Okay, you must have some fun amongst the idiocy of the Eurocrats. It seems that the best intentions of last Friday night’s decision to sacrifice the pawns in the game have done exactly what I thought the ill-conceived plans would accomplish. For 10 billion euros of bailout capital the fallout has been large drops in equity values. The capital losses are small compared to embarrassment facing the European policy makers. In a Bloomberg article by James Neuger, “Europe Plays I-Didn’t-Do-It Blame Game on Cypriot Deposit Levy,” it seems that German FM Schaeuble, France’s FM Moscovici, Spain’s FM Guidnos and even Finland’s FM Urpilainen all claim that they were opposed to taxing the guaranteed deposits of under a 100,000 euros. They all seem to point to the ECB and IMF as wanting the “bail-in.” This is a classic example of what my friend Andy Schreiber used to say: “Success Has Many Fathers, Failure Is But An Orphan.” The Cypriot situation is a situation that punches way above its weight. Carmen Reinhart, an economist I cite regularly on financial repression, silenced the talking heads on CNBC when she claimed that, “Do not take size as an indicator of importance.”
Professor Reinhart’s work with Kenneth Rogoff on the levels of sovereign debt and their impact on growth potential is so widely respected that her voice is given great respect. The importance of Cyprus will be the fallout on the periphery of Europe and can result in an outbreak of European contagion. When the Cypriot banks default two possibilities take place: 1. A restructuring; or 2. A massive expropriation of external deposits. Now the deposits don’t actually have to be seized but what can happen is that your 90-day CD can be extended to a 10-YEAR deposit. Then the extended deposits can be resold to other investors looking to try to acquire questionable assets on the very cheap. Where I disagree with professor Reinhart is on the issue of Russia for she doesn’t think the Russians will be there to bail out the Cypriot financial system.
Many other commentators forwarded the same idea. My take on it is that the Russians will push the negotiations to the latest hour to exact the greatest deal for themselves. Remember that this bailout is less than the “buyout” of Heinz where a 9% preferred was the offer. I believe the Russians are posturing to see if the TROIKA blinks under international pressure and the IMF/ECB find the will to raise the needed capital. The Russians should tell Madame Lagarde that they would be willing to take some IMF GOLD as collateral for shoveling the money to Cyprus. Chancellor Merkel’s effort at seeking to punish the Russian kleptocracy has unleashed a firestorm (Chicago Cub Fans will refer to this as another Merkle’s Boner) … another irony in tribute to Mr. Rheems.
***Again, if there is trouble in the European banking system it should be reflected in the Euribor market and we should also see pressure build to start FLATTENING THE YIELD CURVES IN THE PERIPHERAL STATES. At this time, the curves are not sending any signals but be attentive to all of the market’s barometers. The Spanish, Italian, Portuguese and Irish curves all remained well anchored to their levels of the last seven months. In Chairman Bernanke’s press conference yesterday, the Fed chairman noted he was concerned about Cyprus and hopes that the Europeans can come up with an “efficient and equitable solution.” The markets are of a like mind.
***The FOMC statement and Chairman Bernanke’s Q&A offered up no great surprises and the market’s reaction was the calmest in a very long time. There were a few things that I found of interest:
- The FOMC vote was 11-1 with Esther George of the K.C. Fed the lone dissenter. Governor Jeremy Stein voted with the majority but it seems that his worry about QE‘s impact on financial stability and the mispricing of risk is still getting some traction. If only Stein would vote the way he presents;
- The chairman reiterated that the QE and other Large Scale Asset programs (LSAP) have been a success in terms of the dual mandate and should not be measured in asset prices. What about the PORTFOLIO BALANCE CHANNEL and its cousin the wealth effect? The chairman also pointed to the program’s success in stabilizing or raising home prices and the positive effect on consumer demand from increased equity. This is the Greenspan formula and turns all asset classes into a vehicle of pro-cyclicality. I am in favor of the monetary authorities leaning against the wind. More bothersome was the chairman’s response the question about a possible equity bubble. Bernanke said he wasn’t concerned about the record high in the DOW because that was in NOMINAL TERMS NOT REAL TERMS TAKING PRICE INFLATION INTO CONSIDERATION. Chairman Bernanke talking about asset prices in such terms is??????
- When Chairman Bernanke was asked about too big to fail banks said that some type of surcharge may be leveled on the capital of the largest banks. Wouldn’t it be better if the too big to fail with a high-risk profile paid a higher level of FDIC insurance premium based on their trading and investment profile? Coupled with this would be a weekly disclosure of their risk profile … as close to real-time as possible. Let the market act to exact a real price for bank risk. What a concept–markets settling risk premia in a capitalist system.