I think S&P is already overvalued. I thought 1,500 was reasonable without this potential risk.
I think there is a high risk of an overshoot. Too many are too long, and we already have potential risks that QE to infinity is about to be replaced with QE for a long time. It is easy to see a pullback, and what scares me is it is easy to see a pullback that overshoots very quickly and very far because there is so little real liquidity. I think we are almost at a record divergence between what people say (cautious) and how they are invested (aggressive).
My current most likely scenario is this:
- Early weakness, talks of contagion, some stupid sales, me saying it is potentially overdone and feeling foolish
- A bounce as the “contained” message comes across
- A bigger move severe risk off trade. Not just stop losses but a reevaluation of valuation and risk. Really this is the scenario that will take time to settle in, and while it might be avoided, if it does become the “meme” of the day, then we will see continued weakness and real fear.
Things Take Time
One last thought which I mentioned already. Russia took at least a week from the initial news to the disaster it became in 1998 (I have some great LTCM stories, but that is for in person meetings only). Lehman also took time to develop. The markets did not crater the day after Lehman and many bounced the following day. It took time and other events to unfold before the real sell-off began.
June 2007 was all time tights on IG. October 2007, after first signs of too much complacency and dangers, was when we saw the all time highs on equities. Then too it was the Fed, the discount window, infinite liquidity that drove things. March 2012 felt similar to now, though less on the Fed but more on the data.
The list goes on but the message is that no immediate reaction isn’t an assurance that it isn’t important and that price and mark to market losses trump almost everything else in this world.
Anyways, time for some corned beef and cabbage and the realisation that the only culture that might cook less healthy than Ukrainian, is Irish.
Disclaimer: The content provided is property of TF Market Advisors LLC and any views or opinions expressed herein are those solely of TF Market Advisors. This information is for educational and/or entertainment purposes only, so use this information at your own risk. TF Market Advisors is not a broker-dealer, legal advisor, tax advisor, accounting advisor or investment advisor of any kind, and does not recommend or advise on the suitability of any trade or investment, nor provide legal, tax or any other investment advice.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.