Archive - Mar 18, 2013 - Story

At long last, Europe's flimsy facades of State sovereignty, democracy and free-market capitalism have collapsed, and we see the real machinery laid bare: the Eurozone's political-financial Aristocracy will stripmine every nation's citizenry to preserve their power and protect the banks and bondholders from absorbing losses. The deposit-confiscation "bailout" of Cyprus confirms the Eurozone's fundamental neocolonial, neofeudal structure and the region's political surrender to financialization.

For the first time, a mainland Chinese company has defaulted on its bonds. SunTech Power Holdings has been clinging on by its teeth but after failing to repay $541mm of notes due on March 15th - and following four consecutive quarters of losses through the first quarter of 2012 and since then having failed to report quarterly earnings - owed to Chinese domestic lenders, the firm is restructuring. As Bloomberg reports, Chinese solar companies are struggling after taking on debt to expand supply, leading to a glut that forced down prices and squeezed profits - and most notably were unable to renegotiate its liabilities and obtain “additional flexibility” from creditors. This is highly unusual and perhaps is the beginning of a trend for Chinese firms. We already know the little discussed but gargantuan size of China's corporate bond market (which dwarves the US relative to GDP) as the mis-allocated credit tsunami of the last few years begins to hit its lending limit - just as Chinese corporate leverage is surging. If Suntech, the world’s largest solar-panel maker as recently as 2011, could not renegotiate its loans, we humbly suggest there are more problem firms out there about to find their friendly local banker a little less enthusiastic - just as Marc Faber warned recently.

There are three key highlights in yet another take on Cyprus, this time from JPMorgan's Robert Henriques: the first, and most obvious, is that "more extreme scenarios of burden-sharing will not necessarily reinforce investor confidence" - that much is clear; the second, as we pointed out over the weekend, is that what happened in Cyprus is a "the death knell for an EU Common Deposit Guarantee scheme, which was to be an integral part of the Banking Union proposals" - so much for the key part of European monetary and fiscal integration. But the third, and most important, is that "we would expect future crises to be exacerbated by more extreme deposit flight. This would likely mean the ECB would have to increase its presence as liquidity provider of last resort, which, under normal circumstances, would lead to increased asset encumbrance and lower recoveries for senior debt." The problem for Europe, as diligent readers know too well already, is that asset encumbrance is already at record high levels, meaning the ability to find "free" assets used to create new loans will be next to impossible.

European equity, credit, and sovereign bond markets all started their day with a jolt. Smashing down to multi-week lows following the FX market (and US futures) implied opens. The reflexive buying began almost immediately but was slow and steady - leaving Spain and Portugal out in the cold still (+32 and 21bps respectively in the last 3 days - the biggest 3-day jump in 4 montsh). Spanish and Italian equity markets trod water near their lows through the European session but once the US opened in its magical way, they rallied 1.5% off the day's lows! EURUSD also rallied back - aided by POMO but didn't close the gap unlike US equities. European financials suffered most - as expected - but even they bounced back off earlier lows - though credit is still shouting loudly that stocks have it all wrong. Away from the mainstream manipulated measures of how awesome a 10% deposit haircutis, Swiss 2Y was in demand all day - trading as lows as 0.003% on safe-haven demand and the 3month EUR-USD basis swap (indicator of bank stress) tumbled its most in 6 weeks.

The implications for people’s trust in their government and financial system are obvious. It would be remiss to think that this wariness will be contained just to Cyprus. While many will be watching next week for signs of financial contagion from the Cypriot decision in other parts of the eurozone, with Spaniards or Italians possibly withdrawing savings from their banks, there is a more insidious infection that could spread... Citizens in other troubled eurozone countries will watch and grow warier. They will interpret the policies advocated by the stronger members as punitive for the weaker. They will consider the hypocrisy of leaders who cry foul about money laundering in Cyprus but turn a blind eye if it is happening in Lichtenstein, Switzerland, Luxembourg, the City of London or anywhere else in Europe.  They will begin to ask themselves where their interests lie, what’s in the euro for them and whether other options would be better. And, as they are mulling over these thoughts, they will look to other parts of Europe and see people like them but also analysts and policy makers wondering what all the fuss is about. They will hear others who have not had to suffer any hardship or financial losses wonder why there is such a negative reaction to wages being slashed, taxes being hiked or deposits being taxed. This is the point at which the links within the eurozone will begin to pop apart, when citizens will turn to Beppe Grillo-style solutions, to nationalists, extremists or to anyone who promises a different path. This is the point at which the vehicle stops functioning and the road ends.

While the equity markets inch back to their 'safe' place of de minimus volumes and slow leakage higher, it seems real money is flooding into the safety of Switzerland (and gold). Swiss 2Y rates are testing back into negative territory once again and have dropped (on demand) their most since August 2012.

Prior to yesterday, if you were trying to handicap how the unelected leaders of the Eurozone were going to react to a tough situation, you only had to refer to the quote "When it becomes serious, you have to lie" from Mr. Junker to understand their mindset. But so long as someone at the ECB was willing to flood the world with free EURs (with significant backup provided the US Federal Reserve) the market closed its eyes, held its breath and took the leap of faith that all was well. However, post the Cyprus decision, the curtain has been pulled back and wizard revealed with all his faults and warts. It would be hard to over-emphasize how significant the Cyprus situation is. The damage done here is not related to the size of the haircut - currently discussed between 3 and 13% - but rather that the legal language which each and every investor on the planet must rely on in order to maintain confidence in the system has been subordinated to the needs of the powerful elite.

The first proposed haircut on Cypriot deposits, which saw deposits under €100,000 haircut by 6.75%, and those €100,000 and larger (i.e., the "Russian oligarch" pool) trimmed by 9.9% appears to be hours away from renegotiation. The reason is that Europe now is convinced the only reason the bailout proposal would not pass parliament is that the tax on the "common man" deposits is too high, which means it will be revised to 3% or perhaps lower, with the possibility of staggered thresholds, such that deposits under €20,000 remain untouched. This will be decided at a conference call at 6:30 pm GMT when Europe will once again confirm its cluelessness, and inability to make concrete, firm decisions. While none of this will restore confidence in the Cypriot and European banking system, the open question is what will be the Russian impairment - i.e., what is the most that whale deposits can be cut by? We now know the answer, courtesy of this interactive widget from Reuters, which allows one to calculate what the haircut on large deposits would be assuming an X% haircut on smaller deposits. It appears that the worst case for Russians will be 15.26% - this is how much of all Cypriot deposits €100K and higher would be taxed by if there is 0% tax on the small deposits.

What was initially a single-day Bank Holiday has now morphed into three days as the farce that is the wealth tax in Cyprus will now keep the citizenry from their money until Thursday according to the latest from the Central Bank...

• *CYPRUS CENTRAL BANK SAYS BANKS TO BE CLOSED UNTIL THURSDAY: AP

Which begs the question "Which Thursday?"

While not the Molotov-cocktail-throwing, smoke-bomb-hurling debacle that Greece (and Spain) became, the Cypriot demonstrations are gathering pace with a large protest planned for this evening and tomorrow during the parliament's vote. The following images give a sense of the feeling among the people...

Until this weekend's Cyprus black swan, the biggest red flag facing the market was the threat of persistent Chinese inflation, manifesting itself in very sticky and upward rising home (and many other) prices. In fact, quite recently the new Chinese leadership encouraged "bold" and aggressive steps to tame real estate inflation and instituting fresh curbs on house appreciation "speculation", which is a natural byproduct in a nation that has an underdeveloped and untrusted capital market - unlike in the US where the S&P absorbs all the Fed's reserves (with no money multiplier impact) keeping inflation elsewhere largely tame. It is this inflation that has kept the PBOC not only on the global "reflation" sidelines, but forced it to withdraw liquidity with several record repos in the days following the Chinese new year. It is also the downstream effects of this inflation that has pushed the Chinese stock market red for the year. So just how much of an issue is the soaring Chinese real estate market as global liquidity makes its way to triplexes in Shanghai? The chart below explains it all.

At this point a question is in order: while in Cyprus, and soon probably elsewhere, the government will openly confiscate deposits to fund insolvent banking systems, in the US excess deposits are used by the prop desks of banks like JPMorgan to inflate risk assets, corner a bond market (IG9), and to generally create a wealth effect... for the 1%.

The Cyprus bailout package tax on bank deposits is a deeply dangerous policy that creates a new situation, more perilous than ever. It is a radical change that potentially undermines a perfectly reasonable deposit guarantee and the euro itself. Historians will one day explore the dark political motives behind this move. Meanwhile, we can only hope that the bad equilibrium that has just been created will not be chosen by anguished depositors in Spain and Italy. The really worrisome scenario is that the Cypriot bailout becomes euro-systemic – in which case the collapse of the Cypriot economy will be a sideshow. This will happen when and if depositors in troubled countries, say Italy or Spain, take notice of how fellow depositors were treated in Cyprus. All the ingredients of a self-fulfilling crisis are now in place: It will be individually rational to withdraw deposits from local banks to avoid the remote probability of a confiscatory tax. As depositors learn what others do and proceed to withdraw funds, a bank run will occur. The banking system will collapse, requiring a Cyprus-style programme that will tax whatever is left in deposits, thus justifying the withdrawals. This would probably be the end of the euro.

While hope appears to still be alive that the Cypriot government will hand over their natural resources to wealthy Russia (or Gazpromia) and all depositors (Russians and Cypriots alike will be saved), we suspect there is a much bigger threat from Russia that has not been discussed. As Monument Securities' Marc Ostwald notes "there's a 50/50 chance Cypriot bailout fails because of the 'massive danger' a large amount of Russian cash flees Cyprus following deposit tax plans." Russia has ~$60 billion exposure to Cyprus, including loans to companies registered in the country and after the haircut 90% of Russian deposits will still be free to leave the country if the levy is approved.

Cyprus is now old news: local (and Russian... and UK... and European) depositors will see anywhere between 3% and 13% (or more) of their deposits, depending on what the "fair" threshold of a "lot" of money is determined to be in the first revision to the deposit tax levy, confiscated and in return they will get "equity" in broke banks, and maybe some gas-linked bonds. That much we know. The question then becomes: what would "Cyprus" look like if it took place in the US? Below, courtesy of William Banzai, is one artist's impression...