Saturday, 23 March 2013

Cyprus bailout - simply put

Phew! That was close

I don't pretend to know more than I read in the headlines but this is how I see the Cyprus situation.

Cyprus banks have inadequate cash to cover their capital requirements. They invested heavily in Greek Government bonds and the value of these was cut as part of the Greek bailout. In the good times they lent heavily to the Greek private sector. A large part of those loans has turned sour. The Cyprus government is too small to bail them out (see the first picture). Without extra funds coming from somewhere, the banks would collapse and depositors would lose all their money, Cyprus would be ejected from the Euro and a devaluation would decimate any funds that were left. The EU guarantee of deposits up to €100,000 would be all but worthless.

If you remember there was another little island that let its banks grow out of proportion with its population. If its baks went belly up Cyprus and its inhabitants would end up even worse off than the population of Iceland which lived through a similar crisis beginning in 2008 and officially ending in 2011. The Icelandic bailout cost $5.1bn which came from the IMF and the Nordic countries. Iceland has a population about a third the size of Cyprus's 1.1mn.

It looks as though the new Cyprus deal will involve the nationalization of its banking sector and a split of capital into good banks and bad banks. Depositors of less than €100,000 would retain their guarantees denominated in € but larger investors would not be protected. Moreover it might be several years before these larger savers, probably a majority of whom are foreigners, would see how much of their funds they would get back. In any event they are likely to face a tax (the last proposal called it a levy but these are just words cojoured up to hide the fact that it is a confiscation) on their deposits which will help to fund the Cypriot share of the bailout.

Of the €68bn in deposits €38bn are deposits of over €100,000 (56%). It would appear that this is largely Russian money, some of it ill gotten. This is why there was a hope that the Russian government might pitch in with some funds in exchange for the names of its citizens who, at the very least might be hiding iincome to avoid tax. Russia has refused to join in the rescue.

Moody's have downgraded deposits in Cyprus Banks to Caa3 just two levels above its lowest grade i.e. "you'll be lucky to get your money back."

This useful chart shows the relative scale of the proposed €10bn EU bailout for Cyprus.

Effect on the markets

US stock markets, which have never taken this crisis seriously, ended the week at about the same place they started it. The S&P shown below was very slightly lower.

The effect on European markets was more pronounced but remember the volume spike which caused me to react, occurred on Friday, before the Cyprus crisis kicked off.

My reaction

None of this explains my reaction to Friday's volume spike. For that you have to go back 13 years to when I started to trade on the stock market. I began in September 1998 when the dot com bubble was inflating happily. I went on a course which taught me how to value shares and to pick those which were undervalued. 

This did not include tech shares. These were already horrendously overvalued. But my friends persuaded me, against my better judgement, to jump on a band wagon that was running frighteningly fast. I did and I made money at a rate greater than I could ever have dreamed. Luckily my instincts of self preservation proved stronger than my greed and I jumped off before that wagon came to a shuddering halt. For weeks I watched the market and counted the money I could have been making. This measured in the tens of thousands of pounds. But then it all came to an end.

Some stock brokers, encouraged their clients to take advantage of the "buying opportunity" as prices "pulled back." There were little pull backs but the rout continued for over three years and the stock market lost over half its value. I made modest amounts of money in each of those three years.

I bring this up because of what I learned. When the collapse in the market sets in, it is every man for himself and the devil takes the hindmost.  In those days you bought and sold shares on the telephone. My friends would sit on the end of the 'phone for hours, waiting to speak to their stock broker. Often they would be cut off and have to ring back and rejoin the end of the queue. As they waited the value of their holdings would continue to tumble as those ahead of them dumped their shares on reluctant market makers. Market makers, who aggressively cut the prices they offered.

It would not be any different if it happened now. The internet would not help. An attempt to sell shares online would result in a message saying "no online price is available at this time, please route your deal through a broker." You would get through to a broker after a long, long wait and then you would hold on as the broker tried to get in touch with a market maker. The price would be falling all the while. Just imaging the emotional impact of that scenario.

Best to sell out before the crunch comes and sit on the sidelines.

But this does not solve the problem of what to do with your money once you have cashed in.

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