13/1/16: Bail-ins in Europe: Have Some Fun, Legal Eagles…

In a recent article for Forbes, In Europe, 2016 Will Be The Year Of Lawsuits, Frances Coppola neatly summed up the problem of the EU’s attempts to structure a functional bail-in mechanism for failing banks resolution regime.

I covered to topic in a number of previous posts here (the more recent one). But as the first days of the New Year are rolling in, the problem is becoming apparent.

FT covered the problem with Portugal’s Novo Banco bail in here. Summing up the case: “Europe’s new regime for winding up failing banks has made an inauspicious start, as investors lashed out at the European Central Bank for allowing Portugal to impose losses on almost €2bn of senior bondholders in Novo Banco”.

And beyond Portugal, there is the case of Austria’s attempt to reduce burden on taxpayers from bailing out Hypo Alpe Adria via “imposing losses on bondholders through a reversal of guarantees given by the province of Carinthia”. Back in July 2014, the whole house of cards that is Europe’s ‘no-bail-outs’ promise of the new regulatory architecture was taken down by the Austrian court ruling that ex post bail ins of bondholders can’t be done. Which rounds things from the impossibility of ex post bail-ins to the impossibility of ex ante bail-ins.

And then there is the case of the Cypriot banks’ depositors bail-ins of 2012 that is about to start going.  A reminder of the case: “The EU initially agreed to provide bank recapitalisation assistance as it was necessary to safeguard the Eurozone, but in March 2013 the European Commission and the European Central Bank relented and set new conditions for providing financial assistance that involved depriving depositors of Cyprus Popular Bank (Laiki Bank) of all their savings – except the government-guaranteed amount of €100,000 – and in the case of Bank of Cyprus of 47% of uninsured deposits. The EU’S change of mind was unprecedented and unexpected because bank deposits are regarded as sacrosanct. …The EU was not prepared to assist depositors in Cyprus with €7 billion because the International Monetary Fund (IMF) was not satisfied Cyprus could sustain such a debt.”

One must also remember the role of the European ‘regulators’ in all of this mess. Take the Bank of Cyprus. It passed EU banks stress tests just before it crashed and burned in a subsequent bail-out and bail-in to the tune of €23 billion to the taxpayer and a 47.5% haircut on deposits over €100k.

It looks like 2016 is going to be a fun year for European financial sector ‘reforms’ and a stimulus to the legal profession. All paid for by the taxpayers, of course.

12/1/16: That Savage Deleveraging: Global Debt 2000-2015

Here's a neat summary chart based on data from BIS through June 2015, covering total global credit (debt) outstanding (excluding IMF debt), issued in three main currencies:

That savage deleveraging... it has been truly epically... unnoticeable... Oh, and one more thingy: the unsustainable build up of debt prior to the onset of the Global Financial Crisis (GFC) was just about the same as the increase in debt during the so-called deleveraging period since the onset of the GFC.

11/1/16: Dealing with Systemic Sovereign Debt Crises: IMF's Animal Farm Model

IMF brainiacs have been struggling over time to develop some sort of a coherent framework for managing the fallouts from systemic sovereign debt crises. So far, the golden rule has ben elusive for them. However, following the Cypriot and Greek experiences with private sector bail-ins and realising the direct connection between these experiences and the cases of other peripheral Euro area states, most notably Ireland and Portugal, the IMF have been coming around to the idea that while all countries are ‘equal’, some are ‘more equal’ than others. In other words, that in the world where might is right, there are two tiers of countries: those that get whacked and those that get properly rescued.

Behold the IMF’s latest thinking on the subject. Sandri, Damiano of IMF’s research department authored a new working paper, titled “Dealing with Systemic Sovereign Debt Crises: Fiscal Consolidation, Bail-Ins or Official Transfers?” (October 2015, IMF Working Paper No. 15/223: http://ssrn.com/abstract=2711133).

It says what it does: “The paper presents a …model to understand how international financial institutions (IFIs) [read IMF and European ESM/EFSM/EFSF and so on] should deal with the sovereign debt crisis of a systemic country, in which case private creditors' bail-ins entail international spillovers.” Notice the emphasis on ‘systemic’ country. In other words, ‘not the ordinary fry’ like smaller ‘peripherals’.

“Besides lending to the country up to its borrowing capacity, IFIs face the difficult issue of how to address the remaining financing needs with a combination of fiscal consolidation, bail-ins and possibly official transfers. To maximize social welfare, IFIs should differentiate the policy mix depending on the strength of spillovers. In particular, stronger spillovers call for smaller bail-ins and greater fiscal consolidation.” Which simply says: more systemic is a country, less risk of bail-ins, so if you are a French or a German depositor or lender, you are lucky. If you are a Belgian or Irish depositor or lender, tough sh*t, mate.

“Furthermore, to avoid requiring excessive fiscal consolidation, IFIs should provide highly systemic countries with official transfers. To limit the moral hazard consequences of transfers, it is important that IFIs operate under a predetermined crisis resolution framework that ensures commitment.” Oh, what this means is that systemic countries get bailed out via official sector (IMF et al) burden sharing. Small countries - get screwed by not having access to such largess.

Here’s more beef from the paper:

“…consider the optimal policy mix to address the financing needs of a non-systemic country, for which bail-ins do not entail international spillovers. In this case, besides lending to the country up to its borrowing capacity, IFIs should use only fiscal consolidation and bail-ins.” In other words: small country gets only funds sufficient to cover its standing allowance under the normal rules and not a penny more. Rest of ‘rescue’ funds should be squeezed out of the country economy. “Official transfers should …be avoided because they do generate severe moral hazard since they are not priced into countries’ ex-ante borrowing rates.” Which simply says: look, bailing out through official burden sharing will not increase fiscal pain for smaller countries as yields on government debt are not going to rise high enough.

So, please, whack these small countries harder, to teach them a lesson and who cares about their economies and people. Lessons matter, you peasants.

Now onto systemic countries case: “Dealing with the sovereign debt crisis of a systemic country, …a first implication is that bail-ins should be used to a lesser extent since they are more socially harmful due to the associated spillovers. If IFIs are prevented from providing transfers, any reduction in bail-ins would need to be offset entirely through an increase in fiscal consolidation. In this case, systemic countries might be required to endure an excessive amount of consolidation to spare the international community from the systemic consequences of bail-ins. When dealing with systemic countries, it may thus become efficient to compensate the reduction in bail-ins not only through greater fiscal consolidation, but also with official transfers.” So in simple terms: if you are a big country, you will be treated entirely differently from a small country. Never mind that moral hazard thingy - systemic countries get official sector burden sharing, lending over allowed capacity and less bail-ins pressure.

Of course, the IMF Working Paper is not reflective of the Fund official position, as disclaimers go. So this paper is nothing more than a ‘discussion’ of what should take place, rather than what will take place. But, of course, we all know one simple fact: in the world of IMF, some countries are ‘more equal’ than others.

10/1/16: My 2004 article on Irish property bubble

Per friend's reminder, here is an article of mine from November-December 2014 Business & Finance magazine, showing the dangerous levels of house prices overvaluation in Ireland relative to underlying fundamentals:

10/1/16: Russian Banks: Licenses Cancellations Galore

Why Russian Central Bank’s chief Elvira Nabiullina deserves title of the best central banker she got in 2015? Why, because she sticks to her stated objectives and goes on even in challenging conditions.

When Nabiullina came to office, Russian banking system was besieged by underperforming and weak banks - mostly at the bottom of banking sector rankings, but with some at the very top too (see ongoing VEB saga here http://trueeconomics.blogspot.ie/2016/01/1116-another-veb-update-things-are.html). And she promised a thorough clean up of the sector. I wrote about that before (see http://trueeconomics.blogspot.ie/2014/12/22122014-elvira-nabiullina-roubles-last.html and http://trueeconomics.blogspot.ie/2013/03/1432013-comment-of-appointment-of-new.html).

But times have been tough for such reforms, amidst credit tightening, rising arrears and economic crisis. Again, majority of the problems are within the lower tier banks, but numbers of loss-making institutions has been climbing over 2015. January-November 2015 data shows that almost 30% of Russian banks are running operating losses and overdue loans have risen by nearly 50% to RUB2.63 trillion. Still, this constitutes less than 7 percent of total credit outstanding. Stressed (but not necessarily overdue) loans rose from 7 percent of total credit in January 2015 to 8 percent at the end of December 2015. Notably, both stressed and overdue loans numbers are surprisingly low. And on another positive side, bank’s own capital to assets ratio averaged 13 percent. The aggregate numbers conceal quite some variation within the banking sector, as noted by Bofit: “At the beginning of November, 129 banks had equity ratios below 12%. Large deficiencies in calculating the capital have come to light in several bank insolvencies.”

Amidst this toughening of trading conditions, CBR continued to push our weaker banks from the market. Over 2015, 93 banks lost their licenses, almost the same number as in 18 months prior with just 740 banks left trading the market as of December 2015. As the result, banking sector concentration rose, with 20 largest banks now holding 75 percent share of the market by assets. In January-October 2015, some 600,000 depositors in Russian banks were moved from banks losing licenses to functioning banks, per report here.

Chart from Bofit illustrates the trends in terms of banking licenses revoked:

Overall, this is good news. Russian banking system evolved - prior to 2009 - into a trilateral system of banks, including strong larger (universal) banks, medium-sized specialist and foreign banks with retail exposures, weak and sizeable fringe of smaller institutions, often linked to industrial holding companies. Aside from VEB - which officially is not a bank - larger banks are operating in tough conditions, but remain relatively robust. Smaller banks, however, having relied in previous years on higher risk consumer credit and holding, often, lower quality capital, have been impacted by the crisis and by the lack of liquidity. Shutting these operations down and consolidating the smaller banks' fringe is something that Russian needs anyway. 

10/1/16: Tsallis Entropy: Do the Market Size and Liquidity Matter?

Updated version of our paper:
Gurdgiev, Constantin and Harte, Gerard, Tsallis Entropy: Do the Market Size and Liquidity Matter? (January 10, 2016), is now available at SSRN: http://ssrn.com/abstract=2507977.

Abstract:      
One of the key assumptions in financial markets analysis is that of normally distributed returns and market efficiency. Both of these assumptions have been extensively challenged in the literature. In the present paper, we examine returns for a number of FTSE 100 and AIM stocks and indices based on maximising the Tsallis entropy. This framework allows us to show how the distributions evolve and scale over time. Classical theory dictates that if markets are efficient then the time variant parameter of the Tsallis distribution should scale with a power equal to 1, or normal diffusion. We find that for the majority of securities and indices examined, the Tsallis time variant parameter is scaled with super diffusion of greater than 1. We further evaluated the fractal dimensions and Hurst exponents and found that a fractal relationship exists between main equity indices and their components.

10/1/16: Crisis Contagion from Advanced Economies into BRIC

New paper available: Gurdgiev, Constantin and Trueick, Barry, Crisis Contagion from Advanced Economies into Bric: Not as Simple as in the Old Days (January 10, 2016). 

Forthcoming as Chapter 11 in Lessons from the Great Recession: At the Crossroads of Sustainability and Recovery, edited by Constantin Gurdgiev, Liam Leonard & Alejandra Maria Gonzalez-Perez, Emerald, ASEJ, vol 18; ISBN: 978-1-78560-743-1. Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2713335.

Abstract:      

At the onset of the Global Financial Crisis in 2007-2008, majority of the analysts and policymakers have anticipated contagion from the markets volatility in the advanced economies (AEs) to the emerging markets (EMs). This chapter examines the volatility spillovers from the AEs’ equity markets (Japan, the U.S and Europe) to four key EMs, the BRIC (Brazil, Russia, India and China). The period under study, from 2000 through mid-2014, reflects a time of varying regimes in markets volatility, including the periods of dot.com bubble, the Global Financial Crisis and the European Sovereign Debt Crisis, the Great Recession and the start of the Russian-Ukrainian crisis. To estimate volatility cross-linkages between the advanced economies and BRIC, we use multivariate GARCH BEKK model across a number of specifications. We find that, the developed economies weighted return volatility did have a significant impact on volatility across all four of the BRIC economies returns. However, contrary to the consensus view, there was no evidence of volatility spillover from the individual AEs onto BRIC economies with the exception of a spillover from Europe to Brazil. The implied forward-looking expectations for markets volatility had a strong and significant spillover effect onto Brazil, Russia and China, and a weaker effect on India. The evidence on volatility spillovers from the advanced economies markets to emerging markets puts into question the traditional view of financial and economic systems sustainability in the presence of higher orders of integration of the global monetary and financial systems. Overall, data suggests that we are witnessing less than perfect integration between BRIC economies and advanced economies markets to-date.

10/1/6: After the Flood Comes the Tax: European Road to Financial Transactions Tax

New paper, forthcoming as Chapter 10 in Lessons from the Great Recession: At the Crossroads of Sustainability and Recovery, edited by Constantin Gurdgiev, Liam Leonard & Alejandra Maria Gonzalez-Perez, Emerald, ASEJ, vol 18; ISBN: 978-1-78560-743-1, titled After the Flood Comes the Tax: European Road to Financial Transactions Tax is now available on my SSRN page: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2713332.

Abstract

This chapter presents the results of the comprehensive literature survey and supportive empirical assessment of the potential impacts of the Financial Transactions Tax recently adopted by the European Commission in response to the significant financial sector misallocations arising from the Global Financial Crisis. A survey of fifty academic articles relating to both Financial Transaction Taxes and Tobin Taxes shows that although a reduction in liquidity can be expected from such taxes, the impacts this will have on volatility and efficiency in a market is less obvious. A regression model quantifying what the possible effect of an introduction of a 0.1% tax on financial transactions would be on trading volumes and levels of volatility in the European equity market confirms the survey results in broader terms. These results can be used to infer that such a tax would likely increase volatility levels but may not have much effect on trading volumes. As a result the proposed tax can be viewed as an exercise in revenue generation but not as a macro-prudential tool for addressing potential future shocks and imbalances within the European financial system.

8/1/16: Some CIS Currencies & Westremlin-ised Brains...

It is a common meme amongst 'Westremlin' analysts on social media to attribute the massive fall in Russian Ruble over the last 15 months to the economic policy failure of Moscow, ignoring two simple facts: oil prices and free floating regime for the Ruble.

How much this ignorance is not a bliss?

Source: BOFIT

Unless your brain has been so solidly 'Westremlin'-ised by some poli-sci department from U.S.ofA, neither Kazakhstan, nor Azerbaijan are run from Moscow... oh an Uzbekistan is producing only 83K bpd of crude, NGPL and other liquids combined (Russia - roughly 11,400K Kazakhstan 1,691K and Azerbaijan roughly 865K).

Arithmetic is simple: more oil produced, heavier devaluation. Excluding, of course, Turkmenistan, where reality never collides with daily life...

8/1/16: Baltic Dry Index Hits Another All-Time Low

Let's give another cheer to the repaired global economy... as Baltic Dry Index continues to plough new record lows: the index fell 6.9% in YTD terms and down 38.54% y/y to close at a new record low of 445.0 (4.17% below Wednesday close).

or on longer time scale:

But never fear - everything has been repaired.

7/1/16: BRIC Brake on Global Growth

As I noted in analysis of the BRIC Composite PMIs (http://trueeconomics.blogspot.ie/2016/01/6116-bric-composite-pmis-december.html) December turned out to be another month when BRIC economic fortunes were weighing on the global economy.

As a reminder, overall 4Q 2015 BRIC Composite Activity Index stood at 99.0, down on 99.2 in 3Q 2015 and on 102.1 recorded in 4Q 2014.

Sectorally, both Services and Manufacturing Aggregate Indices for BRIC group of countries continued to trend down - a trend now running uninterrupted since the start of 2H 2010 and accelerating since 2H 2014 for Manufacturing.

Meanwhile, Global Composite PMI slipped in 3Q and 4Q 2015 below longer trend (that is still gently upward).

Chart below illustrates:

6/1/16: BRIC Composite PMIs: December

In recent posts, I covered Manufacturing sector PMIs for BRIC economies based on monthly data and Services Sector PMIs here.

Now, let’s consider Composite PMIs for BRIC:


Brazil Composite PMI fell from 44.5 on November to 43.9 in December, As the result, the economy posted 10th consecutive month of sub-50 readings, and since April 2014, Brazil’s economy registered above 50 readings in only three months, with none of these three readings being statically significantly different from 50.0. The last time Brazil’s Composite PMI posted reading statistically consistent with positive growth was in February 2013.

In December, both Manufacturing and Services sectors indicated contracting activity, with Markit concluding that “Private sector activity in Brazil continued to plunge in December as a deepening economic retreat contributed to a further contraction in new business. The seasonally adjusted Composite Output Index fell from 44.5 in November to 43.9 at the year end, pointing to a sharp and stronger rate of reduction. Whereas the downturn in manufacturing production eased (though remained severe), services activity declined at a quicker pace.”

Over 4Q 2015, Brazil Composite PMI averaged 43.7 which is about as bad as the average of 43.6 achieved in 3Q 2015 and much worse than already contractionary average of 49.0 posted in 4Q 2014.


Russian Composite PMI was covered in detail here. Overall, Russia’s Composite index slipped into contraction during December, falling to 47.8, from 50.5 in November, with the decline in output reflected across both manufacturing production and services activity. Overall, Russian economy’s composite PMI averaged 49.1 in 4Q 2015 which is much worse than 50.4 average for 3Q 2015. The data strongly suggests that not only did the economy failed to attain stabilisation, but that growth might have turned more negative in 4Q 2015.


Chinese Composite PMI also signalled declining business activity in December, falling to 49.4 from 50.5 in November. Overall, China posted four months of below 50 readings on Composite PMIs out of the last 5 months and the last time Chinese Composite PMI was consistent with statistically significant growth was in August 2014. In 4Q 2015, Chinese Composite PMI averaged 49.9, which is better than 3Q 2015 average of 49.2, but much worse than the 4Q 2014 average of 51.6. Unlike Russia and Brazil, which posted sub-50 readings across both Manufacturing and Services, China posted sub-40 reading in Manufacturing and above 50 reading in Services, That said, the Services reading was 50.2 - statistically consistent with zero growth - and the second weakest on record (the weakest point was 50.0 in July 2014).


India Composite PMI rose unexpectedly from November’s five-month low of 50.2 to a four-months high of 51.6 in December. Thus, per Markit, the index was “indicative of a rebound in growth of private sector activity. Whereas manufacturing production decreased for the first time since October 2013, services activity increased at an accelerated pace.”

Further per Markit: “Leading services activity to increase was a solid rise in incoming new work, one that was faster than that seen in November. Anecdotal evidence highlighted strengthening demand conditions. Conversely, manufacturing order books decreased, with panellists indicating that demand had been suppressed by the Chennai floods. Across the
private sector as a whole, new business inflows expanded at a faster pace that was, however,
modest.”

4Q 2015 Composite PMI for India stood at 51.5, down from 52.1 in 3Q 2015 and down on 52.2 average for 4Q 2014.


Overall Russia was a negative contributor to the BRIC Composite Activity Index dynamic in December, although overall ex-Russia group performance continued to deteriorate in December faster than in November, as indicated in the chart below:

Note: Composite Activity Index is based on my own calculations weighing BRIC economies by their shares of global GDP. The Index is based on a scale of 100=zero growth.

In 4Q 2015, average Composite Activity Index for BRIC ex-Russia was 96.7 which was marginally better than in 3Q 2015 (86.5) but worse than 101.8 average for 4Q 2014.

Overall 4Q 2015 BRIC Composite Activity Index stood at 99.0, down on 99.2 in 3Q 2015 and on 102.1 recorded in 4Q 2014. 

The chart below shows a clear downward trend in BRIC activity setting on from June 2014 and accelerating since May 2015.