Archive for March, 2013
“Nice banking system you got there. Be a shame if something … happened to it.”
Obviously this paraphrases the lengthy talks which took place earlier this month between the Cypriot government and the Troika – the biggest, most powerful and most ruthless gang of organised cross-border lenders in the world. But it is the case that the Troika’s three bosses (the European Commission, ECB and IMF) have their desperate borrower firmly by its heart and mind. Impertinent Cyprus initially tried to stop the Troika taking a cut of its bank deposits, voting it down in its little parliament on Tuesday. So Cyprus was given the chance to vote again (and get it right this time, or else). We shall see, probably tonight, whether Cypriot lawmakers give up some of their bank deposits in return for being allowed to keep the system as a whole propped up by Troika lending.
The idea of a government-sponsored bank raid might have seemed outlandish a few years ago. What is truly fascinating about the events of recent days, however, is the equanimity which has met them. Like the reaction to the elections in Italy we wrote about last week this surely has something to tell us about the current level of market confidence.
After all, we have been somewhere very similar before. Almost two years ago, scary demands from lenders were emerging about something called “private sector involvement” (PSI) – the idea that holders of Greek bonds should share the pain of bailing the country out with European taxpayers. Initially a German idea, it was approved by Merkozy (remember them?) and in due course officially adopted as part of the restructuring arrangements for Greek sovereign debt last year.
At the time, PSI caused chaos. As this blog observed on 8 July 2011, for example:
… Markets were blindsided on Tuesday by the decision of Moody’s, the credit rating company, to junk Portugal. Confidence was creeping back in after Athens took its austerity medicine, securing the release of emergency funds – and then, wham! – a cent off the euro, a down day for equities and a two point jump in Portugal’s 10 year yield.
From Moody’s full statement it is clear that their main concern is the possibility that private sector creditors may be expected to incur losses in a hypothetical future renegotiation of Portugal’s bailout. This concern arises from the possibility that such private sector losses will form part of the renegotiation of the bailout of Greece.
It really was pandemonium: no one knew what was going to happen, and almost everyone was panicking.
This time the background is the same. Deposit-holders have taken the place of bondholders; a dangerous precedent is being set; there is the risk of cross-border contagion in the eurozone and elsewhere; the whole plan was an unexpected surprise. But this time the panic is missing. Peripheral eurozone bond yields have not shot higher, equity markets are not materially weaker and the euro is about where it was a week ago.
Part of the explanation may lie in practicalities. Punishing Greek bondholders was a larger-scale and more arbitrary exercise than going after Cypriot banks. Cyprus is a country half the size of Wales with a population of 1.1m. It has GDP of about €18bn, and less than $1bn in gold and foreign exchange reserves. And yet it has €68bn of bank deposits, about a third of which are estimated to be of Russian origin.
This latter estimate is necessarily imprecise. The attraction of Cyprus as a banking centre lay in a combination of many things: low tax rates, an accommodating approach to offshore investment, a common law heritage which recognises the validity of trusts – and strict rules on banking secrecy. Suspicions of money laundering improprieties were raised months ago and led to an investigation of money laundering controls as a precondition of the Troika’s bailout.
Nonetheless, whatever one thinks of the properness of Cypriot banking, the sanguine response to the confiscation of bank deposits in a eurozone country is noteworthy, and especially so in the context of PSI and the reactions to it at the time.
While we haven’t seen anything like the Arab Spring this year, it has not exactly been politically quiet. The recent general election in Italy, for instance, got a lot of international attention, and the new parliament has opened amid wrangling and apparent deadlock. But the market reaction so far has been very muted.
When Greece held inconclusive elections last May, European stock markets continued a decline powered by renewed concerns over the eurozone crisis, with the FTSE 100 and the Stoxx 50 both ending the month about 5% lower. Since the Italian elections this year, however, both indices are up. The Milan bourse itself is flat. Ten year government bond rates in Italy have risen by all of 14bp, and the spread to Germany remains tighter on the year to date. (Last May the increase in the 10-year yield was 50bp.)
After all, electoral chaos in southern Europe is nothing new. Since the end of the military junta in Greece in 1974 there have been twelve prime ministers (not counting two caretaker-leaders), and fifteen elections during the course of which the vote counting system was changed four times. The story in Portugal is almost identical: thirteen elections and prime ministers since the establishment of constitutional government in 1976. Italy has held eleven general elections since 1974, only one more than the UK – but it has had more than double the number of prime ministers over the same period (seventeen versus seven), a reflection of the volatility of its fragmented coalition politics.
This is not to disparage the significance of politics in these countries. Much of the interest in events in Italy centres on the popularity of the anti-establishment Five Star Movement, which won over 25% of the vote on the concise though administratively opaque campaign motto, “F- Off”. It remains to be seen how exactly the message will be interpreted by the political class. And of course the situation could have been worse. Unlike the Greeks, the Italians gave their gaggle of far right parties less than 1% of the vote, and the communist alliance did little better. (Neither won any seats.)
In Portugal, the politics leading to the 2011 election were pivotal in the country’s request for a bailout – something which it might otherwise have chosen to avoid. Likewise, the defeat of Spain’s Jose Zapatero later that year presaged austerity measures and budgetary embarrassment for his successor reminiscent of the “I’m afraid there is no money” line which confronted the UK’s incoming coalition in 2010.
If the focus on European politics continues to diminish, then, it will be further evidence that the world is returning to normal. Changes in government and electoral emergencies in countries like Italy will once again be taken in people’s stride. After all, just look how little excitement there is over the latest EU summit going on in Brussels today – there is coverage, but it hasn’t made a single British front page. Similarly, it would have been easy to miss Ireland’s successful return to the bond market this week with €5bn of 10-year paper carrying a coupon of 3.9%.
The sovereign debt problems faced by countries in the eurozone and elsewhere are far from solved. But in terms of investor confidence and world sentiment, we should remember the old adage: no news is good news.
This year’s positive start was strengthened again today by better-than-expected data on US employment. Markets have continued to shrug off the messy political situation in Italy and the UK downgrade a couple of weeks ago. For the time being at least, sentiment is taking the relative robustness of America as its example and putting the problems of Europe to one side.
We have been here before. Almost exactly a year ago we saw good data from the US on the one hand and a sovereign default from Greece on the other. At the time this blog asked: who will win the tug of war: the US, or Europe?
The answer – eventually – was the US. Greek elections last spring plunged markets into a familiar state of uncertainty, but 2012 as a whole passed without various long-awaited disasters and constructively for risk assets overall. Part of the reason for this is of course that time is a healer (as well as an essential ingredient in the transmission mechanisms of monetary policy).
In any event it seems an apposite moment to consider a few of the anniversaries we’re passing this March.
First of all, 2007. It was at the beginning of this year that movements in something called the ABX index began to draw the attention of a few structured credit professionals. This index – then a new product – tracks the prices of sub-prime mortgage-backed securities. Coupled with occasional news of fraud and other problems in the origination market, it was telling a select crowd of market pariticipants that something was going very wrong. It was a forerunner of a huge slew of CDO and other ratings downgrades in the summer which would begin to widen interest in the subject of American mortgages.
2008. By the spring of this year, some smaller banks were being bailed out (Northern Rock, Bear Stearns), confidence was sagging, recession was dawning and stock markets had begun to suspect that something was amiss. Plenty of complacency still lingered though: oil was rising to new records, RBS was still rated Aa1 and Chancellor Darling announced in his budget speech that “the British economy will continue to grow through this year and beyond.”
2009. In March this year we were all doomed. Unprecedented crisis, leading to unprecedented recession, had brought about unprecedented debt and everyone by this stage was feeling a level of pessimism which was utterly without precedent. Those few banks which had not been nationalized had stopped lending. Ratings company staff had gone into hiding. Iceland had gone bust. Stock markets had collapsed through the floor. And then the recession ended, confidence returned and the MSCI World Index ended the year 27% up.
2010. For most of the year’s early months, optimism persisted. We knew that various countries were on the verge of posting eye-wateringly abysmal budget deficits for the previous year, but the recession was over! Recovery was on the way! Then the ratings companies, who had suddenly become rather less obliging, began to suggest that it wasn’t just little out-of-the-way places like Iceland that were vulnerable to default after all. Shortly after Easter, S&P junked Greece and the first eurozone bailout programme was born.
And now, here we are. It has been an interesting few years. Not wishing to read too much into it, but it is the same markets and observers who were so slow to spot that something was wrong in the first place that have been equally cautious in more recent times of entertaining the idea that things also go right.
The same tug of war we wrote about a year ago is still being played out. The further we get from the financial crisis and its historic events, the closer the contest gets to being decided – in favour of one side or the other.