Every Asset That Depends on Cheap, Abundant Credit (Housing, Bonds, Stocks) Is Doomed

Four words: financialization, debtocracy, diminishing returns.

About a month ago I asked What If Stocks, Bonds and Housing All Go Down Together? (May 24, 2013). Why would such an outrageous thought even occur to me?

Four words: financialization, debtocracy, diminishing returns. The entire global economy, developed and developing nations alike, is now dependent on cheap, abundant credit for everything: for "growth," for asset inflation, and ultimately for central state deficit spending, which props up all the cartels, rentier arrangements, fiefdoms and armies of toadies, lackeys, apparatchiks and embezzlers that suck off the Status Quo.

I have long endeavored to explain the harsh reality of neofeudal, neocolonial financialization: Neofeudalism and the Neocolonial-Financialization Model (May 24, 2012) and the neofeudal debtocracy that depends on low yields (interest rates) to enable enormous deficit spending: Why Krugman and the Keynesians Are Lackeys for the Neofeudal Debtocracy (April 24, 2013).

The wheels fall off the entire financialized debtocracy wagon once yields rise.There's nothing mysterious about this:

1. As interest rates/yields rise, all the existing bonds paying next to nothing plummet in market value

2. As mortgage rates rise, there's nobody left who can afford Housing Bubble 2.0 prices, so home prices fall off a cliff

3. Once you can get 5+% yield on cash again, few people are willing to risk capital in the equities markets in the hopes that they can earn more than 5% yield before the next crash wipes out 40% of their equity

4. As asset classes decline, lenders are wary of loaning money against these assets; if the collateral for the loan (real estate, bonds, stocks, etc.) are in a waterfall decline, no sane lender will risk capital on a bet that the collateral will be sufficient to cover losses should the borrower default.

Let's take a look at four charts about housing and household net worth. For the middle class, the home remains the key asset, so housing and household net worth are correlated.

Here is a chart of mortgage rates since 1970. Rates were pushed to 17+% to snuff inflation in the early 1980s, and they've dropped over the past 30 years to historic lows: the rate for a fixed-rate 30-year conventional mortgage was about 3.5% a few weeks ago. It has now risen above 4%.

In the golden age of growth from 1991 to 2002, mortgages rates bounced between about 7% and 9%. The band from 1970 to 1979 was about 7.5% to 10%.

In other words, in eras of strong growth and low inflation, mortgage rates have been around 7% to 9%. So what happens to the monthly payments when the mortgage rate doubles from 4% to 8%? The monthly payments rise by about 54%. And what happens to the price of houses when rates double? They fall to the point that households borrowing money at 7.5% - 8% can afford to buy a house, i.e. a price much lower than today's Housing Bubble 2.0 prices.

Here's mortgage debt. If mortgage debt had expanded at the previous rate, total debt would be closer to $5 trillion instead of $10 trillion.

You see what happens when debt becomes cheap and abundant: debt rises faster than wages or assets.

But hasn't household wealth increased mightily in the past decades? Here is a chart that plots the relationship of household net worth and total credit owed, i.e. debt:

Household wealth may be rising, but what this chart reveals is debt is rising even faster--that's why the line is declining. Put another way, every dollar of new debt is generating less and less wealth.

You might think that The Federal Reserve's policy of making credit cheap and abundant would goose people to consume and invest more money. Alas, the velocity of money is hitting historic lows: the Fed may be creating credit but people and enterprises aren't putting that money into circulation.

It's called diminishing returns: every dollar of debt creates interest payments, but it's no longer doing households or enterprises any good. The Fatal Disease of the Status Quo: Diminishing Returns (May 1, 2013).

That's why all asset classes that depend on cheap, abundant credit are doomed: once yields/rates rise, the valuations of those assets implode. And once valuations implode, there's not enough collateral left to support the loans used buy all those cheap-credit-inflated assets. So the financial system also implodes.

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Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy
Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)

Thank you, Daniel R. ($20), for your exceedingly generous contribution to this site -- I am greatly honored by your support and readership.

Thank you, Jesse G. ($25), for your splendidly generous contribution to this site -- I am greatly honored by your support and readership.

Read more...

Artificial Abundance, Moral Hazard and the Federal Reserve's Doomsday Machine

A loss of faith in key institutions cannot be fixed with more cheap credit or subsidized mortgages.

Today's topic is important but a bit tricky; you may want to refill your beverage container before buckling in.

Moral hazard is the separation of risk from consequence. A person who knows they won't suffer the consequences of a risky bet gone bad will behave quite differently from a person who knows the full consequences of a risky bet gone bad will fall on them.

A person who is insulated from risk will have an insatiable appetite for risky bets because any gains will be theirs to keep but any losses will be covered by someone else--for example, the Federal Reserve or taxpayers.

Correspondent Jeff N. recently alerted me to the equivalence of the perception of abundance and moral hazard. Jeff was responding to An Abundance of Bad Decisions(June 13, 2013), which noted that decisions made in the euphoria of abundance were generally bad because they were based on 1) projecting the good times would last for the indefinite future and 2) the Status Quo, having delivered abundance, was working fine and should not be challenged or changed.

As a result, both critical thinking and innovation atrophy, as neither are needed in times of abundance. Indeed, they pose an active threat to the Status Quo and are thus marginalized or suppressed.

In eras of extended abundance, the populace slowly loses the ability to think critically and develop concepts outside the narrow confines of the Status Quo.

When the abundance/prosperity ends, as it always does, the populace has lost the ability to make difficult choices and realistically assess cost-benefit. Magical thinking and nostalgic references to past glories dominate the conventional mindset.

In How Empires Fall (April 17, 2013), I noted that two of the key characteristics of an empire in terminal decline are complacency and intellectual sclerosis, what I have termed a failure of imagination.

Michael Grant described these causes of decline in his excellent account The Fall of the Roman Empire, a short book I have been recommending since 2009:

There was no room at all, in these ways of thinking, for the novel, apocalyptic situation which had now arisen, a situation which needed solutions as radical as itself. (The Status Quo) attitude is a complacent acceptance of things as they are, without a single new idea.This acceptance was accompanied by greatly excessive optimism about the present and future. Even when the end was only sixty years away, and the Empire was already crumbling fast, Rutilius continued to address the spirit of Rome with the same supreme assurance. 

This blind adherence to the ideas of the past ranks high among the principal causes of the downfall of Rome. If you were sufficiently lulled by these traditional fictions, there was no call to take any practical first-aid measures at all.

In other words, if our idea of intellectual rigor and honesty is Paul Krugman dancing around the Neo-Keynesian Cargo Cult campfire mumbling nonsensical claims of grand success, we are well and truly doomed.

I went on to suggest that central banks and deficit-spending political Elites have created an artificial sense of abundance by printing or borrowing trillions of dollars and flooding their economies with this false abundance.

This bogus prosperity has led to a continuation of bad decision-making, as it has nurtured a magical-thinking faith that abundance can be conjured with monetary tricks. This is the essential feature of cargo cults, the magical-thinking belief in the return of abundance without having to chart a new path of authentic reforms.

What Jeff N. pointed out is The Federal Reserve's Cargo Cult Magic of artificial abundance acts just like systemic moral hazard. In Jeff's phrase, "reducing the perception of the cost of the action’s consequences" induces the same cost-risk-benefit mindset as moral hazard.

In other words, the Bernanke Put--the implicit promise that the Federal Reserve will never let the stock market significantly decline--is the exact equivalent of giving someone $100,000 in a casino and telling them they can't lose because the casino has their back. How prudent do you reckon the gambler's bets will be? His perception of the costs and consequences of his betting have been fatally distorted, and once everyone in the casino has been given the same assurance, the systemic risks skyrocket as every player starts making risky bets in the confidence that they can't lose.

The Fed has created a Doomsday Machine. The Fed has nurtured moral hazard in every sector of the economy by unleashing an abundance of cheap credit and low interest mortgages; the implicit promise of "you can't lose because we have your back" has been extended from stocks to bonds (i.e. the explicit promise the Fed will keep rates near-zero forever) and real estate.

An abundance based on the central bank spewing trillions of dollars of cheap credit and free money (quantitative easing) is artificial, and it has generated systemic moral hazard.

This is a Doomsday Machine because the Fed cannot possibly backstop tens of trillions of dollars of bad bets on stocks, bonds and real estate. Its power is as illusory as the abundance it conjured.

Once the losses mount, the punters who believed the Fed had their back will realize it was all a con. They will lose faith in the Fed and its promises of permanent abundance, low rates and rising asset prices.

This loss of faith will trigger what I call the delegitimization of both the markets and the institutions which have essentially promised a permanent upward bias in assets, i.e. the Federal Reserve and the other central banks that have conjured the same illusion.

This loss of faith in key institutions cannot be fixed with more cheap credit or subsidized mortgages; delegitimization triggers a fatal decoherence in the entire Status Quo.

---

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).
We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)

Thank you, Uniplus Info Systems ($15), for your most generous contribution to this site -- I am greatly honored by your support and readership.

Thank you, Albert Z. ($25), for your splendidly generous contribution to this site -- I am greatly honored by your support and readership.

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Hey Mr. Market, That QE Monkey on Your Back Has You By the Throat

Mr. Market has one little problem: the Fed monkey on his back has a death-grip on his throat: "One hell of a price for you to get your kicks."

One of the enduring analogies of the Federal Reserve's quantitative easing (QE) program is that the stock market is now addicted to this constant injection of free money. The aptness of this analogy has never been more apparent than now, as the market plummets on the mere rumor that the Fed will cut back its monthly injection of financial smack. (The analogy typically refers to crack cocaine, due to the state of delusional euphoria QE induces in the stock market. But the zombified state of the heroin addict is arguably the more accurate analogy of the U.S. stock market.)

You know the key self-delusion of all addiction: "I can stop any time I want." This eerily echoes the language of Fed Chairman Ben Bernanke, who routinely declares he can stop QE any time he chooses.

But Ben, the pusher of QE money, knows his addict--the stock market--will die if the smack is cut back too abruptly. Like all pushers, Ben has his own delusion: that he can actually control the addiction he has nurtured.

You're dreaming, Ben--your pushing QE has backed you into a corner. The addict (the stock market) is now so dependent and fragile that the slightest decrease in QE smack will send it to the emergency room, and quite possibly the morgue.

But like all highs based on addictive substances, the stock market high cannot be sustained without an increase in the drug. But there is a diminishing-return dynamic to ever higher doses of QE smack--the higher doses are no longer generating the same highs. The addict (the stock market) has become desensitized to the QE free money injections, and higher doses no longer generate the desired state of bullish euphoria.

The more Ben talks about eventually decreasing the injection of financial smack, the more panicky the addict becomes. The more he increases QE, the less effect it has. The Fed is backed into a corner: increasing QE has no positive effect but decreasing it unleashes a catastrophic breakdown in the stock market.

Why Krugman and the Keynesians Are Lackeys for the Neofeudal Debtocracy (April 24, 2013)

You may recall the Keynesian parrot, who repeats the same demand for more free Federal money to be squandered on the cartels, grifters, embezzlers, toadies and lackeys of the Status Quo.

Here is the Keynesian parrot with the Fed QE monkey on his back: you may notice the Keynesian parrot is none too pleased with the Fed monkey's death-grip on this throat.

Unfortunately for the stock market, it's in a double-bind: the Fed monkey is choking it, but if the monkey falls off its back then the market goes into cold-turkey collapse.


The other delusion of the pusher and the addict is that the endgame of addiction can be avoided. We all know the endgame of addiction; the 1970s rock band Lynyrd Skynyrd captured it very succinctly in their song Ooh That Smell:

One little problem that confronts you
Got a monkey on your back
Just one more fix, Lord, might do the trick
One hell of a price for you to get your kicks

Ooh, that smell
Can't you smell that smell?
Ooh, that smell
The smell of death surrounds you

The Junkie in the Pool and False Idols: Faith in Wall Street and The Fed Has Eroded(August 10, 2011)

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Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)

Thank you, Michael R. ($200), for your outrageously generous contribution to this site -- I am greatly honored by your steadfast support and readership.

Thank you, William H. ($5/month), for your much-appreciated generous subscription to this site -- I am greatly honored by your support and readership.

Read more...

The Real Story of the Cyprus Debt Crisis (Part 2)

Not only is the bail-in a direct theft of depositors' money, the entire bailout of Cyprus is essentially a wholesale theft of national assets.

Here is Part 2 of our comprehensive account of the banking/debt crisis in Cyprus.As noted yesterday, the debt crisis in Cyprus and the subsequent "bail-in" confiscation of bank depositors' money matter for two reasons:

1. The banking/debt crisis in Cyprus shares many characteristics with other banking/debt crises.

2. The official Eurozone resolution of the crisis may provide a template for future resolutions of other banking/debt crises.

It also matters for another reason: not only is the bail-in a direct theft of depositors' money, the entire bailout is essentially a wholesale theft of national assets. This is the inevitable result of political Elites swearing allegiance to the European Monetary Union.

History, geography and economy of Cyprus (Wikipedia)

I am honored to present Part 2 of Cyprus resident John H. Morgan's report.

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The Cyprus Bank Deposit Bail-in

On 16 March 2013, the noose was tightened around Cyprus. Emergency Liquidity Assistance (ELA) was cut off. Banks remained closed while the Government negotiated with the Eurogroup of European finance ministers to save the Cyprus banking system. President Anastasiades announced the first proposal to the nation: he would tax all bank deposits in Cyprus to fund the recapitalisation of Laiki Bank. This plan was rejected by the Cypriot Parliament as it infringed the guarantee on all insured deposits up to €100,000. The Minister of Finance visited Russia to ask for financial assistance, to no avail.

On 25 March 2013, as Greece celebrated Independence Day, it was announced that Laiki Bank would be wound up and Bank of Cyprus would be restructured. All Cypriot depositors in Laiki Bank and Bank of Cyprus who held more than €100,000 would be forced to pay for Cypriot bank losses and withdrawals, mostly sustained in Greece (the so-called “bail-in” of depositors). Bank of Cyprus would be responsible for paying back Emergency Liquidity Assistance provided by the European Central Bank to Laiki Bank. It would also assume liability for all Laiki insured deposits up to €100,000.

The value of uninsured deposits over €100,000 held by Cypriot Banks came to €38bn (billion) out of a total €68bn in deposits. The governor of the Central Bank of Cyprus stated that 70% of all uninsured deposits were held by foreigners. There are an estimated 60 000 British citizens, 30,000 Russian citizens and 10,000 other European nationals living in Cyprus. Together with Cypriot-domiciled foreign firms (such as German shipping companies), they had deposited €30bn in Cypriot banks.

Cypriot Banks were closed for 10 days to prevent a bank-run. Their overseas branches stayed open to preserve a semblance of normality and avoid triggering a bank-run on Greek banks. Cash was rapidly withdrawn from the British, Greek and Russian branches of the Cypriot banks. The value of the assets held by the Greek branches of the Cypriot Banks was €23bn. These assets received huge haircuts as they were traded for €9.2bn of Emergency Liquidity Assistance (ELA). The ELA was provided by the European Central Bank to replace money withdrawn from Cypriot Banks via their Greek branches. To prevent further losses in Greece, the Central Bank of Cyprus was ordered to sell the Greek operations of the Cyprus Banks in a fire-sale.

Piraeus Bank of Athens paid €524m (million) for the remaining Greek assets of Laiki Bank, BoC and Hellenic Bank. The purchase was funded by the European Central Banks’ European Financial Stability Fund (EFSF), using Piraeus shares as collateral. The boards of Laiki Bank and BoC resigned immediately as they had been kept out of negotiations. The governor of the Central Bank of Cyprus confirmed that the deal was stitched together by the Cypriot and Greek governments and the Eurogroup of finance ministers. Piraeus Bank of Athens was even awarded a €3.1bn write-back on the purchase price for buying impaired assets. It recorded its first profit in years.

This massive mark-down of assets owned by Cypriot bank shareholders and bondholders (worth 75% of Cyprus’ annual GDP), was hushed up. Once again, Cyprus banks had been forced to make crippling sacrifices to support Greece’s ailing economy. Within weeks of the deal, the CEO of Piraeus Bank of Athens was in Cyprus touting for business.

In a radical departure from accepted practice, two major groups of creditors, financial institutions and government agencies, were exempted from the bail-in haircuts. This meant that Central Banks were refunded their liabilities ahead of uninsured depositors. The ECB would get 100% of its €9.2bn ELA and the Bundesbank would get 100% of its €7bn TARGET2 liability.

These loans had been given to Cypriot Banks to replace the cash withdrawn when depositors moved their money elsewhere, especially to Germany. Technically, ELA is no different from a bank bailout, apart from costing 4% interest compared to 2.5%. The TARGET2 component of the Eurosystem shifts Euros back to European banks whose deposits have been depleted by interstate transfers, in effect giving them a loan.

Under the Troika deal, the liquidity provided by the European Central Bank and Bundesbank would be refunded first. Uninsured depositors would receive worthless bank shares to replace the cash and assets confiscated to cover Central Bank liabilities. It would have caused massive scandal in the EU if Cyprus commercial banks defaulted on the liquidity assistance provided by European Central Banks. Politically, it was much easier to raid the uninsured deposits of Cyprus account-holders after accusing them of money-laundering.

This ruthless action by the Eurogroup reassured taxpayers of Germany, Finland, Netherlands and Austria, who saw Northern economies carrying ever-increasing risks of default by Southern European banks and governments. Currency controls were put in place to staunch the movement of capital out of Cyprus. Nevertheless, billions of Euros are leaving Cyprus on a monthly basis.
As a reward for its compliance with the conditions set by the Troika of lenders, the government of Cyprus was granted a soft loan of €10bn by the European Stability Mechanism and IMF. €4.1bn was made available to roll over Cyprus external sovereign debt; €3.4bn was given to President Anastasiades to spend on governance; €2.5bn could be used to re-capitalize Cyprus’ smaller banks, Hellenic Bank and the Co-op Bank.

The Cyprus government must start repaying the loan and interest back after 10 years. The interest bill will exceed €3bn. This will be enough time to fund loan repayments from offshore gas revenues, expected to be earned from 2018 onwards.

External bond-holders of Cypriot Government debt will be repaid 100% of their investment, courtesy of Cypriot taxpayers. This vindicates the promise made by EU Economic and Monetary Affairs Commissioner Olli Rehn of Finland. In a January 2013 interview with Handelsblatt daily, Rehn reassured financial markets that there would be no haircuts on Cyprus Government Bonds.
However, President of the European Central Bank, Mario Draghi, announced in May 2013 that Cyprus banks may use Cyprus Government Junk Bonds “guaranteed by the Cyprus Government, with the agreed haircuts” as collateral for ECB funding.

This means that uninsured depositors will pay off much of the Cyprus Government debt as the value of Cyprus Government Bonds has been written down. The ECB has agreed to accept lower quality Asset-Backed Securities as collateral. Uninsured depositors will lose yet more of their funds in order to pay out the billions of Euros of insured deposits that are being painstakingly withdrawn within the constraints of capital controls.

Slowly, brick by brick, the last remaining wealth of Cyprus is being wrung from its soil and auctioned off. Central banks are extracting every ounce of gold from an island that was once renowned for its copper in Roman times.

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Economic Effects of the Cyprus Bank Deposit Bail-in

Cypriot businesses have seen their working capital plundered. The country is increasingly reverting to a cash-economy with a consequent dive in tax revenues. Provident funds, including those of bank-employees, have been severely impaired.

Most companies have cut wages, leading to severe distress among families who are paying off housing loans. This is intended to achieve the Troika’s goal of “internal devaluation”. By cutting labour costs, it is hoped to make Cyprus as competitive as countries like Germany.

Cyprus Airways is undergoing restructuring. Half of its staff have been retrenched. €20m in severance pay will be paid out of future airline revenues as the European Commission has barred the state from subsidising a commercial airline. The three Lufthansa consultants in charge of the restructuring are set to receive €1.3m. The remaining staff will suffer a 25% salary cut.

Even charities have not been spared a deposit haircut. Soup-kitchens for the legions of unemployed rely on constant donations of food from the public. The Cyprus Olympic Committee has lost €600,000 from the bail-in.

In an act that beggars belief, the Cypriot Parliament has levied a 30% tax on the interest earned from bank deposits. This has made Cypriot banks totally uncompetitive and deposits are tapering off. Money is being deposited offshore and ELA requirements of the Bank of Cyprus are increasing. The Central Bank of Cyprus announced that €6.34bn or 9.96% of deposits were withdrawn from domestic banks in April 2013. Deposits had dropped by €14.23bn or 19.87% since April 2012. (This fall, in one year, is equivalent to 80% of Cyprus’ annual GDP.)



In another measure which defies logic, a property tax was insisted on by the Troika of international lenders. The government aims to extract maximum tax revenue by inflating property prices by the annual rate of consumer price inflation since 1980. Currently, property prices are at an all-time low. This tax will further depress the property market and withdraw large amounts of liquidity from the battered economy.

The reasons are not hard to fathom. A week after the Memorandum of Understanding was signed with the country’s lenders, President Anastasiades apologised to State employee unions that he had been forced to cut their salaries and pensions. He assured them that there would be no further cuts. The Minister of Finance assured government employees that their benefits would be maintained by reducing state expenditure on infrastructure. The opening of a new medical faculty at the University of Cyprus, costing €100m, would be funded, as it formed part of an election pledge.

Between January and May 2013, unemployment in the Cyprus private sector increased from 52,000 (11.8%) to 71,000 (16.1%), the steepest increase in the European Union. The EU has warned that Cyprus runs the greatest risk of social upheaval of all European countries.

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Economic and Political Prospects for Cyprus post-2013

Unable to devalue its currency to remain competitive, unable to print money to buy its citizens’ assets and stimulate its moribund economy, the Republic of Cyprus has come to realise that membership of the Eurozone is a poisoned chalice. The island has been cast adrift from Europe and left to sink or swim.

NATO continues to frame the geopolitical agenda of the Eastern Mediterranean, as it did when Turkey was allowed to invade the island in July 1974. In May 2013, two months after the Cypriot government had ceded control of its economy to the Troika of international lenders, Prime Minister Erdogan of Turkey listed 5 demands to President Barack Obama of the USA. One of those demands was that none of the estimated €200 billion of Cyprus offshore oil and gas reserves be sold to Russia. A week later, the Secretary General of NATO, Anders Fogh Rasmussen, warned the leaders of Cyprus that the island must settle the Cyprus Problem before it drills for oil and gas.

There is no need to bribe NATO member Turkey with trillions of cubic feet of hydrocarbons from the Levantine Basin to facilitate settlement of the Cyprus Problem. Turkey can use its military superiority to seize the island and its gas reserves. Despite reassuring noises that America will defend American energy companies drilling for hydrocarbons off the Cyprus coast, it is likely America would support its strategic ally Turkey, rather than side with insignificant Cyprus. In a display of solidarity, NATO allies in Europe have moved Patriot missiles to Turkey’s border with Syria.

Europe and Turkey are about to sign the aptly named “European Readmission Treaty” whereby Turkey has agreed to become a dumping ground for illegal migrants who have entered the EU through Turkey from countries to its east. This goes a long way towards reassuring German and French voters that the European Empire is spreading eastwards, rather than the Ottoman Empire spreading westwards.

During 2013, in a sign of Europe’s softening stance on Turkey, the European Court of Justice accorded Turkish Law primacy in settling all land restitution claims on the island of Cyprus.
Greek and Turkish speaking Cypriots have been promised a €200 billion bonanza from the discovery of hydrocarbons off the Cyprus coast. The use of most of the gas revenues to bankroll multinational energy conglomerates and to offset State “borrowings” will go largely unnoticed: a drop in the vast ocean of political corruption.

copyright 2013 by John Henry Morgan; all global rights reserved in all media

John Morgan is the director of a company based in Larnaca, Cyprus. He owns property in Cyprus and has lived there since 2004. He comes from the United Kingdom. He has also worked in Europe, Africa and the Middle East.

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The 2013 Cyprus Deposit Bail-in: POSTSCRIPT

"I run a Cypriot marine & diving company operating in the UAE in the Middle East. We have had €400,000 (a 90% retention) frozen by the Bank of Cyprus which was all the money we had to finish mobilizing for the final stage of a project. We desperately need that money to finish our mobilization and complete the project. We must finish the project in order to receive payment for all the work we have already done. We are now without funds in an Arab country that imprisons debtors and we have debts. We can't pay the salaries and wages of our people, and soon won't have enough money to feed them. We stand to lose our marine and equipment assets if we can't pay our debts. We are in very serious trouble and all the pleading and demands that at least some of our funds are released are ignored. We are desperate. We are the only company in this sort of trouble according to the Cypriot Ambassador. There is no protection for foreign nationals in this country. We need our money, we need help. Can you help us please by investigating or publishing our story?"Christopher M Penny

Bank of Cyprus starts process of turning uninsured deposits into stocks

Dubai Business Directory Listing for COMBINED DIVING & INSPECTION SERVICES

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Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Kindle edition: $9.95       print edition: $24 on Amazon.com
To receive a 20% discount on the print edition: $19.20 (retail $24), follow the link, open a Createspace account and enter discount code SJRGPLAB. (This is the only way I can offer a discount.)

Thank you, Martin S. ($50), for your stupendously generous contribution to this site -- I am greatly honored by your support and readership.

Thank you, Michael R. ($5/month), for your much-appreciated generous subscription to this site -- I am greatly honored by your support and readership.

Read more...

The Real Story of the Cyprus Debt Crisis (Part 1)

I highly recommend this deeply insightful two-part series on the banking/debt crisis in Cyprus.

I am privileged to present a comprehensive yet succinct two-part account of the banking/debt crisis in Cyprus, prepared by a knowledgeable resident of that nation. Why do the debt crisis in Cyprus and the subsequent "bail-in" confiscation of bank depositors' money matter? They matter for two reasons:

1. The banking/debt crisis in Cyprus shares many characteristics with other banking/debt crises.

2. The official Eurozone resolution of the crisis--the "bail-in" confiscation of 60% of bank depositors' cash in an involuntary exchange for shares in the bank (which are unlikely to have any future value)--may provide a template for future official resolutions of other banking/debt crises.

In other words, since the banking/debt crisis in Cyprus is hardly unique, we can anticipate the resolution (confiscation of deposits) may be applied elsewhere.

Readers may recall that the initial resolution in Cyprus called for all depositors to accept a "haircut" (the harmless-sounding vernacular for confiscation). This triggered widespread outrage, and was soon amended to exempt the first 100,000 euros on deposit. 60% of the remaining "uninsured" deposits would be confiscated and involuntarily exchanged for bank shares, in two tranches of 37.5% and 22.5%: Bank of Cyprus starts process of turning uninsured deposits into stocks (April 29, 2013)

In sum, it's extremely important to understand the real story of the Cyprus Debt Crisis to be able to sort out which features of the situation may be considered unique and which ones are shared by other banking/debt crises.

We are fortunate to have this on-the-ground account by a longtime resident of Cyprus, John H. Morgan. Here is Part 1 of his report. 

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The story of The Republic of Cyprus’ descent into bankruptcy is a Greek tragedy of epic proportions.

The Cyprus Political Crisis post-1974

In July 1974, in the face of an airborne invasion backed by the armour of NATO member Turkey, 200,000 Greek Cypriot citizens ran from their homes with only the clothes on their backs. The Greek Cypriot armour and infantry were no match for the second largest standing army in NATO, equal in size to the British and French forces combined. The Greek Cypriots were easily routed. The victors conducted summary executions of thousands of their prisoners and threw some of the bodies down wells to hide their crimes.



History, geography and economy of Cyprus (Wikipedia)

37% of the island of Cyprus was taken; 50,000 Turkish Cypriots fled north and took shelter in the homes abandoned by the Greek Cypriots; 200,000 Greek Cypriot refugees fled south and were housed in tents, in the same way that hundreds of thousands of Syrian refugees are now sheltered by the Turkish Government in 2013.

Yet so began the housing boom in Cyprus. Refugees in the Turkish-occupied North had the pick of thousands of abandoned homes. Refugees in the South had to build their own. The Cyprus Government parcelled out plots of government land. The banks would not give mortgages on state land so the Cyprus Government stepped in and funded the construction industry.

Political opportunism was not far off. During his election campaign Former President Glafcos Clerides allegedly promised to give Greek Cypriot refugees temporary title to thousands of Turkish Cypriot homes and land. Once he was elected, the programme was halted. He handed out 8,000 Government jobs to party cronies in his 10 years as President, perhaps by way of consolation.

Patronage, cronyism and clientelism have been the hallmark of government control in both the South and occupied-North of Cyprus. Since the Turkish occupation, employment in the State sector in Cyprus has been used to reward party loyalty (and to incentivise elections). The civil service in the free Republic of Cyprus has grown from 18,000 workers in 1978 (costing €36 million in annual salaries and benefits), to 70,000 workers in 2012 (costing taxpayers and business €2.8 billion per year).

One in six workers out of a total workforce of 440,000 are employed in the public sector. The government controls an empire of 63 Semi-Government Organisations (SGOs) plus the Cyprus National Guard, an army of conscripts headed by a permanent officer corps. Officials in charge of the SGOs are appointed by party affiliation. SGOs are monopolies and can set their own tariffs.

State teachers have become the highest paid in Europe, with top teachers earning almost three times (282%) the salaries of their counterparts across Europe. In January 2013, state teachers went on strike because they were required to work one extra lesson per week, 40 minutes. Electricity prices skyrocketed to the second highest in Europe, to fund the pensions of the broader state sector. Between 2009 and 2011, the price of domestic electricity doubled. A clerk in government with a High School Certificate could earn the same salary as a Professor in a private university.

In December 2012, the pension funds of the Telecommunications, Electricity and Ports Authorities were raided to pay State workers their 13th cheques. In May 2013, the workers of the Ports Authority downed tools because their 14th cheque was reduced by half.

All political parties have been complicit in the transfer of wealth from the private sector to the public sector. In 2009, 98 shipping containers of Iranian armaments on their way to Syria, were intercepted by the US Navy. On 11 July, 2011, they exploded while being stored at the Cyprus naval base. The island’s main power station was destroyed and 13 lives were lost. Insurance companies paid out the first claims within weeks. The Cypriot Parliament charged the taxpayers €99 million to cover claims for “Public Liability”. The item was slipped in as the last entry of the 2013 State Budget.

The DIKO Party is the government’s coalition partner (and coalition partner of most of the previous governments). While in power from 2003 to 2008, is alleged to have amassed €18 million of Party funds by endorsing a contract to buy two additional Airbus planes for the loss-making Cyprus Airways.

In 2007, the DIKO government asked parliament to approve the construction of a multi-billion Euro offshore floating Liquefied Natural Gas (LNG) terminal. The gas was meant to be used to power the Vassilikos Power station (destroyed in July 2011, as mentioned above). Parliament questioned why such a massive construction was needed when a few storage tanks would suffice. The government failed to tell the nation that trillions of cubic feet of gas had been discovered offshore. Politicians had set up a front company to take a cut of the billions of Euros taxpayers would contribute to build the plant and to ensure they received an annual dividend from the profits of selling millions of cubic feet of LNG to Europe.

Government debt has been compounded because Cypriots generally avoid paying taxes. Indeed, there are only 52 tax inspectors in the whole country. In her report to Parliament in April 2013, the Auditor-General noted that Cypriots owed their government €1.6 billion in back-taxes and fines, enough to pay off all Eurobond debt due in 2013. She pointed out that failure to collect taxes meant that €300 million of State revenue had been irretrievably lost.

At the end of December 2012, ex-President Christofias vacated the rotating Presidency of the European Council. For 6 months work, he would receive an EU pension estimated at €10,000 per month, courtesy of European taxpayers. For his 17 years as an MP and 5 years as President of the Republic of Cyprus, he would receive a State pension of €22,000 per month, a brand new BMW limousine costing €43,000, a driver, a secretary and 15 body-guards, courtesy of Cypriot taxpayers.

Just one month before Cypriot Presidential elections of February 2013, the Trade Union-backed Communist regime of ex-President Christofias was assiduously appointing party apparatchiks to all key State posts, such as to the Central Bank of Cyprus and the newly-formed State Hydrocarbons Company (theoretically a private company). This guaranteed that the looting and pillage of the Cyprus economy could continue, long after President Christofias had left power.

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The Cyprus Banking Crisis

Corruption was also endemic in the Russian Federation after the fall of the Soviet Union. The chaotic privatisation during the Yeltsin years from 1992 to 1999, made a selected few Russians very wealthy. Many of the new Russian oligarchs wanted to safeguard their money and moved their operations to Cyprus. The country offered a low tax regime. Few questions were asked. The island became a favoured tourism and business destination. The debt overhang which had accrued from rebuilding the Cyprus economy became manageable. There was a plentiful supply of homes and offices, a legacy of rebuilding the devastated island.

In 2004, the Republic of Cyprus joined the European Union. A new wave of investors brought great wealth to the island. House prices in the United Kingdom had been heavily inflated owing to short supply and easy credit. 60,000 Britons chose to buy affordable second homes or retirement homes in Cyprus. Between 2004 and 2007, fueled by a housing bubble, the Cyprus economy grew at 4% per year. At the end of 2007, the State Budget was showing a 3.5% surplus. Public debt was less than 60% of GDP. Cyprus qualified to join the Eurozone.

In 2006, attracted by the huge wealth deposited in Cyprus Banks by British and Russian investors, an innovative salesman managed to sell two insolvent Greek banks to the island’s second largest lender, Cyprus Popular Bank. He became chairman of the enlarged bank, which was named Marfin Popular Bank or Laiki Bank.

After Cyprus joined the European Monetary Union in January 2008, he was able to move €5.1 billion of Cyprus bank deposits to a company he set up in Athens. He used equity in his new company as collateral. This substantially weakened the balance sheet of Laiki Bank. €500 million was lent to a Greek Monastery to buy shares in his company. The Vatopedi monks swapped state land they laid claim to, for prime real estate in Athens. Greek politicians facilitated the deals in return for kick-backs. The scandal brought down the Greek government in 2009.

To cover their capital shortfalls, Cypriot banks invested in Greek Government Bonds which offered very high interest rates. Cypriot banks were also heavily exposed to the Greek property and commercial markets. When the local banks could no longer finance Cypriot Government spending, the Christofias government "borrowed" the €7 billion which had been built up by the Social Security Fund.

The Greek Government applied for a financial bailout in 2010. Cypriot banks held €5.3 billion of Greek Sovereign Debt and a total of €23 billion of Greek assets. Cypriot banks suffered heavy losses in the Greek financial meltdown. Laiki Bank alone endured a €2.4 billion write-down on the value of its Greek Government Bonds. The 80% “haircut” on bonds was proposed by German Chancellor Merkel and French President Sarkozy to make Greece’s debt burden manageable. Other losses by Cypriot banks were estimated at 25% of their total Greek loan book.

The country’s largest bank, Bank of Cyprus, had been affected by a €2 billion write-down of Greek Government Bonds during the Greek PSI, but its directors had made provisions. One of the provisions, used by both BoC and Laiki Bank, was to offer €1.8 billion of Contingent Convertible Bonds to the public. This was preceded by intense marketing.

Sixty thousand customers transferred funds from low-yielding deposits to take advantage of the promised high-yield bonds. In the end, their money was converted to worthless bank equity. The depositors claimed they had been tricked. There were public protests. When auditors reviewed the records of BoC during its subsequent restructuring, 28,000 computer files relating to the purchase of Greek Government Bonds had been deleted by special software.

The Cypriot Banks applied to the Central Bank of Cyprus for support. The state nationalised Laiki Bank and injected €1.8 billion (10% of GDP). The state was then shut out of the international bond markets.

Laiki Bank was technically insolvent. There were rumours that the bank would default. Depositors had already withdrawn €3.3 billion of deposits by July 2012. The Central Bank of Cyprus propped up the ailing bank with billions of Euros of Emergency Liquidity Assistance (ELA).



In July 2012, the Christofias government turned to the rest of Europe for a bailout. President Christofias tried to dictate conditions to the Troika of lenders, the European Commission (EC), the International Monetary Fund (IMF) and the European Central Bank (ECB). He wished to avoid the political cost of signing the Memorandum of Understanding. This called for massive restructuring of the economy of Cyprus in return for a bailout. He had decided to pass the problem on to the next President.

Up until January 2013, a month before the Cypriot Presidential elections, German Finance Minister, Wolfgang Schäuble, denied aid to Cyprus by insisting that Cyprus did not qualify for European financial support. All the while, the Cypriot commercial banks were bleeding heavily in the Greek economic meltdown and were posting their best Greek assets as collateral for emergency funding from the Central Bank.

Furthermore, Schäuble told German voters, Cyprus should not receive German-guaranteed loans as it was an offshore tax haven and Germans would not want to risk their money to bail out wealthy Russians who had hidden their ill-gotten gains in Cyprus. (In a report commissioned by the Troika of lenders, European fraud agency Moneyval and Deloitte Financial of Italy reported a widespread lack of due-diligence, but could find little direct evidence to support such claims.)
Summary of Main Financial Report by Moneyval and Deloitte

Tomorrow: Part 2: The Cyprus Bank Deposit Bail-in and the Economic and Political Prospects for Cyprus post-2013

copyright 2013 by John Henry Morgan; all global rights reserved in all media
John Morgan is the director of a company based in Larnaca, Cyprus. He owns property in Cyprus and has lived there since 2004. He comes from the United Kingdom. He has also worked in Europe, Africa and the Middle East.

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Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

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