12/9/2013: Lorenzo Bini-Smaghi Strikes... again

A very interesting article in Telegraph quoting from Lorenzo Bini-Smaghi's book on went inside Berlusconi's PMship at the 11th hour of his tenure. Bini-Smaghi is one of the key ECB and Euro system insiders and is hardly a naive or malinformed observer.

Link: http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100025507/italy-floated-plans-to-leave-euro-in-2011-says-ecb-insider/

If true, there are massive implications (items 1 and 2) on political/governance side and a point of deflated rhetoric (item 3):

1. According to information give by Bini-Smaghi, Berlusconi was effectively removed from democratically-held office due to his willingness to discuss Italy's exit from the euro. This puts a solid boot into the idea of democratic EU and limited sovereignty. If a democratically elected head of state raising concern about the suitability of his/her country membership in the common currency leads to the removal of the head of state, the notion of sovereignty is not limited (as in restricted by the letters of the treaties signed), but truncated (implying absolute exclusion of some considerations from the set of feasible policies).
2. The only thing that held the Euro together in the end was not the ECB with its OMT, but convincing Merkel of the MAD consequences of Greek exit from the union. This in turn implies that there are no institutional constraints on German (or Germano-French axis) power within the union. This problem will not be fixed by all the policies harmonisation and banking supervision reforms anyone can imagine.
3. Being not a specialist on Target 2, I cannot exactly / scientifically confirm or decline Mr. Evans-Pritchard's concerns about the risk transfer within the eurosystem. My understanding is that Target 2 'imbalances' on Bundesbank side are caused by deposits swelling, not assets. Here is how the system functions, in my view: peripheral bank borrows funds from the ECB against collateral. Collateral lands at ECB as an asset. Peripheral bank uses borrowed funds to repay liability to a, say, German bank. Peripheral bank writes down liability to offset the writedown of cash paid. Peripheral bank remains oweing to the ECB. German bank gets cash in exchange for writing down the asset (peripheral bank's liability) and deposits money with Bundesbank which enters as a positive entry on Target 2. Now, suppose the peripheral bank defaults on ECB loan. ECB still has a collateral claim. The net loss (loan amount less collateral value), shall one arise, is amortisable over the entire Eurosystem - all CBs, not just Bundesbank or ECB alone. And more, per Jorg Asmussen: "If a net loss remains even after taking into account all provisions and reserves, it could be recorded on the balance sheet as losses carried forward and be offset by any net income in the following years." (see: http://www.ecb.europa.eu/press/key/date/2013/html/sp130611.en.html). Finally, I do not know where he is getting the information that Bundesbank is selling offset securities to any banks to balance out inflows of funds to German banks from the periphery.

Note: many thanks to Lorcan Roche-Kelly (@LorcanRK) for acting as a sounding board for my doubts on Target 2 and the link to Asmussen's speech above.

6/9/2013: BlackRock Institute survey: North America & Western Europe: August 2013

BlackRock Investment Institute released its latest Economic Cycle Survey for North America and Western Europe region.

Per summary: "This month’s North America and Western Europe Economic Cycle Survey presented an improvement in the outlook for global growth over the next 12 months – the net proportion of respondents with a positive outlook increased to 70% from 60% last month. 

The consensus outlook for the Eurozone was particularly positive, where the 6 month forward outlook shifted from 57% to 75% expecting the currency-bloc to move to an expansionary phase. 

The picture within the bloc was not uniform however, with most respondents expecting Portugal, Greece, Belgium and the Netherlands to remain in a recessionary phase, while the consensus has shifted to expect expansion for France, Spain, Finland and Ireland over the next 2 quarters. An even mix of economists expect Italy to be expansionary or recessionary at the 6 month horizon (and similarly so for Norway, outside of the currency-block). 

With regards to the US, the proportion of respondents expecting recession over the next 6 months remain low, with the consensus view firmly that North America as a whole is in mid-cycle expansion and remaining so through H2 2013."

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

Here are two summary charts:

8/7/2013: IMF on Euro Area: Repetition in the Endless Unlearning of Reality

IMF released its statement on 2013 Article IV Consultation with the Euro Area

The Statement reads (emphasis mine):
"Policy actions over the past year have addressed important tail risks and stabilized financial markets. But growth remains weak and unemployment is at a record high."

So what needs to be done, you might ask? Oh, nothing new, really. Euro area needs:
-- To take "concerted policy actions to restore financial sector health and complete the banking union". Wait… err… this was not planned to-date? Really?
-- "continued demand support in the near term and deeper structural reforms throughout the euro area remain instrumental to raise growth and create jobs". In other words: find some dish to spend on stuff and hope this will do the trick on short-term growth. Reform thereafter.

Not exactly encouraging? How about this: "…the centrifugal forces across the euro area remain serious and are pulling down growth everywhere. Financial markets are still fragmented along national borders and the cost of borrowing for the private sector is high in the periphery, particularly for smaller enterprises. Ailing banks continue to hold back the flow of credit." So the solution is - more credit? Now, what did we call credit in old days? Right… debt, so: "In the face of high private debt and continued uncertainty, households and firms are postponing spending—previously, this was mainly a problem of the periphery but uncertainty over the adequacy and timing of the policy response is now making itself felt in falling demand in the core as well." Wait a second, now: more credit… err… debt will solve the problem, but the problem is too much debt… err… credit from the past…

Ok, from IMF own publication earlier this year, what happens when credit - debt - is let loose:

Source: http://blog-imfdirect.imf.org/2013/03/05/a-missing-piece-in-europes-growth-puzzle/


Just in case you need more of this absurdity: "…reviving growth and employment is imperative. This requires actions on multiple fronts—repairing banks’ balance sheets, making further progress on banking union, supporting demand, and advancing structural reforms. These actions would be mutually reinforcing: measures to improve credit conditions in the periphery would boost investment and job creation in new productive sectors, which in turn would help restore competitiveness and raise growth in these economies. A piecemeal approach, on the other hand, could further undermine confidence and leave the euro area vulnerable to renewed stress." Oh, well, 5 years ago we needed

1. 'actions on repairing banks balance sheets' - five years later, we still need them;
2. actions on 'supporting demand' - aka, no tax increases and some investment stimulus - five years on, we still need them;
3. actions on 'advancing structural reforms' and five years on, we still need them too;
4. "measures to improve credit conditions in the periphery would boost investment and job creation in new productive sectors" - wait a second ten years ago we had easy credit conditions in the periphery and they failed comprehensively to 'boost investment and job creation in new productive sectors', having gone instead to fuel property and public spending bubbles… five years since the start of the crisis, we now should expect a sudden change in the economies response to easier credit supply?

IMF is more sound on banks: "bank losses need to be fully recognized, frail but viable banks recapitalized, and non-viable banks closed or restructured". But, five years, bank losses needed to be fully recognised too and we are still waiting. And when it comes to closing or restructuring non-viable banks, pardon me, but where was the IMF in the case of Ireland when the country was forced by the ECB to underwrite non-viable banks with taxpayers funds?

"A credible assessment of bank balance sheets is necessary to lift confidence in the euro area financial system." Ok, we had three assessments of euro area banks - none credible and all highly questionable in outcomes. Five years in, we are still waiting for an honest, open, transparent assessment.

Cutting past the complete waffle on the banking union and ESM, "The ECB could build on existing instruments—such as a new LTRO of longer tenor coupled with a review of current collateral policies, particularly on loans to small and medium-sized enterprises (SME)—or undertake a targeted LTRO specifically linked to new SME lending." Ooops, I have been saying for years now that the ECB should create a long-term funding pool for most distressed banks, stretching 10-15 years. Five years into the crisis - still waiting.


On structural reforms, IMF is going now broader and further than before and I like their migration:

"For the euro area, …a targeted implementation of the Services Directive would remove barriers to protected professions, promote cross-border competition, and, ultimately, raise productivity and incomes. A new round of free trade agreements could provide a much-needed push to improve services productivity. In addition, further support for credit and investment could be achieved through EIB facilities. The securitization schemes proposed by the European Commission and the European Investment Bank could also underpin SME lending and capital market development." Do note that the last two proposals are still about debt generation (see above).

"At the national level, labor market rigidities [same-old] should be tackled to raise participation, address duality—which disproportionally hurts younger workers—and, where necessary, promote more flexible bargaining arrangements. At the same time, lowering regulatory barriers to entry and exit of firms and tackling vested interests in the product markets throughout the euro area would support competitiveness, as it would deliver a shift of resources to export sectors [ok, awkwardly put, but pretty much on the money. Except, greatest protectionism in the EU is accorded to banks and famers, and these require first and foremost restructuring]."

In short - little new imagination, loads of old statements replays and little irony in recognising that much of this has been said before… five years before, four years before, three years before, two years before, a year before… you get my point.

21/6/2013: Europe's Capacity Deficit Illustrated

Want an example of Europe's 'capacity deficit' I mention here: http://trueeconomics.blogspot.ie/2013/06/1962013-european-federalism-and-emu.html

Look no further than the latest set of quotes fired off by ECFIN E-news letter:

Let's take them through reading.

Mr Rehn says that 'Banking Union is not about bailing banks'. Of course he is right - the EU has bailed out the banks before it conceived the EBU. However, one major objective of the EBU is about systematising future bailouts of the banks, in theory - to restrict taxpayers' expected liabilities in such bailouts, and to regulate future depositors' liabilities. And EBU is - according to the EU Commission and the ECB - a necessary element of the sovereign-banks 'break' that includes ESM. Now, ESM is about bailing out the banks.

Is EBU 'about getting a banking system that serves the real economy'? Well, nothing in the EBU proposals so far has much to do with the 'real economy' in a positive sense of serving it. At least nothing that requires an EBU and cannot be done absent EBU. Deposits insurance? Doesn't need an EBU. Joint supervision and regulation? Hardly much to do with the real economy, unless one is to make a claim that the two are fail-proof way of ensuring that a new crisis won't happen. In fact, when it comes to the real economy, the EBU is a part of the policy instruments package that includes depositors  bail-ins, mechanism for sovereign liabilities imposition and fiscal harmonisation - these are about the real economy, but there is little in terms of 'support' here. More like 'limiting damage' by 'spreading the cost'. Reality check: UK has an EBU equivalent, US and Japan have one... all had banking crises that cost their real economies dearly...

So Mr Rehn is just plain propagandising, right? Well, sort of - the EBU is a necessary, but not a sufficient condition for the survival of the Euro. If you accept the thesis that Euro's survival is the 'service' that real economy needs, then you have 1/2 of Rehn's equation there.

Onto Mr Lamy who says that Europeans need something new to drive their attention away from the bad things that are old. Contemplating the past is disuniting the peoples of Europe. Giving them something new to desire (may be a promise of a new iPad for everyone would work?) will shift them to work toward the future, presumably forgetting and forgiving the past and the present. How did the Soviet leaders not think this one up? 'We promise you this better future because we screwed up your past and present' school of politics...

Ireland's Taoiseach is honestly thinking that EBU is necessary to give credibility to European leaders because they promised EBU. Neither the concept of 'do we need A in the first place', nor the irony of his party pre-election promises not being delivered on strike Mr Kenny as being a touch testing. And then there's 'following through on decisions is the very least our citizens expect and demand'. Not really. Citizens demand that political leaders (a) adopt right decisions, then (b) implement right decisions. Having not established that EBU is right fails both (a) and (b).

But the most priceless bit of Mr Kenny's statement is that he believes that something is crucial because it is a credibility test. Mr Kenny's logic here is risking a resemblance to a schoolboy's logic who, in fear of hearing 'Chicken! Chicken!' from a schoolyard bullies heads off to carrying out a silly and dangerous deed, lest his 'credibility' be challenged.

This, per the EU's powerful, is 'leadership' at the time of a crisis?..

17/6/2013: On Debt of the Nations & Euro Crisis: 2 links

Update from the ZeroHedge on the Debt of the Nations: http://www.zerohedge.com/news/2013-06-04/debt-nations

Worth a read!

And while on the case of crises (for whatever you might read about Reinhart and Rogoff debate, debt overhang is a crisis) we have an excellent contribution by Dani Rodrik on solutions for the Euro area crisis: http://www.project-syndicate.org/commentary/saving-the-long-run-in-the-eurozone-by-dani-rodrik

Thought-provoking and comprehensive summary (albeit I do not necessarily agree with all of Rodrik's conclusions).

14/5/2013: The Sick Man of Europe is... Europe

An excellent set of stats on the decline of public legitimacy of the EU between 2012 and 2013 from Pew Research: http://www.pewglobal.org/2013/05/13/the-new-sick-man-of-europe-the-european-union/

Certainly worth a read and confirms similar trends captured by other surveys.

25/3/2013: Cyprus 'deal' - notes from the impact crater

What are the true 'innovations' of the Cypriot 'bailout' deal?

1. At this junction one must face the realisation that European 'leadership' vacuum has reached alarming proportions. Cyprus was pushed to the brink, literally hours away from ELA cut-off, with a deliberate and mechanical precision. This is hardly consistent with any spirit of subsidiarity and/or cooperation that the EU was allegedly built on. In a further affirmation of the mess that is EU policy-making, the markets must now be aware that the EU has no defined approach to dealing with debtors and creditors, nor with issues of assets or liabilities. In other words, five years into the crisis and numerous 'white papers' later, with acronym soup of various 'solutions' and new 'institutions' thicker than pasta fagioli - there is still no clarity, no legal or institutional commitment, no formula, no predictability, but rather politically-motivated swinging from one extreme (no bail-ins in Ireland) to the other (all bailed-in in Cyprus).
2. We now have bailed in uninsured bank deposits within the so-called 'open' economy with 'common currency' and 'common market' based on rules and laws. In other words, unlike in Ireland, Portugal and Greece, the EU has crossed another line.
3. We now have bailed in senior bank bondholders (and the sky did not fall)
4. We now have capital controls within 'common currency' area and within the 'common market' - kind of equivalent to Louisiana declaring its dollars purely domestic to Louisiana. 
5. Bail-ins under the Cypriot deal are non-transparent and not defined, showing that the entire package was put together is a half-brained fashion at the last minute. Surely this, if not the first but very much the most exemplary indicator of the complete mess in policymaking. It further reinforces the view of PSI measures - both in Greece and in Cyprus - as being politically motivated, rather than systemically and legally structured.
6. The fact that the Cypriot banking system will now be completely shut out of the funding markets reinforces my view that unwinding the 'emergency' measures deployed by the ECB during the crisis will be: a) risky, b) costly and c) protracted. As the result, the monetary policy risks missing the window for optimal interest rates reaction and either over-reaching on the inflationary side or over-tightening to the detriment to future growth. either way, peripheral countries will be the likely victims.

Overall, from the EU-wide point of view, Cypriot 'deal':

• Does not reduce the risk of contagion or re-amplification of the crisis in other peripheral states;
• Does not create or even enable a break between sovereign and bank crises; 
• Adds to the overall quantum of policy uncertainty; 
• Raises even more doubts as to the functionality of the cornerstone crisis-related institutions (ESM and OMT); and
• Acts to strengthen the hand of eurosceptic, nationalist and populist political movements and parties in the Euro area 'periphery'.

25/3/2013: Debt, Demand & Deposits: Cyprus 2013

Der Spiegel has a handy graphic detailing the extent and the depth of the Financial Services sector in Cyprus...

[link]

The above lumps together couple of things that should, really, be addressed:

1. Cyprus' financing needs only cover banks recapitalisations to the deposits base as provided by the end-of-January 2013 figures. Since then at least EUR3-5 billion and more likely even more fled the country. And selection bias suggests that larger depositors (potentially with more political connections) were more likely to avail of 'systemic' exemptions to withdrawals in recent days.
2. As termed deposits mature, more will leave, unless the Government imposes involuntary lock-in for depositors with termed contracts.
3. Cyprus' financing needs above do not include non-CB and non-deposit funding for the banks that is going to mature in months to come and has to be replaced by some other source of funds (presumably we can assume that ECB / ELA will step in, but I don't see how that arrangement in the medium term can be pleasing to the ECB).
4. The deposits above do not break out MFI deposits, corporate deposits and personal deposits. It is one thing to bail-in personal accounts and yet altogether another matter to bail-in corporations and other banks (the former are subject to more strict capital controls than the latter two).

These are material risks to the sustainability of the Cypriot 'bailout' programme.

25/3/2013: Bankrupted Cyprus, aka 'The Rescue'

While European 'leaders' celebrate the breakthrough 'bailout' agreement with Cyprus, let's get back to Planet Reality, folks. The 'deal' is based on a EUR10bn loan to the Cypriot Government for which the taxpayers will be on the hook.

EUR10bn = 56.2% of the country 2013 forecast GDP.

And now, let's begin counting the proverbial chickens:

1. IMF forecast for GDP - used above - is based on nominal GDP growth over the fiscal year 2013 of 0.33%. Even by IMF 'rosy' standards this is way off the mark, as other (EU Commission and Cypriot own) forecasts envisioned GDP contracting between 0.5% and 1.3% in 2013.
2. IMF forecast is based on pre-bailout assumptions with the banking sector returns to the economy being at the levels consistent with full functioning of the Cypriot financial services sector.
3. Even outside the above points, IMF forecast through 2017 saw Government debt/GDP ratio in Cyprus rising to 106.11%, prior to the current 'deal' on foot of forecast GDP growth of 2.87% per annum on average between 2013 and 2017.

Now, with the deal:

1. Shrinkage of the financial services sector will be immediate and deep;
2. Deficit financing of any capital investment by the Cypriot Government will cease;
3. New debt is going to be loaded onto the country;
4. Reduced savings and exits by larger depositors will mean reduced revenues for the economy, etc

Much of this was outlined in my previous post on debt sustainability in Cyprus (http://trueeconomics.blogspot.ie/2013/03/2432013-are-cypriot-debt-dynamics-worse.html)

Now, let's do simple exercise. Add EUR10bn to Cypriot debt pile and get scenario of Cyprus (post-crisis with no growth effects).

Then, adjust GDP growth from 2013 through 2017 to yield average rate of economic growth of -0.18% annually (note, this is much more benign than Greek forecasts for the first 5 years of the crisis which are equal to -2.94% annually on average). This yields scenario of Cyprus (post-crisis with growth effects).

The above two scenarios are compared in the chart below against Greek forecasts by the IMF and the pre-'bailout' forecast by the IMF for Cyprus:

This is what the EU leadership is currently celebrating - a wholesale, outright bankrupting of the entire country. Well done, lads!

24/3/2013: Few Cypriot Myths & Few Billions in Losses

Ever wondered why would the IMF (and reportedly the EU Commission) reject the proposed (Plan B) Cypriot Government raid on state pensions funds? Oh... ok... IMF review from November 2011:

Naughty, naughty little Cyprus...

And the very same IMF note also sheds some light on those 'oligarchs' deposits that are so vast, the entire EU is apparently chocking on chicken breasts at Herman von Frompuy's dinners:

"First, non-resident deposits (NRD) in Cypriot banks (excluding deposits raised  abroad by foreign affiliates) are €23 billion (125 percent of GDP), most of which are  short-term at low interest rates [note: ECB official data does not exclude foreign affiliates deposits, which are normally out of touch in levy imposition. Also note: much of bulls**t about Russian oligarchs deposits was about high interest rates allegedly collected by them on Cyprus deposits. Guess that wasn't really the case as chart below confirms: deposit rates decline sharply by nationality grouping for both corporates and individuals... so who was exactly earning 'high returns' on Cypriot deposits? oh, well... Cypriots...].

"These could prove unstable in the event of  further confidence shocks. [In other words, Cyprus requires very stringent capital controls if it is to avoid instantaneous bankruptcy even with ELA continuing]

"This risk is partly mitigated by the 70 percent liquid asset requirement against the €12 billion in NRD in foreign currency), and the 20 percent requirement for the €11 billion in euro-denominated NRD). [Wow, so apparently 'oligarchs' deposits carry massive safety cushions, whilst 'ordinary' depositors are not...]

"Second, €17 billion in deposits collected in the Greek branches of the three largest Cypriot-owned banks could be subject to outflows in response to difficult conditions in Greece. Outflows in the first half of 2011 were close to €3 billion (nearly 15 percent of the total), although a portion of these returned to the Cypriot parents as NRD. [Now, there was more of Greek money than 'oligarchs'?]

Now, couple more revealing charts:

Clearly, structuring PSI the EU authorities & IMF knew the above factoid, right? Just as they knew the following (which clearly highlights the fact that any substantial hit on Cypriot banks would have immediately spelled insolvency of the entire economy):

24/3/2013: Are Cypriot Debt Dynamics Worse than Greek?

A nice chart via Pictet (link) on the size of the banking sector in Cyprus and its dynamics since 2006:

Now, do notice, reducing the above to 300-330% of GDP as required by the Troika in Plan A (and so far not disputed by the Cypriot Government) will imply lowering liabilities by EUR66.6 billion. Overall, banking margins in Cyprus are running at around 1.2% net of funding costs, we can roughly raise that to double to include wages and other costs spillovers, which implies that EUR66.6bn deleveraging of liabilities should take out of the Cypriot GDP somewhere around EUR1.5bn annually or 9% of GDP. Auxilliary services, e.g. legal, accounting and associated expatriate community benefits that arise in relation to international banking services being offered from Cyprus will also have to be scaled back. Assuming that these account for 50% of the margin returns to the economy, overall hit on Cypriot economy from deleveraging can be closer to EUR2.2bn annually or 12.7% of GDP.

Now, consider the loans package of EUR10 billion that Cyprus is set to receive if it manages to close the EUR5.8 billion gap. Absent banking sector deleveraging, this will push Cypriot Government debt/GDP ratio to over 140% of GDP. However, with reduction in GDP, the debt/GDP ratio (assuming to avoid timing considerations assumptions a one-off hit to GDP) will rise to 161%.

Now, recall that IMF and Troika 'sustainability' bound for debt/GDP ratio used to be 120%. We are now clearly beyond that absolutely abstract number even without the banking sector deleveraging. And let's take the path of debt/GDP ratio forecast by the IMF which would have seen - absent the 'rescue' package - debt/GDP ratio in Cyprus rising 106.1% of GDP by 2017. With the 'rescue' package and banking sector deleveraging, this can now be expected to rise to 174% of GDP in 2017 against Greek debt of 153% of GDP.

In short, the EU 'rescue' is going to simply wipe Cyprus off the map in economic terms. All debt 'sustainability' consideration are now out of the window.

Here's the chart:

Of course, the above analysis is crude as it ignores:

1. Potential positive effects of replacement activity and the fabled 'gas revenues' etc - which presumably were already reflected in GDP growth figures in the IMF forecasts
2. Potential negative effects of tourism, real estate sales and other services declines due to the reduced activity in the banking sector, which can raise the above adverse impact of the banking sector deleveraging to 15% of GDP. Corporation tax increases can yield further losses.
3. Timing issues for the deleveraging which is not expected to happen overnight.

Nonetheless, all in, there have to be some severe doubts as to viability of the Cypriot debt path under the Troika Plan A, let alone under the Cypriot Plan B.

22/3/2013: Cypriot Plan B - any better than Plan A?

So the reports are that Cyprus has a Plan B. And the outlines of the Plan - filtering through yesterday - are quite delusional.

The Plan consists of 3 main bits:

1. Split Laiki bank (see below) into a good and a bad bank. The 'bad' bank will take on deposits of over 100K and deposits under 100K (guaranteed by the State) will be shifted into 'good' bank. Other banks will be recapitalised but there are no specific as to how, when or to what levels of capital. This stage of the Plan aims to reduce the recapitalisation costs by about €2.3bn. The problems with this stage are massive, however. First: smaller depositors are more likely to run on the bank as they are less likely to have termed deposits and as their withdrawals (even under capital controls to be imposed - see below) will be less restricted than for larger depositors. In other words, the Plan B is likely to reduce stability of deposits and funding in the resulting 'good' bank. Second: while Cypriot banking system losses are currently crystallised, reducing uncertainty for any recapitalization, there is no guarantee that depositors flight will not undermine their balance sheets beyond capital injections repair. Thirdly: the new 'good' bank will have a balance sheet (again, see table below) saddled with massive exposure to ELA & ECB funding at ca 40% of the total liabilities. If associated assets move along with larger depositors, it is likely that ECB funding ratio to Assets is going to be close to 50%. How on earth can this be called a 'good' bank beats me.

2. Step two in the delirious process of Plan B repairs of the Cypriot banking system will be the creation of a sovereign wealth fund backed by state, church, central bank and pension funds 'assets'. Even 'future gas revenues' are thrown into the pot. Put simply, the fund will be a direct raid on state pension funds, state properties and enterprises and gold reserves. It will also contain a direct link to the collective psychosis induced by the crisis - the pipe dream of Cypriot 'Saudi Arabia of the Mediterranean' Republic. Honestly, folks, this crisis has taught us one thing: the quantity of hope-for oil & gas reserves in the country is directly proportional to the degree of economic / financial / fiscal insolvency of the nation. So, having set up a bogus and bizarre fund (with hodgepodge of assets and a rich dose of 'dreamin in the night' claims to assets) the state will issue 6-year bonds against these 'assets' to raise some €2.5bn. Now, what idiot is going to voluntarily buy into this fund is quite unclear at this stage, but presumably, with bond yields set at crippling levels, the fund will find some ready buyers.

3. Step 3: the remaining shortfall of €1bn is to be covered through a small deposit levy on deposits above 100K.


Laiki bank latest balance sheet summary is provided (via Global Macro Monitor) here:

It is a whooper… with Assets at EUR30.375bn the bank is over 178% of Cypriot GDP. Deposits are at 105% of GDP.

The question is whether this plan, even if acceptable to the EU and ECB, will prevent or even restrict the deposits flight once the Cypriot banking system opens up. The EU Commission is working with Cypriot Government on developing capital controls to stem outflow of funds. But there are serious questions as to whether such capital controls can be imposed in the country that is part of the common market.

Another pesky problem is whether the bonds issued by the fund in Step 2 above will count toward Government debt. Presumably, EU can allow any sort of fudge to be created (e.g. Nama SPV in Ireland) to avoid such recognition. If not, then whole Plan B is a random flop of a dead whale beached on Cypriot shores…

Third pesky issue is what happens if the Fund goes bust. With pension funds committed to it, will the Cypriot state simply default on all of its pensions obligations? deport its pensioners to Northern Cyprus? whack the remaining (I doubt there will be any) Russian 'oligarchs' once again? or invade Switzerland? The Cypriot Government attempted to dress up the Plan B as the means to avoiding hitting small savers and ordinary people with the bank levy. It so far seems like risky leveraging of ordinary retirees and future retirees to plug the very same hole that would have been created in their budgets by the deposits levy.


Meanwhile, here's the question for those reading this blog in Ireland: According to the ESCB Statures Article 14.3, the Governing Council of ECB can make a determination to shut off liquidity assistance to the national banking system only on foot of a 2/3rd majority vote. The ECB Council did announce such a move for Cyprus comes Monday. This implies that at least one peripheral state National Central Bank governor casted the vote against Cyprus. Would that have been our Patrick Honohan, one wonders, given the frequent propensity of Irish officials to kick other peripheral states in order to gain small favours from the EU/ECB?

8/3/2013: The Cyprus' Russian Bail-in Dilemma

With the new Government in place and with more urgency than ever before, Cyprus is heading for the last ditch effort to secure the bailout from the Troika.  However, all indications are there will be no agreement in March, pushing any potential deal closer to the June 3 when EUR1.415 billion of Government bonds come to maturity. The bonds amount to a massive 9.65% of the country GDP and are unlikely to be rolled over unless at a punitive yields.

Cyprus original request for the bailout dates back to June 2011, looking for up to EUR17bn (ca 100% of GDP) and the current foot-dragging from the EU is a clear signal of Frankfurt's and Brussels' conviction that the acute peripheral crisis is now over and there is little risk of contagion from Nicosia. If the full EUR17bn were granted, the bailout would push Cypriot Government debt to ca 145% of GDP, well ahead of the IMF-set sustainability threshold of 120%.

Furthermore, the EU policymakers clearly perceive Cypriot crisis to be distinct from other peripheral states while Cypriot banking system (the cause of the crisis) to be decoupled from the rest of the euro area. The former smacks of the usual euro area denialism, while the latter is probably closer to truth. Nonetheless, someone has to be concerned with sustainability of any debt in excess of 90-100% of GDP in an economy that is about to take a massive hit at the heart of its growth engine: banking and associated exportable services.

Cypriot banks hold assets valued at 8 times the country GDP (roughly EUR 120 billion worth of assets), with deposits of roughly EUR70 billion recorded prior to the recently started 'quiet' bank runs. Within last week alone Cyprus banks lost just over 2% of their deposits. Around 42-43% of these deposits belong to foreign (primarily British and Russian) residents.

The latter are now at the crosshair in the EU vs Cyprus war for bailing-in the depositors in insolvent Cypriot banks.

In 2012, there were some 60,000 Russian expatriates living in Cyprus, a country with the total population back in 2011 at 1.116 million. Russia was the second largest source of tourists inflows into Cyprus in 2011-2012 and Russia received FDI of USD12.3bn via Cyprus (although probably 99%+ of this was recycling of funds that originally left Russia for Cyprus). In 2011 Russia extended a EUR2.5 billion bilateral loan to Nicosia. Despite common theme in the press about Cypriot banking system being used for Russian tax evasion, Russia and Cyprus have signed and ratified the Protocol to the Double Taxation Treaty.

At the end of 2011, many, but not all and not even majority, of the non-Euro deposits in Cypriot banks originated from Russia - amounting to ca EUR18 billion (more than 100% of the Cypriot GDP), but just 20% of the total deposits in the country. Russians are also major holders of equities in BOC and CPB banks. These Russian deposits have declined since then. More ominously, the accounting of these deposits is somewhat dodgy. There are many conflicting figures out there.

Below is the table - courtesy of the Piraeus Bank - detailing the deposits structure in Cypriot banking system through early 2012:

In contrast, Fitch (via International Herald Tribune) reported slightly different figures that are at odds with both above figures and the Min Fin claims (see below):

According to the Min Fin, as of end of 2012, Cyprus banks deposits remain around EUR70 billion and less than EUR30 billion of these are accounted for by foreign depositors, with Russian deposits standing around EUR15 billion. The problem is that all of the above figures include deposits in Cyprus-regulated pure Russian banks, such as division of VTB, for example, which are not going to be covered by the bailout or the haircuts.

A recent estimate by the Euromoney puts non-domiciled Russian deposits in Cyprus closer to 7-10% of total deposits or EUR5-7 billion.


Confusion aside, it is relatively clear that so-called Russian 'oligarchs' funds, while prominent in the overall deposits volumes, are neither the source of the Cypriot problems, nor a source for the sustainable solution to that problem. Even a 50% bail-in of these would not deliver (given the existent EUR100,000 guarantee on deposits, and the fact that large volumes of the Russian money is most likely held in the names of EU-registered entities) Cypriot system to health or even to contribute more than EUR2-2.5 billion to the EUR17-17.5 billion bailout.

Matters are worse, when it comes to bail-in of Russian depositors, when one considers the existent and growing links between the real economies of the two countries. In 2008, Cypriot economy gained EUR1.9 billion (11% of GDP) from tourism trade surplus. Inflows of Russian visitors to the island were up 55% in 2011 in y/y terms and they now represent the second largest source of tourism revenues after the UK (although Russian tourists account for only around 8-10% of all visitors to the island, as opposed to the UK tourists who accounted for closer to 50%). A loss of Russian tourism in the wake of any bail-in would be pretty hard to offset for Cyprus' economy left without the core pillar of International Financial Services. Country income from accounting and legal services amounted to ca EUR700 million or 4.0-4.1% of GDP in 2008, and much of that came from Russian residents, businesses, investors and depositors.

Russian investments in real estate in Cyprus (excluding Russians resident in Cyprus) amounted to ca 7% of total real estate investment back in 2006, a rate that is 1/10th of the UK residents investments there, but nonetheless - significant support for the economy. And this excludes investments by Russian nationals resident in Cyprus.

Overall, prior to the crisis, Russian business and individual activities in Cyprus contributed closer to EUR600-800 million in annual revenues to the economy, excluding taxes and wages. Applying some multipliers to that suggests overall GDP contribution from Russian-linked activities to Cypriot GDP of some EUR2 billion annually or up to 11.7% of the country GDP.

In other words, bail-in of Russian depositors can gain Cyprus some EUR2-3 billion under very adverse conditions imposed on non-resident depositors and cost Cyprus some EUR0.75-1 billion in annual economic losses. How fast does this math start spelling net loss? And how fast does this math start spelling inability to service 120% or so debt/GDP ratio post bail-in?

3/12/2012: Current crisis systemic risk comparative

THE LIBERALIZATION AND MANAGEMENT OF CAPITAL FLOWS - an IMF paper released today has an interesting chart putting into perspective the extent of the euro area crisis in comparative terms to other crises (click on the image to enlarge):

The above clearly shows that to Q3 2011, the euro area crisis has been

1. Systemically separate from the preceding global financial crisis of Q1 2008 - Q1 2010, 
2. Much smaller in magnitude than the preceding crisis,
3. As measured by the crisis indicator - comparable in magnitude to the early stage of the Asian-Russian crises and ERM crisis, as well as to the early stages of the Scandinavian crisis
4. However, the spillover from the euro area crisis to the global economy remained more limited than contagion in previous crises, as illustrated by the systemic crisis indicator.

Another interesting feature of the chart is that it shows that the Age of Moderation (1990-2007) was actually a period with four systemic crises: the Scandinavian crisis of the 1990s, the ERM crisis, the Asian and Russian crises, and the dot.com bubble

Lastly, the above shows that both, the IMF systemic crisis indicator and Equal-weighted crisis indicator are not sufficient in providing lead-up signals for systemic stress build up.

2/9/2012: Gun, no bullets, a charging bear

Via an excellent recent post on the SoberLook, here's a chart showing a Central Bank with no ammunition left to fire at the charging bear:

The chart plots the rapid rise of monetary base in Japan courtesy of BOJ.

And as to the portrait of the bear (via same post):

The above plots Japan's GDP y/y changes. Here's the point - in 20 years between 1995 and 2014 there will be not a single 5 year period in which Japan did not have a recession. Not a single one.

Now, recall that 'we will do everything necessary to rescue euro and, believe me, it will be enough' statement from Mr Draghi... BOJ needless to say tried the same... it has been working marvels for Japan's economy, albeit the yen is still there.

16/8/2012: Italy's 'this time, it's different' moment

This time it's different for Italy now... according to an excellent article by Charles Wyplosz here. Read the whole thing, Wyplosz is excellent on the basics of the Italian situation.

Update: new link to the article.

16/8/2012: Financial Repression - Round 2

Financial repression continues to gain speed in Ireland: link here.

Basic idea: having raided actual pensions funds, the Irish Government is to issue special annuities (priced accordingly to reflect State's 'grudging acceptance' for now of the pensions tax break) for insurance and pensions providers.

The good part of the idea is, as Fitch points in the note, added funding stream for the Government.

The bad parts are, as Fitch does not bother to note:

• Deleveraging economy means that funds will be taken out of the already diminished private investment stream, should the annuities be successful in raising such funds;
• Risks of claims exposure to Ireland for Ireland-based providers will now be amplified by more assets tied to Ireland (de-diversification);
• The new funding is debt, priced more expensively than what we can avail of from the Troika programme and subsequently from the ESM (at least access to and the cheapness of the ESM funds was the Government-own rationale for convincing the voters to back the Fiscal Compact earlier this year - something that the rating agencies have confirmed, as I recall);
• The new funding is still debt, which means that the new 'source' is not going to help restoring Irish public finances to sustainability path;
• Payments on these annuities will be subject to the same seepage out to imports (consumption of recipient households) as any other income and thus will have lower impact on our GDP, and an even worse impact on our GNP, than were the annuities structured using foreign governments' bonds;
• Share of the Irish state liabilities held by domestic investors will rise, which automatically implies riskier profile for both: Exchequer future funding and pensions;
• The latter (pensions funding risk profile deterioration) will also induce higher expected value of future unfunded liabilities (basically, as risk of pensions funding rises, probability of claims on state in the future to fund public pensions rises as well), and so on.

But, hey, why would the Irish State bother with any of these concerns when they've found another quick fix to €3-5 billion of our cash?

And on a more macro level, financial repression is back on the EU agenda too. The latest spike in French rhetoric about the need for 'own-funding' of the EU operations (link here) is just that, have no doubt. The idea is to give EU some central taxation powers so, as claim goes, it reduces the 'burden' on national governments. So far so good? Not exactly. Neither the French, nor any other Government in Europe at this stage is planning to 'rebate' (or reduce) internal tax burdens to compensate for EU new tax burden. In other words, the Governments ill simply pocket the 'savings'. Which, to put it simply, means the new 'powers' will simply be new taxes for the already heavily over-taxed and recession-weakened economies of Europe.

All in the name of deleveraging the State at the expense of the real economy. And that is exactly what the financial repression is all about.

Updated: And just in case we need more 'creative' thinking, here's an example of financial suppression: It turns out Nama (Irish State Bad Bank - don't argue that SPV thingy, please) should use public purse to suppress normal price discovery processes in Irish property markets. Right... you really can't make this up. Irish elites are now so desperate for relevance, they are fishing that Confidence Genie anytime anyone is feigning some attention to what they have to say.

15/8/2012: Total Insolvency in Greece Meets Total Denial in Europe

And so as predicted here back in February, Greece is now in a complete meltdown when it comes to fiscal targets (report here). The only thing that is keeping this Euro charade still rolling is seemingly endless willingness of the European 'leaders' to deny the reality of Greek complete and total insolvency.

27/7/2012: A thought... for a Happy Friday

Just a thought:

How soon will the Finns be sending a note to Merkel along the usual 'concerned neighbors' lines: "Angie, neighbors here across from de puddle. You've left for a vacation, we know, but yer kid from de Frankfurt is running wild partying. Shouts he'll buy up every lemon from the garage sale across the roundabout, yer know - where de siesta fans live - with mum's credit card. Threattens something about 'giving dem de bank'... Not to be too concerned, ...err... but de Dutch family de other side of de fence is a bit ruffled up by this ruckus... Though the pesky Frenchies the other side of the street are egging yer kid on. Enjoy sunshine, but do give your lad Draghi a buzz there to calm him a bit."

17/7/2012: Euro area debt crisis timeline

One hell of an infographic via The Financialist here summarizing the time line for the euro area debt crisis.