CrossBorder Capital sees eurozone shuffling towards the abyss post-Cyprus
Putting aside developments in and around Cyprus, the real challenge to the eurozone is how to reconcile still significantly different levels of competitiveness, argues CrossBorder Capital.
Cyprus is a political tragedy and a moral disaster, but, for once, it reflects correct economics from the eurozone. Cyprus is not systemic. Her banks made bad lending decisions; they did not suffer bad funding ones. Yet, Cyprus will inevitably re-awaken investors’ concerns about Europe.
It should finally dispel the end-2012 hope that all was right again and market outperformance was guaranteed this year. Eurozone bank shares have tumbled by 25% thus far in 2013. In short, most investors badly underestimated the risks.
These risks come down to three things:
(1) Long-term bank funding needs to be tackled
(2) Long-term competitiveness gap between the North and South must be addressed
(3) Economic policy must reverse the currently weak eurozone economy
On this last point, European ‘nowcasters’ who excel in plotting the true state of economies from masses of current, sometimes daily, data, warn of downside risks to German growth in 20131. A weak German economy will surely precipitate further up-coming funding problems for eurozone?
Already, ECB liquidity injections have collapsed. According to the ECB, the decline in the eurozone monetary base and the ‘early’ repayment of long-term loans both suggest that monetary conditions in the Eurozone have eased and that wholesale markets are working. The slump in our ECB ‘effective’ liquidity index and a similar drop in our overall eurozone liquidity index strongly refute this.
Funding: Illiquidity Vs Insolvency
Banks are often insolvent: they are less often illiquid. Insolvent banks can survive and struggle on: illiquid ones cannot.
Insolvency is a legal opinion: illiquidity is a market decision. The key Cyprus banks and probably also many Spanish banks are insolvent, but only the Cyprus banks are currently illiquid. The gift of more liquidity from the IMF/ ECB/ EC has been made conditional on depositors suffering a ‘haircut’ on their deposits. Many think this unfair, but is it? Cyprus banks allegedly lost most by investing in Greek debt. Unlike many other Western banks they were predominantly funded by retail deposits rather than wholesale funds. In other words, Cyprus is more an old-fashioned case of poor lending/ investment decisions than a question about a sudden lack of wholesale funding. Moreover, Cyprus is not systemic, or too big to fail. It is Europe’s equivalent of the Barings Bank failure. Therefore, the IMF/ ECB/ EC troika can afford to take a tough line. On the other hand, it is a fine-division being drawn here, and one that seems to rest on the source of bank funding: retail or wholesale?