Union: One Survived; One May Not

Submitted by Mark J. Grant, author of Out of the Box,

Uncounted Liabilities
One of the most interesting issues of what has happened in Cyprus is where was the problem three weeks ago? There was not a mention, not a hint of anything that was wrong. All of the banks in Cyprus had passed each and every European bank stress test. The numbers reported out by the ECB and the Bank for International Settlements indicated nothing and everything reported by any official organization in the European Union pointed to a stable and sound fiscal and monetary policy and conditions. The IMF, who monitors these things as well, did not have Cyprus or her banks on any kind of watch list.
What happened?
Let me assure you it was not some "Miracle on 34th Street" that took place overnight while everyone was in bed and counting sheep. I can also assure you it was not because some bean counter in Brussels or Frankfurt stumbled over some new bit of data and informed his superiors. Nothing of the sort. The culprit is what is counted and not counted in the European financial system and the quite real consequences of uncounted liabilities.
Before I even go on with Cyprus, so you do not glaze over the punch line, I point out to you what has taken place. In just two weeks' time we have gone from not a mention of Cyprus to a crisis in Cyprus because none of the official numbers were accurate. Without doubt, without question, if this can happen in Cyprus then it could happen in any other country in the Eurozone because the uncounted liabilities are systemic to the whole of Europe. The European Union does NOT count sovereign guarantees of bank debt, sovereign guarantees of corporate debt, derivatives or many other types of contingent liabilities. They are all uncounted, but still there, no disappearing act, and as the bills roll in they have to be paid by someone. Dexia was fine, the mortgage company in the Netherlands was fine, Bankia was fine and overnight, "Snap, Crackle Pop!"
And Jack comes out of the Box.
For investors here is the crux of the problem. The Press is handed the official numbers and reports them out as if they were accurate. To be fair to the Press; they have no choice. Some EU Finance Minister send out a press release and the story is printed. S&P, Moodys and the rest have some choice but it is limited if they wish to keep doing business in Europe. In a sense it is the CDO issue all over again. The ratings agencies take the word of Europe, make judgments based upon the faulty data and opine based upon the erroneous information. As the geeks among us would say; Garbage in---Garbage out.
Then many money managers rely upon the official data, rely upon the ratings agencies and make investment decisions based upon the data that they are given. The CDO issue again you see where everything was rated inaccurately. So then we have Garbage in---Investments based upon Garbage. Therefore I will tell each and every one of you; if you are making decisions relying upon the official numbers of Europe and upon the ratings of European sovereign debt then you are going to get burned. You are relying upon falsified data and any ratio that you might run is wrong as the underlying numbers are inaccurate.
Just Garbage---Everyone is talking Trash.
When discussing Cyprus, besides, the systemic mis-reporting of data, I always hear the wrong headed thinking that they are so small that they don't matter. Think of the Senate in the United States. New York has two Senators and Rhode Island has two Senators and the argument goes that only the New York ones matter. Sorry folks, every Senator has one vote and is part of the Senate regardless of the size of their State.
There is a distinction in the law of the United States and Great Britain between private property and investments. Your own money and your own house are treated differently than the ownership of securities. Both countries, also, have due process of law where courts decide who is entitled to what under the bankruptcy laws. The government does not and cannot mandate the seizure of private property without this due process. Then let us compare this to the demands of the EU and Germany.
They want bank accounts seized and part of the money to be used to pay off the national debt. They have not asked for the bondholders to be jeopardized because the bonds in Cyprus are governed under British law and they will not allow for a retroactive change of covenants. They also have not pressed for this because then they too would have to take a hit and they prefer the Russians, the British and the normal, ordinary people of Cyprus to pay the price. What a great message for the Cypriots; you pay your share for the banks of Spain, you pay for Greece, for Portugal and for Ireland as a member in good standing of the European Union. Then when you are in trouble we will seize your assets so that you can pay for yourself. Such nice people.
Germany now says that all of the bank in Cyprus are bankrupt. It is on this basis that they demand the depositors money; all of the depositors or perhaps just the wealthier ones with deposits over one hundred thousand Euros. There are French banks, British banks, Emirates banks and Swiss banks in Cyprus. In the case of Switzerland it is UBS. No one has told us yet that UBS is bankrupt. Perhaps they are waiting to tell us on Saturday night as is their usual practice, but today we all think that UBS is solvent. The German argument is spurious.
There are also American deposits in Cyprus. General Electric, Procter and Gamble, Caterpillar et al do business there and I am sure have money in the banks somewhere. How nice of Europe to expropriate American money along with the rest. Very kind of them. It is not a vast sum I am sure. It is not a significant amount of money; no doubt, but I am not sure that the act of stealing is defined by the amount of money that is taken. Maybe Merkel will send Obama a note thanking him for the extra liquidity. She could certainly send that note to Bernanke given the amount of money that the Fed has supplied to the foreign banks.
"While the Union lasts, we have high, exciting, gratifying prospects spread out before us, for us and our children. Beyond that I seek not to penetrate the veil. God grant that in my day, at least, that curtain may not rise! God grant that on my vision never may be opened what lies behind! When my eyes shall be turned to behold for the last time the sun in heaven, may I not see him shining on the broken and dishonored fragments of a once glorious Union…"
                       -Daniel Webster
A different day. A different time. A different Union. One survived; one may not.