Archive - Mar 2013 - Story

While Cyprus grabs the headlines, there are stirrings in Spain, New Zealand, and the UK with regard to how depositor funds (and their apparent insurance) is considered in the new normal banking system. As John Aziz notes, essentially, if there is to be any confidence in the banking system, the possibility of depleting liquidity insurance funds to bail out banks needs to be taken off the table completely. The possibility of insured depositor haircuts needs to be taken off the table completely. If banks need bailing out, the money must not come from insured depositors, or funds designed to compensate insured depositors. If banks fail, the losers should be the uninsured creditors.

The Bernank confirmed, in almost perfect hypocrisy to his previous implied comments, that the Fed is not targeting some asset price appreciation but no matter which way you look at it - the 'wealth' effect is an easy concept to comprehend as levered unrealized gains are seen as disposable income. However, as we have pointed out many times, the 'wealth' effect only helps an already wealthy few and as BofAML notes today, spending across income groups is extremely disparate reflecting the 'spending gap' in our aggregately stimulated economy. It is quite intuitive that those with more income will be able to spend more. The top 20% of the income distribution make up nearly 40% of total consumer spending. The spending gap is the most extreme for apparel and services and the least for healthcare and food. Lower income households, unsurprisingly, allocate a larger share of their budget toward necessary items. When will the trickle begin...

Why is the global economy in so much trouble?  How can so many people be so absolutely certain that the world financial system is going to crash?  Well, the truth is that when you take a look at the cold, hard numbers it is not difficult to see why the global financial pyramid scheme is destined to fail.  In the United States today, there is approximately 56 trillion dollars of total debt in our financial system, but there is only about 9 trillion dollars in our bank accounts.  So you could take every single penny out of the banks, multiply it by six, and you still would not have enough money to pay off all of our debts. Overall, there is about 190 trillion dollars of total debt on the planet.  But global GDP is only about 70 trillion dollars.  And the total notional value of all derivatives around the globe is somewhere between 600 trillion and 1500 trillion dollars.  So we have a gigantic problem on our hands.  The global financial system is a very shaky house of cards that has been constructed on a foundation of debt, leverage and incredibly risky derivatives.

Rumors and news continue to play but some slight weakness after-hours (Treasuries at session highs) suggest fears might have legs. While the Cypriot government submits its bank restructuring (good-bank / bad-bank and capital controls) and Solidarity Fund (CCOs), there will be no vote until tomorrow morning Europe time.

• *CYPRUS SUBMITS LAWS ON CAPITAL CONTROLS, SOLIDARITY FUND
• *CYPRUS SUBMITS LAW ON BANKING REFORMS, SPEAKER SAYS
• *CYPRUS PARLIAMENT TO DISCUSS NEW LAWS TOMORROW, CYBC SAYS

All of this after rumors of a 'rejection of all Cyprus government proposals' by Russia was the talk on desks and that more than a few Cyprus MPs believe the bank bill is too strict and needs more discussion. The ECB/ELA deadline looms with the path/hurdles now "Cyprus discussion" - "Cyprus vote" - "Troika analysis" - "ECB / EU Agreement" - and theoretically find a (non-Russian) funder for the CCO - before Tuesday's European open. Stay long Brussels and Nicosia caterers.

Goldman Sachs and Morgan Stanley are down 6.5% on the week (and even BofA has turned red on the week) as US equities have started to show 'slight' strains on European fears (as well as global PMIs and US earnings - what else is there?). Homebuilders gave up all their week's outperformance in the first hour of the day. Dow Transports are down 2.5% on the week now - notably underperforming and reverting their outperformance. VIX surged 1.25 vols to 14.00% - with protection remaining bid relative to stock's modest drop so far. While Treasury yields pushed lower all day (-6bps on the week) as did WTI (-1.5% on the week now), gold and silver flatlined after the spike higher this morning (both up 1.4% on the week). JPY strength was a key factor today as carry-trades were unwound. Risk-assets in general were once again highly correlated as credit tracked lower closing at its lows of the day like stocks. Equity trading volume was above average but average trade size is still falling and S&P 500 futures inability to hold VWAP into the close suggests institutional selling pressure is picking up.

Surprise! No decision came out of the Eurogroup conference call (and none is expected this evening) as:

• *EUROGROUP EXPECTS CYPRUS TO SUBMIT NEW RESCUE PROPOSAL QUICKLY and
• *EUROGROUP SAYS IMPORTANT TO GUARANTEE DEPOSITS UNDER EU100,000
• *EUROGROUP SAYS TROIKA ANALYSIS NEEDED ON NEW CYPRIOT PROPOSAL

However, Cyprus has decided that it will only undertake small deposit levy (if at all) and prepares to present a new proposal. And just to rub some salt in the wound:

• *CYPRUS CUT TO CCC FROM CCC+ BY S&P; OUTLOOK NEGATIVE

So, Laiki has only hours of liquidity; the government hasn't voted on a proposal yet; Eurogroup won't act until Troika analyzes the proposal; and Cypriot Central banker wants major capital controls.

The Swiss National Bank (SNB), which supposedly guarantees price stability in Switzerland, currently holds about 1,040 tons of gold reserves after gradually selling off at least 1,550 tons and now members of the Swiss People's Party, the far-right Swiss Democrats and the Lega dei Ticinesi movement, is confident a nationwide vote will be called (after they gathered 106,000 signatures) on stopping the sale of gold reserves held by the SNB. It also wants gold bars stored in the US to be returned. As Swiss Info reports, the People's Party leader Luzi Stamm comments, "Gold reserves guarantee the stability of the Swiss franc. They ensure that that private savings, salaries, pension keep their value," warning that gold must not be the object of speculation for the SNB or for politicians and demanding the SNB keep a minimum of 20 per cent of its assets in gold, twice the current level. In addition, they want to force the government to disclose where the gold reserves are stored, since "it is only in safe hands if it is kept in Switzerland."

There are two articles of faith in the central-bank religion: 1) We can keep interest rates near-zero for as long as we deem necessary, and 2) We can suppress inflation at will, too. The question is: can they do both at the same time for as long as they wish? If either interest rates or inflation (and they are correlated) start rising, the central banks' claims of control evaporate. There is an interesting paradox at work here: Since there is an unlimited buyer for low-yield bonds (the central banks), there is no market pressure for higher rates. Why raise yields when you can sell trillions of dollars of low-yield bonds to the Federal Reserve, Bank of Japan, etc.? By buying the new debt with newly created money, the central banks have marginalized the market's ability to transparently price risk and credit: the bond market has in effect been captured by the central banks, who can counter any reduction in demand with newly created money. But the central banks don't control where all this newly issued money goes. If it goes into the real economy, it triggers inflation; if it goes into assets, it inflates asset bubbles. Inflation and bubbles have consequences.

More details are appearing on the latest and greatest plan in the shambles to solve Cyprus' (and Europe's unsolvable) problem. It appears the European Group is implicitly declaring economic war on the 'wealthy' depositors (we noted here non-domestic depositors dominated recent inflows) as these headlines hit:

*EURO AREA SAID TO WEIGH CLOSING CYPRUS POPULAR, BANK OF CYPRUS
*EURO AREA SAID TO WEIGH GOOD BANK, BAD BANK FOR CYPRUS BANKS
*UNINSURED DEPOSITS COULD GO TO CYPRUS BAD BANK, FACE 40% LOSS

We assume followed rapidly by some eurozone law-breaking capital controls to stop the remaining 60% flooding out instantaneously...

Oh the irony:

18/01/2008, Trichet: "For a small, open economy like Cyprus, Euro adoption provides protection from international financial turmoil."

Expected to last 60-90 minutes - if Monday's call is any guide - it seems the European Group's teleconference to discuss Cyprus has pressured stocks and WTI (seemingly the new anchor risk asset) to the lows of the session and VIX to highs...

Just as we predicted, it seems Cyprus is rapidly escalating down the path we feared. The latest step:

Cyprus Popular Bank announces restrictions on ATM withdrawal to EUR 260 per customer per day

Bt on the bright side, for the next few hours, they still have liquidity... We just hope the steps we outlined get stalled before this really escalates.

It appears, based on government officials, that things are going a little critical in Cyprus. Following rumors of the closure (restructuring) of good/bad bank assets for Cyprus Popular Bank, we get this news:

*CYPRUS HASN'T HAD ANY FURTHER NEWS FROM RUSSIA: OFFICIAL
*CYPRUS POPULAR BANK HAS "FEW HOURS OF LIQUIDITY LEFT": OFFICIAL

For a while there, one might have been forgiven for believing that all was going to be well; that the recovery was V-shaped and the new-normal was nothing but the old-normal and Goldilocks would reappear. It appears, however, that the central bank lipstick slapped on the deflationary pig of the over-levered global economy is starting to wear off. As the following 4 charts show, things are not as 'recovering' as many hoped (and still hope).

Following the dismal PMIs this morning, most EU equity indices were declining. From around the open of US equity markets, EURUSD began to levitate as the 'bad' news hit Cyprus Popular Bank being 'restructured', no deal with Russia, and ATM lines mounting. Of course, the machines interpreted EURUSD's rise as a positive and European equities (and US equities) got a lift into the EU close. We suspect, in reality, this EUR strength is very different and given the surge in demand for Swiss 2Y rates (now at 2 month lows), EUR-USD basis swaps, and European sovereign bond markets in the last hour, it would appear this is very much repatriation flows and not 'we love the Euro' flows. European stocks did end the day lower though - catching down to credit's earlier week weakness.