Yesterday, the ‘rubber hit the road’, with the ‘leaked release’ of some of the apparent conditions that will be attached to the agreement reached by Eurozone country finance ministers two weeks ago. These conditions, which are said to include:
- the takeover of Spain’s financial system by the European Union;
- a write down on 67 billion euros of bank debt to be taken by existing creditors of the banks; and,
- a wind-down of at least one Spanish bank
are being called ‘draconian’. This is likely for no reason other than such extreme measures have not previously been seen until now among Eurozone countries. That said, it seems obvious that ‘draconian measures’ are called for, not just in Spain, and not just in the Eurozone.
While this was going on, Spanish Premier Maiano Rajoy announced:
- an increase in Spanish VAT (value added, or sales tax) from 18% to 21% for products (and I assume most services) other than food where Spanish VAT remains at 4%; and,
- introduced 65 billion euros in austerity programs.
Consider the consequences of these measures, which on the balance of probabilities likely include:
- near-term reduction in retail sales from current levels. This given Spain’s current 24% overall unemployment rate and 52% youth unemployment rate;
- increases in at least the overall unemployment rate;
- a drop in Spain’s GDP;
- notwithstanding the austerity measures introduced, a continuing Spanish Federal deficit;
- absent Spanish currency controls, a run on Spain’s banks;
- a very unhappy ‘Main Street’ population with a very real chance of demonstrations and ‘less than happy’ social unrest;
- reduced tourist revenues if that happens, where tourism is very important to Spain; and,
- continuation and likely worsening of the current Spanish economic recession.
It typically is not a good thing when a ‘small shoe drops’. Spain is a ‘big shoe’ in Eurozone terms. Watch for:
- things in Spain to get worse before they get better; and,
- negative economic related contagion issues flowing out of Spain to other Eurozone countries and possibly the world banking system. Look for signs of this with particular vigilance.
Topical References:
Debt crisis: Spain bows to EU ultimatum with drastic cuts, from
The Telegraph, Ambrose Evans-Pritchard, July 11, 2012 – reading time 2 minutes;
Proud Spain again humbles itself to the euro’s demands, from
The Telegraph, Jeremy Warner, July 11, 2012 – reading time 3 minutes;
‘This is reality’: Spain slashes spending, raises taxes in $79B austerity plan, from
MSNBC World News, Jeremy Warner, July 11, 2012 – reading time 3 minutes; and,
Spain to Cede Bank Control, from
The Wall Street Journal, Matina Stevis and Gabriele Steinhauser, July 10, 2012 – reading time 1 minute.
Trust and the banks
Why read: Because if you haven’t focused on this issue, and the possible consequences of it, you ought to.
Commentary: Over the past twenty years the world financial system has become increasing interconnected, and as that has occurred, different assets classes previously thought to be unrelated have become very interrelated, such that they all now in many banks sit in one ‘basket’. This has resulted in:
- individual banks and ‘investment banks’ having quite different and much more complex risk profiles than they had twenty years, or even ten years, ago; where,
- increased and more complex risk typically requires increased Board and Management diligence and exercise of proper and prudent business practices when managing those risks.
Keeping that in mind, consider the following two scenarios. You are happily married, or so you think, when you find your spouse of ten years has:
- had an affair. There can be little question that your view of your spouse will be impacted, and it will affect the important ‘trust relationship’ you had with him/her to some degree. Stated simply, things will never be the same between you. Could they be better – perhaps, but on the balance of probabilities your relationship will be negatively impacted; or,
- been promiscuous. That likely for you is a ‘horse of different colour’. If your marriage somehow survives such a thing, the important marital ‘trust relationship’ you had with him/her is likely to be shattered, in all probability irreparably.
Assuming, hopeful not through personal experience, the foregoing resonates with you, consider whether what has come out over the past several years and in recent weeks will, and has, either seriously harm or irreparably fracture investor, trader and general public perception of the banks and in particular, perception of the ‘investment banks’.
In summary, the following things (among others) have happened since 2007 that might cause more than one person to raise their eyebrows and see the world’s bankers through less-trusting eyes than they otherwise might;
- the levels of salaries, bonuses and severance payments made to banking sector executives;
- the sub-prime mortgage crisis and its continuing after-math;
- the MF Global fiasco that came to the fore in September, 2011, with intermittent news continuing to be reported;
- the Spanish banks undercapitalization expose;
- the JPMorgan derivatives losses announcement and ongoing news coverage;
- the recently publicly exposed and ongoing Libor situation; and,
- the list goes on.
Consider the possible outcomes of this maelstrom of ‘bad business’ in the banking sector as these and very likely more regrettable banking sector news comes forward in the next weeks and months. At least some these are likely to be that investors, traders and the general public (collectively ‘non-bankers’):
- will increasingly mistrust the financial system;
- will increasingly mistrust specific banks and investment banks; and,
- where some or many of them at some point may simply ‘vote with their feet’ after concluding that their mistrust of the banks and investment banks, and hence the financial markets, is such that they are no longer interested in participating on the theory that everything has to have a ‘breaking point’.
While I don’t think movement out of the financial markets for reasons related to such mis-trust is imminent, if I were a money manager at ‘street level’ this ‘trust issue’ is certainly one I would be concerned about.
From my perspective, this is one of the reasons I believe that the best investors and traders will assume increasing responsibility and exercise increased input in the management of their investments and trades going forward.
It is also why I have come to believe laws should be put in place to return the separation of commercial banking and investment banking, thereby segregating what are quite different risk profiles, and enabling a clearer path to fair regulation.
Topical References:
Why Libor matters to Main Street, from
The Globe and Mail, Joanna Slater, July 11, 2012 – reading time 3 minutes; and
LIBOR Manipulation Leads to Questions Regarding Gold Manipulation, from
Financial Sense, Mark O’Byrne, July 11, 2012, reading time 3 minutes.
