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They Really Do Care

It really is a marvel of a market these days. It doesn’t strike me as completely odd that stocks have recovered almost all of the losses they experienced on the first Cyprus news, but what is amazing to me is that the VIX index has retraced about half of its jump and that “fear index” sits just about a point and a half above six-year lows.

Yes, Cyprus is a small country, which is a point that seems endlessly repeated as a sort of incantation, a warding against bad stuff happening. As my friend Andy F pointed out, subprime-mortgage-backed paper was also pretty small (roughly 1.3T in size compared with a worldwide bond market around 80T), and somehow still managed to leave a mark. Cyprus is very small, relative to the Eurozone. But if it was as small in significance as it is in relative GDP, do you think the EU finance ministers would be wasting this much time on them? It’s a bit like saying “I don’t care about my grade in Calculus,” and then staying up all night studying. There’s a clue that perhaps someone cares more than they’re letting on.

If Cyprus was insignificant, as opposed to small, then the other Eurozone countries would simply pony up the dough, or wave goodbye and let Cyprus exit the Eurozone.

But they can’t just pony up the dough, as that would continue a bad precedent.

And they can’t just wave goodbye. Why? Because Cyprus’s significance far outweighs its size. If Greece had left the Euro, there would be no precedent value to Cyprus’s doing so and this crisis would have been but a blip. But it doesn’t matter how big the first domino here is: the EU has sworn that the Euro is inviolate, that it’s impossible to undo, that there’s no provision from anyone leaving the union, etc. If any country leaves the Euro, the statement of absolutes is exposed to be false. And worse, from the standpoint of the elites…what if a country leaves the Euro and survives?

So, while everyone tries to persuade investors (and they’re largely succeeding, it seems) not to be concerned about Cyprus because it’s so small, the country declared that its banks will remain closed through next Tuesday. Russians are lecturing Europeans on how the seizure of private property reminds them of Soviets.  And, after declaring that the Cypriot government had to enforce the levy or lose the bailout funds – and then watching the legislature vote 36-0 to reject the levy – European officials are trying to find some way to look like they are sticking to their principles while compromising them. The ECB has delayed a decision on whether to keep supporting Cypriot banks as the discussions between Cyprus and Eurozone finance ministers continue. Looks like someone really does want to pass that unimportant Calculus exam! Perhaps we should not take the protestations of insignificance at face value.

All of which is to say that within a week or two, unless the Eurozone capitulates, Cyprus is still going to go through bank failures and sovereign default and possibly exit or be ejected from the Eurozone. The market is pricing a near-100% chance that these finance ministers capitulate, scuttling their own political futures for the sake of the Euro and returning the Euro crisis to a slow simmer from a rolling boil – not solving anything, but delaying the inevitable. So far, this has been a good bet. But 100-1 odds are probably worth taking, especially when it involves a politician sacrificing his/her future for an idea.

The FOMC also met today, and as expected the pedal remains pressed to the metal. If there had been any question about that one week ago (and I don’t think there really was), the Cypriot events eliminated any chance that the FOMC would even hint at an eventual walking-back of liquidity. It’s not going to happen any time soon.

On Thursday, we’ll get a look at Existing Home Sales for February. While most focus will be applied to the headline number, which is expected to touch 5.0mm sales for the first time (absent government programs) since 2007, I am much more attentive to the year-on-year rise in the median home sales price. That figure was last at an astounding 12.61%, and surely can’t go much higher than that?

Categories: Euro
  1. March 20, 2013 at 8:17 pm

    Mike, I was wondering when we will finally find a topic we don’t agree on. Found one at last! Cyprus is small, but that’s not the point. Cyprus isn’t playing chicken with the EU. It knows it will have to find the 5.8bn, and the EU will be able to sit tight on this. I am not worried. Full story (in three parts, over the last three days) on karlstrobl.com

    • March 20, 2013 at 9:39 pm

      Karl, I think Cyprus only knows it has to find the 5.8bln if it wants to stay in the EZ. And it’s not at all clear to me why they would want that. But even if we clear all of that away, it really IS significant that the depositors/citizens weren’t “asked” to pay 3%, it was simply seized. I think I would react quite severely if the government seized 3% from my accounts. Would I riot? Well, no one cares about the riots. This isn’t the Middle East; no government coup will be forthcoming. The point is that every institution will ‘diversify’ out of the Euro, or at least out of the weak parts. No bank run, just hastening the inevitable end in Italy etc. At least, that’s how I see it playing out. I like Andy’s idea too.

  2. Andy
    March 20, 2013 at 8:27 pm

    Here’s a thought, Russia steps in, recaps the banks, the country drops the euro and becomes RUB denominated. no muss, no fuss. no collapse as the RUB is a pretty stable and strong currency. The Russians take all the euros in country and convert them to RUB at market rates. no loss of buying power for the people.
    in return, they get the drilling rights and a warm water port in the mediterranean. worth many billions of euros to the russians for that!

    • March 20, 2013 at 9:36 pm

      i like it! well, i don’t like it, but i can see that happening…

      • Eric
        March 20, 2013 at 9:52 pm

        It has been suggested that the whole thing was a game of chicken between the eurocrats and the Russian Mob. Either you guys get your cronies to recap these deadbeats’ banks, or we steal 10% of your laundered money. But right now all the rumors of Russian bailouts are being denied.

  3. Mark B. Spiegel
    March 21, 2013 at 4:34 am

    “…they can’t just wave goodbye….Because Cyprus’s significance far outweighs its size… it doesn’t matter how big the first domino here is: the EU has sworn that the Euro is inviolate, that it’s impossible to undo, that there’s no provision from anyone leaving the union, etc.”

    Yes, but I don’t think that anyone actually believes this, in that I don’t think Cyprus’s decision to stay or go will have the slightest influence on what happens with Spain or Italy.

    (Remember: the “domino theory” didn’t pan out in Vietnam, either!)

    • March 21, 2013 at 6:29 am

      Oh, but it may well have influence on what happens in Greece! All of the tender mercies of the Euroclowns have caused unemployment in Greece to keep rising and rising…I am sure they realize they are being milked but believe the warnings that it would be “catastrophic.” But if Cyprus leaves and survives, it opens up a whole new set of conversations, kills any idea of giving up sovereignty (why would any country do THAT unless they had no choice?), and really changes the whole complexion of the future Euro. As well as, we should say, probably changing the future price of the Euro considerably.

  4. March 21, 2013 at 5:36 am

    @Mike: indeed, it is not clear why they would WANT to stay in the EZ. It’s a mystery.
    But I agree with Mark, if it’s depositor haircut, bondholder haircut, or default, all these scenarios are harmless to the EZ. Giving in (at least too easily) on the 5.8bn target would be the harmful scenario, potentially influencing the way Italy etc. could play out.

    • March 21, 2013 at 6:33 am

      Right, and it appears they won’t cave in. Therefore, I expect Cyprus will quit the EZ, perhaps using Andy’s method. But that’s why I can’t imagine why the VIX is where it is. If anyone leaves the EZ, I don’ t know that it means markets will be much higher or much lower, but there WILL be lots of volatility. If the EZ isn’t inviolate, then how confident are you of EZ backing of Spanish bonds? Don’t know about you, but my confidence that they will pay any price to support Spain would drop dramatically in that case (mostly because Merkel et. al. couldn’t say “we have to support them, no one can leave the Euro.”).

      I think the VIX is probably the cheapest instrument in existence right now. Not that it cannot or will not go lower, but there are many more scenarios that lead to 30 than there were ten days ago. And fewer that lead to 10.

      • March 21, 2013 at 6:39 am

        Actually, I will amend that statement a little bit. March Madness is about to start, and that DOES have a dampening effect on US volatility (when I was an options trader I tried really hard to be short gamma during the tournament). But still…I am concerned that Cyprus will lead to more of this: “Pacific Investment Management Co., home to the world’s biggest bond fund, is considering shedding holdings of Spain and Italy bonds if the Cyprus crisis snowballs.” http://online.wsj.com/article/SB10001424127887324557804578372372793942876.html

      • Mark B. Spiegel
        March 21, 2013 at 7:05 am

        “If the EZ isn’t inviolate, then how confident are you of EZ backing of Spanish bonds? Don’t know about you, but my confidence that they will pay any price to support Spain would drop dramatically in that case (mostly because Merkel et. al. couldn’t say “we have to support them, no one can leave the Euro.”).”

        I think you’re oversimplifying this a bit, in that if it’s in the EU’s interest to back Spanish bonds it will do so, regardless of what happens with Cyprus. Of course we need to define “interest” and if that means the “interest” of the owners of the German and French banks that hold the Spanish debt the voters in those countries may block such support, but I think this would be independent of what happens with Cyprus.

        Michael, I think we both agree that it would clearly be in the long-term interest of all the southern countries to drop the euro. However, I also think there would be a lot of short-term pain (for the “leavers”) in doing so, so if you think a Cypriot secession would influence the citizens of Spain and Italy, I’d guess that such influence (in the short term) would actually be to convince them NOT to leave the euro!

      • March 21, 2013 at 7:14 am

        I do agree that it’s very likely that leaving the Euro and restriking Euro debt, paying it off in a new currency, would mean Cyprus would have a bad year or two, but not much longer than that. And I wonder if we’re underselling the value to the citizens of independence. Do you think that once they announced secession, there would be rioting in the streets, or celebration? I’m guessing there would be celebration! The statistics would look bad, but the Spanish and Italians would say “we had empires for hundreds of years. Now we’re working for Merkel.” Don’t undersell local pride (speaking as a Texan, mind you!).

        But really, my point today is that this is far more unsettled than the market is pricing.

      • Mark B. Spiegel
        March 21, 2013 at 7:19 am

        “Do you think that once they announced secession, there would be rioting in the streets, or celebration?”

        I think that for a week or two there would be “celebration.” Then for a month or two there would be “Okay, what do we do now?” Then for the next couple of years there would be misery– whether or not that would result in actual rioting I don’t know, but it would be the equivalent (for most of the country) of a massive “pay cut.”

      • March 21, 2013 at 7:32 am

        I think you oversell the misery. The misery in Iceland was bad, but not THAT bad. And it’s much warmer in Cyprus plus they have friends in Russia!

  5. March 21, 2013 at 7:47 am

    The ECB’s set the clock ticking
    Come Monday, the can they’ll stop kicking
    If Cyprus won’t pay
    Then Europe will say
    To our guns, this time we are sticking

    Then what will become of that isle
    O’er which we’ve seen plenty of bile
    The Russians will show
    And hand over dough
    A warm-water port makes them smile

  6. Jim H.
    March 21, 2013 at 8:27 am

    ‘What if a country leaves the Euro and survives?’

    What if a country leaves the Euro and BOOMS? After a bad couple of years, post USD delinking, it sure worked for Argentina.

    p.s. THOUGHT I detected a hint of a ‘south of N.J.’ accent in one of your podcasts. But you ain’t from the Big Thicket like me, are ya?

    • March 21, 2013 at 8:39 am

      Fort Worth!
      Yes, agree that very little time is spent these days thinking about the upside of leaving the union. Here I’m talking about Cyprus, and not Texas. Or AM I? 🙂

    • March 21, 2013 at 8:41 am

      …however, I did spend some time in Houston, and a buncha time in Huntsville. And I have relatives in Galveston. So I’m pretty familiar with Pappas cuisine and Bluebell Ice Cream, I guess I’m saying.

  7. Jim H.
    March 21, 2013 at 10:17 am

    Well, I’m relieved that you weren’t ‘doing time’ in Huntsville. We used to go the prison rodeo, but that’s long gone.

    Speakin’ about another cowboy country where Texans feel at home, check out the fever chart of Argentina’s ‘dólar informal,’ up 10 percent in two days against the peso:


    Such is the desperation in the Casa Rosada that the government has just clamped a 20% tax on foreign travel, in a forlorn attempt to conserve forex reserves. Locals sniff that the deal is goin’ down.

    Cyprus v. Argentina: it’s a neck-and-neck horse race to the default finish line!

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