Tag Archives: EU

the Cyprus bank crisis solution

March 25, 2013 By in Cyprus, economics, EU financial crisis Tags: , , , , , , , , 1 Comment

the bailout

Over the weekend the EU and IMF came to agreement with the government of Cyprus on the shape that the rescue of Cyprus’ failing banks will take (I wrote about the overall situation late lase week).  The banks themselves remain closed, as they have been for ten days.

The highlights, if that’s the right word to use:

–the smaller of the two main Cyprus banks, Bank Laiki, will closed down.  It will be separated into a “good” bank, which will contain all insured deposits (those of €100,000 or less), and a “bad” bank, which will contain everything else.  Deposits in the former are safe.  Deposit and bond holders in the latter will get whatever’s left after the bank’s dud loans are settled.  That could well be close to zero–and, in any event, large depositors will have lost access to their funds for a considerable period of time.

–the Bank of Cyprus, the bigger bank, will remain open.  This is a face-saving concession insisted upon by the Cyprus government.  Uninsured deposits will be used to cover the losses on the bank’s loan book, with uninsired depositors losing as much as 40% of their money.

it’s Cyprus’ best alternative

The country’s recent prosperity is due mostly to the access it allows to the rest of the EU, and its less than diligent attention it pays to the provenance of the bank deposits it accepts.

The rescue injects €10 billion of EU/IMF money into the Cyprus banking system.  Cyprus also gets to remain in the EU.  Otherwise, it would still have the same large bank loan losses, but be €10 billion poorer and out in the cold.

Some commentators are saying that the losses that uninsured deposits in Cyprus will suffer will undermine confidence in the banks in other EU countries, like Italy or Spain.  I don’t think so.  The Cyprus story–crazy bank lending, deposits of dubious origin, tax haven–is well-known throughout the EU.  If anything, the union was hamstrung in its efforts to bail Cyprus out by how well-known the story is–and, in consequence, how politically unacceptable an outcome where Cyprus escaped very significant hardship would be.

The main result of the Cyprus episode, I think, will be to give the EU a significant push toward unified EU bank regulation.

 

my take on the Cyprus financial crisis

March 21, 2013 By in Current Market Thoughts, economics, EU financial crisis Tags: , , , , , , , , , Leave a comment

background

Cyprus is a Mediterranean island-state with a population of about 1 million and an annual nominal GDP of around US$24 billion (€18 billion).  The country joined the EU in 2004.  At that time, the union was still in a phase of wanting to be all-inclusive.  But even so, perhaps the only member enthusiastic about Cyprus’s entry was Greece, because of the two nations’ close business and ethnic ties.  As I understand the situation, it took a Greek threat to blackball other prospective members, like Poland, before Cyprus was allowed to slip in the door.  Cyprus joined the eurozone in 2008.

Why the reluctance?

Low tax rates have given Cyprus a long-standing reputation as a tax haven.  But after the collapse of the Soviet Union and the subsequent efforts by the nomenklatura in member countries to abscond with the national wealth, Cyprus is thought to have welcomed the cash of all comers, without being overly finicky about the source or legal status of the tidal wave of money it was receiving.

With its entry into the EU, Cyprus began to exert an even greater magnetic attraction for wealthy Russian immigrants seeking citizenship–and the access to the rest of the EU that a Cyprus passport would bring.  Deposits by foreigners into banks in Cyprus also ballooned.  About 40% of the almost €70 billion in bank deposits the Cyprus banks are thought to hold, are estimated to be from foreigners, most of them Russian.

How did the banks get into trouble?

The influx of cash gave them more money than they knew what to do with.  So they lent  …crazily.  A large chunk of loans went to Greek businesses, and a lot more was “recycled” into Russia and other parts of the old USSR.  The banks bought a large helping of Greek government bonds, as well.  And they funded a local property bubble.

How bad is the situation?

from Cyprus’s point of view

Because of the way they operate, the banks in Cyprus are gigantic in relation to the size of the country.  To get a sense of how big, consider the United States.  According to the Federal Reserve, the total of deposits in commercial banks in the US is $9 trillion, give or take, or about 58% of GDP.  Deposits in Cyprus banks are almost 4x that country’s GDP.

The bailout of the Cyprus banking system proposed by the European Central Bank and the International Monetary Fund is €17 billion.  Of that, €10 billion is supposed to be coming from the EU/IMF.  The other €7 billion is supposed to come from Cyprus–an amount that’s almost 40% of GDP.  Where can/will Cyprus get its share of the money?

A standard remedy for banks facing default would be to go to their lenders and ask they to take a (huge) haircut on their loans.  That’s what Greece ultimately did.  But the Cyprus banks are like giant cash machines.  They haven’t needed to borrow; they have almost no lenders to share the pain with.

The government could raise taxes–but it would have to be a whopper of an increase to make a dent in the funds needed.  And Cyprus’s government finances are  already in bad shape.

So the obvious (read:  only) source of bailout funds is uninsured customer deposits.

Hence, the plan to “tax” these deposits to get Cyprus’s share of the bailout money–offering equity in the restructured banks in compensation.  The way the tax is structured, it seems to hurt ordinary citizens and spare the oligarchs.

from the rest of the EU’s

In the overall scheme of the EU bank rescue, €17 billion is a trivial amount of money.  It’s something like a week’s interest expense on aggregate EU government debt.  But there’s a principle involved.  And there’s a related political issue.

In principle, a country that fails to supervise its banks and mishandles government finances shouldn’t simply be rescued without any contribution of its own.  Also, the biggest beneficiaries of any bailout would be what many regard as Russian criminals laundering their money through the Cyprus banks, with Nicosia complicit.  Understandably a hard sell throughout the EU–or anywhere else.

where to from here

The banks on Cyprus will be closed until some time next week, as the parties work toward a solution.  The main stumbling block sounds like it’s Nicosia’s desire to protect the golden goose of Russian money flow.

Stock market worries have been centered around the possibility of a run on banks in, say, Italy and Spain, if depositors in Cyprus lose part of their principal.  Part of the panic was sparked by economic “experts” who are recognizable names and who churned out the initial reports on late weekend’s bailout negotiations.  I think these pundits reacted to the headlines without knowing many of the facts.  It’s not that I’m an expert on Cyprus–I’m not.  But it’s pretty easy to detect when interviewees are talking through their hats.

The worst case solution for Cyprus would be that its major banks fail and the country is forced to leave the EU.  Very bad for Cyprus.  Almost no one else in the EU would notice.  Russian oligarchs wouldn’t be happy.

A run on other EU banks?  Unlikely, in my view.  The facts in the Cyprus case are very unusual, given the dubious character of its banks.  And the pressure on the EU not to simply throw money at the problem and make it go away is coming from ordinary citizens elsewhere in the EU who have their money on deposit locally.  They seem to see a big difference between their home country institutions and those on Cyprus.  I think they’ll continue to do so.

a wild card

Russia has previously made a bailout loan of €2.5 billion to Cyprus to prop up its banks.  Discussions are apparently underway between Moscow and Nicosia for more aid.  One plan being would have Cyprus grant Gazprom oil and gas exploration rights in return for, say, taking over one of the big insolvent Cyprus banks.

recent world currency movements: stock market implications

January 30, 2013 By in Asian economic development, currency effects, Current Market Thoughts, economics, Foreign markets, Japanese development, Portfolio management, Recent Market Action, Shaping a portfolio for 2013, Strategy Tags: , , , , , , , , , , , Leave a comment

dramatic changes

Although currency movements sometimes can often be overlooked by a stock market investor immersed in the hustle and bustle of day-to-day trading action, there have been a couple of whopping big moves in major currencies over the past half-year.

Since late July 2012, the euro has risen by 12.5% against the dollar.  Over the same time span, the yen has fallen by about 16.5% against the greenback.  A quick bit of multiplication tells us this also means that the euro has risen by about 30% against the Japanese currency.

To my mind, there’s no really satisfactory general economic theory about how currencies work.  But to give a sense of perspective, inflation in Japan has been, say, -1% on an annual basis over the second half of 2012.  We’ve had +1.5% in the US.  Euroland has experienced a 2.5% rise in the price level.  Inflation differentials imply that the yen should be rising against the dollar at a 2.5% annual rate and against the euro by 3.5%.  The euro, in turn, should have weakened by 1% against the dollar and 3.5% against the yen.  The actual outcome has been far different.

Of course, there are reasons for the spectacular assent of the euro and the plunge of the yen.  Until around mid-year, many observers thought Euroland was coming apart at the seams and rushed to get their money out before the demise.  I’m sure there was more than a touch of flight capital mixed in the outflows.  Thanks to Mario Monti’s and Angela Merkel’s actions indicating the political will to save the euro, capital flows have reversed in spectacular fashion.

Newly-elected Japanese Prime Minister Shinzo Abe made it a central plank of his campaign for office that he intends to force the Bank of Japan to print lots of money.  Why?   …to weaken the yen and to create inflation.  The move could easily end in eventual economic disaster, but for now its main effect has been to drive the Japanese currency down a lot versus its trading partners’.

stock market implications

Generally speaking, a rising currency acts to slow down the domestic economy.  A falling currency gives the economy a temporary boost.

Currency changes can also rearrange the relative growth rates of different sectors.  The best-positioned companies will be those that have their sales in the strongest currencies and their costs (e.g., labor, raw materials, manufacturing) in the weakest.

Japan

The decline of the yen has given Japanese export-oriented firms a gigantic relative cost advantage against European competitors, and a significant, though smaller, one against US rivals–or those located in any country that ties its currency to the US$.  Anyone who sells products in Japan that are imported, or made with imported raw materials, has been crushed.

We’ve seen this movie before, however, on a couple of occasions.  It’s ugly.  Domestic firms lose.  Exporters will make substantial profit gains in the local currency.  But from a stock market view, that plus–with the possible exception of the autos–will be offset for foreigners by currency losses they have/will endure on their holdings.  Stocks in even the most advantaged sectors will deliver little better than breakeven to a $ investor, and will certainly rack up large losses to anyone interested in € returns, in my view.

Euroland

The EU has already had a return-from-the-dead rally, where stocks of all stripes in the economically challenged areas of southern Europe have done well.  The message of the stronger currency is that importers, or purely domestic firms in defensive industries will fare the best from here.    Although I think the preferred place to be from a long-term perspective is owning high quality export-oriented industrials, the rise of the euro has blunted their near-term attractiveness.  One exception:  multinationals based in the UK, because sterling hasn’t participated in the euro’s rocketship ride.

Ideally, you’d want a firm that imports Japanese goods into the EU.

the US

Americans are less accustomed to thinking about currency effects that investors in other areas, where their effects are more pervasive.  With the dollar being in the middle between an appreciating euro and a depreciating yen, currency effects will be two-sided. Firms with large Japanese businesses, like luxury goods companies, will be losers.  Firms with large European assets and profits, like many staples companies, will be winners.  Tourism from the EU will be up, from Japan, down.  One odd effect, which I don’t see any obvious American publicly listed beneficiary–the decline in the yen is causing the cost of living for ordinary Japanese to rise sharply, since that country imports so many dollar-price raw materials.  To offset that effect, Japan is beginning to weaken protective barriers that have kept much cheaper finished goods (like food) from entering the Japanese market.  Doubly bad for Japanese farmers, though.

Shaping a portfolio for 2013 (iv): Europe

January 10, 2013 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Shaping a portfolio for 2013, Strategy Tags: , , , , , , , , , Leave a comment

 The Eurozone, which comprises most of the EU, is in recession.  Not only that, but it’s suffering a crisis of trust that threatens to tear it apart.  But you wouldn’t know it from the recent performance of EU stock markets.ward

a quick look back

In over-simple terms, the Eurozone was formed solely as a monetary union, without any fiscal checks and balances.  It was like a partnership where everyone got to use the common credit card.   On the tacit assumption that gentlemen always pay their debts, the EZ never checked to see if users could, or did, pay their bills–even though the group as a whole was responsible for any charges.  The chief lenders were government-controlled banks run by bureaucrats with no notion of how to analyze creditworthiness or detect fraud.  If all else failed, the “parent,” Germany, would presumably pick up the tab.

Not a great real-world concept.

The fantasy balloon was popped in October 2009 when a newly-installed government in Athens discovered the previous administration had been faking the national balance sheets and income statements for many years.  Greece was broke, much more heavily in debt than it had previously revealed, unable to repay.  The new guys made the bad news public, but have been unwilling (my view) to do much, other than ask for debt forgiveness, to remedy the situation.

Members have been fighting about how to proceed since then.  Until very recently, no one has been willing to lend to economically weak nations like Italy and Spain, forcing them into crisis.

Pretty awful stuff.

2012 stock market performance

Last year, the S&P 500 was up by a stellar 13%+,  on a capital changes basis.  Despite the ugly picture I painted above, EU stocks outperformed the US by about five percentage points last year, in dollar terms.  That’s the result of a huge rally since July.  EU stocks, which I pointed out back then were yielding 5.5%, still have a 200 basis point yield preference over the S&P–meaning holders made close to eight percentage points more than the S&P on a total return basis.

A dollar-based investor who bought in late July (something I would have thought to be too risky for just about everyone) would have made over a third on his money in five months.

why?

Some people talk about a four-stage process in problem solving:

Stage 1:  deny the problem exists

Stage 2:  blame someone else

Stage 3:  blame yourself

Stage 4:  begin to fix the problem.

I think the Eurozone reached Stage 4 last July   …and the markets picked up on this very quickly.

where to from here?

I read the positive market reaction so far as being basically an anticipatory rally, in the expectation of change that’s yet to come.  In other words, I think it’s far from a sure thing that the parties involved have the political will to create the closer fiscal union that is needed.

still, some positives

–a 4%+ dividend yield indicates there is still considerable skepticism still in the markets–implying further upside for stocks if good news continues to flow from Brussels and Berlin

–it’s now much less probable that the EU will come apart at the seams (if anything, there’s likely only to be a slow unraveling)

–the end of the scorched-earth “austerity” policy and its replacement with a more accommodative monetary regime means eps growth in 2013 might surprise skeptics on the upside.  For what it’s worth, the OECD is projecting that Europe as a whole will begin to see (admittedly meager) positive year on year comparisons in the second half.

my bottom line

An EU that’s at least not falling apart and where overall GDP is stable or better is a plus for the rest of the world.

Any value investor, I’m sure, will have a field day poring over the financials of the many companies that are trading at under net equity value–the risk, of course, being that there may be legal and cultural barriers to asset value ever being realized.

But there are better places in the world to invest, to my mind, for the moment at least.  If I were forced to have actively managed money in Europe, I’d certainly be significantly underweight.  I’d be emphasizing Germany, Scandinavia and the UK.  I’d also be trying to find well-managed companies with unique products/services, especially ones with the ability to sell outside the EU.

Since I’m not compelled to be in Europe, I’m content await further political developments and to hold only a few names, concentrating on firms listed in the EU but doing most of their business elsewhere.  Personally, I own small positions in a couple of Vanguard Europe funds, plus IHG.  I’d be happy to add a couple more individual stocks, once I have time to do the research.

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