A Cypriot Tragedy

Tragedies are usually associated with Greece - a tribute to the richness of its theatre in the 5th Century BC. Over the weekend, you could be forgiven if you changed your tastes to a Cypriot tragedy. For that's exactly what has happened - albeit in the more prosaic world of economics.

 

These are the facts. Cyprus is another Eurozone country in deep trouble. It needed a bailout. So far, nothing unusual. A bailout was duly announced over the weekend. It was the terms of the bailout that sent a jolt reverberating through the world of economics. The EU is bailing them by about €13 bn (chickenfeed by the standards of bailout). But the conditions of the bailout are that all bank depositors would be levied a tax of between 6.75% and 9.9%. That means on Tuesday when banks opened, all depositors would lose that amount instantaneously.

 

The genesis of the problem is, alas, not new. Cyprus is a very small country. In boom times, it went berserk pushing its financial industry, positioning itself as an island finance centre. That's fine, but it just went way over the top. Cypriot banks had made loans to outsiders equivalent to 8 times the country's GDP. Worse still, a lot of those was to Greece its neighbor. When Greece began to go under, Cyprus was given an almighty whack. The bailout was then a question of when, and not if.

 

Another actor muddling the issue is Russia.  Of the € 68 bn bank deposits which are going to get a "haircut" (the tax referred to above) , a full € 21 bn comes from Russian companies. We shall not speculate where from this close affinity of Russia came from - let us just say that the word "money laundering" comes to mind. Now the Russians will instantly lose € 2bn. Enter Vladmir Putin. He is howling against the "$%^&* Germans who are the orchestrators of the bailout.

 

What about Joe Public in Nicosia. Even if you had say € 100 Euros in the bank, tomorrow it is only € 93. If ever there was a recipe for street riots, this is it.

 

And what about nervous bank depositors in other troubled countries - say Spain or Italy. Tomorrow it might be their turn. Only an idiot will keep his money in a bank anymore if you are an European. Take it out IMMEDIATELY. Dig a hole and bury it in your backyard. Keep it under the pillow. But don't deposit it in a bank even if a gun was pointed at your head.

 

What a mess. The world badly needs a new economic order. Fire all economists. Go back to the basics of countries balancing their budgets. Living within their means. Curbing the excesses in the banking and finance industry ruthlessly. It will be a prolonged period of pain. But when the clouds disperse, it will be a saner and fresher world. 

 

This, of course, is a Utopian dream - which leader is going to tell the truth to his voters. And even if he did, which voter is going to accept it. We shall stumble along from one crisis to another.

Bye Bye New York Stock Exchange

OK - the title is pure hyperbole. The New York Stock Exchange (NYSE) is going nowhere. But the company that owns NYSE is just being bought over. The curious part of the story is that the acquirer does not really want the NYSE, but it comes as part of the package- so he has to take it !

Here's the deal. NYSE is part of a conglomerate called NYSE Euronext. The conglomerate consists of NYSE itself, Euronext, which is a combination of three European stock exchanges and Liffe which is a London based derivatives exchange. NYSE and Euronext are ugly spinsters nobody wants. The beauty amongst the beasts is Liffe. For it is the sexy new hottie - a derivatives exchange.

And therein lies the story. In the modern day casino , that is finance , equity exchanges like NYSE are worthless as businesses. Margins are supposedly low. Stock exchanges are the places where almost all companies that require capital list and that's where investors channel their savings into productive investment. One would have thought that  the raison d'être for financial markets was to fulfill that objective, but obviously I am an old foggie.

In today's world, the money is all in running commodities exchanges,  derivatives markets etc - not boring old equity. The acquirer is a company called ICE that did not exist before 2000 (for the record NYSE was founded in 1817). ICE purely handles derivatives trading. The career of Jeffrey Sprecher, the CEO of ICE says it all. He started his career building power plants.  But he realised that there was more money (in facts tons more money) playing on financial contracts relating to power than in generating power itself. So he started ICE , obscurely in Atlanta, in 2000. See where he has got to in 12 years.

We've now come to a stage where even the NYSE is an unattractive prize - in fact positively repellant. Given a choice Mr Sprecher would probably spin off NYSE, or sell it off somewhere or simply forget about it. Unfortunately that is politically simply unthinkable. So he has to live with it and make pious noises of how important it is.

Its a symptom of where the world is going.  This post is one sided and biased (whoever said that a blog has to be objective !). Derivatives markets are not all evil and equity markets are not all saints. Both serve useful economic purposes. But you can see where this is headed. Esoteric, ununderstandable financial structures are getting to be more important than the underlying asset itself. That's why, a wise old fox from Omaha, back then in 2003, called derivatives a weapon of mass destruction.

Many years ago, when the world was a simpler place and when this blogger was a young man (!), he went to 11 Wall Street, entered the visitors gallery of NYSE and gazed at the trading floor in awe.  Little did he know that not in the too distant future, this lovely lady was going to be thrown out into the street as an ugly old crone.

Even crooks deserve a fair deal

Remember Jérôme Kerviel  ?  OK, very excusable if you have forgotten who he is. He was the rogue trader who almost brought Société Générale ( a reputed French bank) to its knees. This happened in 2008. Kerviel was a trader who punted like crazy in the casino, that is euphemistically called financial markets - he was making gigantic bets that involved European stock index futures. The whole thing unraveled, he was fired, Société Générale tottered and ultimately lost € 4.9 bn.

 

Criminal proceedings were launched against Jérôme Kerviel  and he was sentenced to prison and a fine. He appealed, and, on Friday, lost his appeal. What caught me was the quantum of the fine. He was fined € 4.9 bn, the quantum of the loss that Société Générale incurred.  A fine of € 4.9 bn ???? Kerviel has no money and is unemployed and probably unemployable. How on earth is he expected to pay  € 4.9 bn ?

 

This is outright crazy. The judges have fallen hook line and sinker to Société Générale's assertions that it didn't know what was happening and that Kerviel acted alone. PPPPlease ........ That, to put it mildly, is nonsense.  His bosses must have been cheering loudly as long as he made profits and have thrown the book at him, when the whole thing collapsed.  The bank didn't know ??????? Baloney.

 

Société Générale , and the judge, argue that the massive fine is to prevent him from capitalizing on his story by writing a book (which he has done) or making a movie. That is extreme logic. Every crook tries to make money from his infamy. Jeffrey Archer wrote a whole book about his prison experience and sold God knows how many copies. The fault is not that of the crook - the fault is with those who buy the book or go see the movie. 

 

Kerviel is not your ordinary villain. Sure he broke company rules and did unauthorized trading. But then a few thousand bankers have done the same . He made no money personally - even his bonus wasn't obscene. He was a case of gambling instincts gone completely out of control. Does he deserve a € 4.9 bn fine ?

 

The logic that employees are personally responsible to make good the losses that arise if they violate the rules is a dangerous one. Sometimes company rules are not explicit. Sometimes bosses nod and wink when they expect employees to do things that are shall we say, fifty shades of grey ! If I were to calculate the possibility of personal liability, when taking a business decision, I would never make a decision in the first place. Something like this is what is happening in Indian government circles today - no babu is making any decision for fear that Kejriwal will allege that he is corrupt. Everything has ground to a complete halt.

 

It is a reflection of the anger against bankers that public opinion has no sympathy for Kerviel. Nobody, but a few busybodies have raised a whimper. I however think this is an outrageous court decision. Kerviel deserves to be punished. He deserves to go to jail. But he should not be fined € 4.9 bn.

 

It is a mark of civilized society that even crooks are given a fair deal.

Spare a thought for the poor Iranians

There is economic cataclysm going on in Iran. What guns and rhetoric have failed to do might be achieved by grubby old economics - the downfall of the nut cases who have been ruling Iran for sometime.

The Iranian rial has plunged into free fall. It declined by 25% in one week in October against the US dollar. Since the beginning of 2011 it has fallen by 70+%. It was some 10,000 rial to the US $ in 2011. Its now around 30,000 rials to the US $. The rial is now virtually worthless. Inflation by official estimates is some 25%, in reality more like 70%. There is economic chaos.

Why is this important ? You only have to look towards  the street protests that have sprung up in Iran to see how this is affecting everybody in Iran - the rich, the poor, and yes, even the mullahs. But, wait a minute. Iran is oil rich, right ? It should be rolling around in wealth. And yet, the country  is in deep crisis and the population is suffering.  Why ?

If ever there was an example of how a rotten government can destroy its people, it is Iran.  By all rights Iran should be a rich country. It is an ancient and rich culture and full of extremely bright people. And above all, it is swimming in oil. But unfortunately it has a government that must surely compete with North Korea and Zimbabwe for the title of the worst government in the world. It exports terrorism, it dips its fingers into every trouble spot in the region - it finances the Hezbollah in Lebanon, it backs the Syrian regime, it supports the Hamas in Gaza........ It is trying its best to build a nuclear bomb.

Consequently it has pissed off the world. Crippling economic sanctions have been the result. Nobody bar Russia and China, and to some extent India, is trading with it. It has been kicked out of SWIFT - the international banking settlement system. Therefore everybody, including Russia and China have to deal with it via the back door.  If anybody trades with Iran he has to virtually receive suitcases of cash in return. That's not easy to do on scale. So even exporting oil has become difficult.

End result is that the rial is plunging like a stone. So everything becomes incredibly more expensive. Food prices are doubling. Luxuries, which might even be necessities in other parts of the world, are becoming unthinkable. The common Iranian, like most others in the world, cares two hoots about religious purity and dogma. He wants to fill his stomach. And then wants to buy a mobile phone. After that he wants to post on Facebook. Simple.  If you deny that from him for too long and make him slide backwards, his patience will break and he will burn the beards of those who are stopping him. 

So for Israel and the hawks in America, here is a pleasant thought. You don't have to nuke Iran to stop them from acquiring nuclear weapons. The rial is doing the job for you brilliantly. With a bit of journalistic license I say, the bill is mightier than the bomb !

The emperor's new clothes

Somebody has to say this. Like the kid from the proverbial Hans Christian Andersen's tale, who exclaims that the emperor is actually naked, I will go ahead and say it. Stock markets have become a weapon of mass destruction.

The original purpose of stock markets was to become efficient allocators of capital. Capital was always scarce and economics needed a mechanism where capital would be pooled from investors and allocated to the most efficient users of capital. Voila, the stock market was born. It is important to remember why this mechanism was created in the first place.

One of the most important benefits that stock markets provided was liquidity. Investors needed liquidity to be able to withdraw their investment without affecting the company that they invested in. Contrast this with property markets which are not very liquid - try selling a property, especially in India. Liquidity was , and is, provided in stock markets by speculators. They performed the useful function of ensuring liquidity and hence were tolerated even though speculation climbed to above 90% of all trades in stock markets.

But witness what has happened in the last 10 years. Most of the trading is now done by computers against computers. By automatic trading ; not by human decisions. A concept called High Frequency Trading has come into being. Big trading firms have invested in creating a competitive advantage where their automatic trading computers can gain a few nano seconds advantage over competition. I am not exaggerating  - a few nano seconds advantage. A millisecond is considered an eon in high frequency time. Two critics of the way stock markets function today - Sal Arnuk and Joseph Saluzzi have been laughed at for proposing a solution that firms honour the prices they offer for a share for at least 50 milliseconds.

Software is vulnerable, as all of us know. Knight Capital, an American Equity broker, started using a new software programme to execute its trades on 1 August. Within one hour of the market opening errant trading had cost the firm $440m. It virtually went bankrupt and only escaped from near death at a huge cost and will never be the same again. Such events are now becoming not uncommon. In May 2010, The Dow Jones Industrial Average plunged 1000 points in minutes and for a brief period Accenture was trading at 1c a share !

Such high frequency trading is not performing any usual social function. They are not based on a company's future or a view on the economy. This is pure gambling based on tiny changes in price. The amounts of money are so huge - several times the GDP of the world, that a catastrophic systemic failure is a real real risk. It almost seems to be a question of when, and not if.

I submit that the original purpose of stock markets has got grossly distorted and weakened. Before a meltdown occurs, it is important to go back to the roots - stock markets have to be reborn as efficient allocators of capital and not a Las Vegas on steroids. Its better to do this before the calamity hits, rather than after.

I say this loud and clear. Almost everybody on Wall Street, Dalal Street, etc etc, is stark naked. Unfortunately, that is not a pleasant sight - potbellies, warts and all. What does it say about our society, when its best brains are running naked and looking as ugly as hell. This naked horde might do well to remember , as The Economist points out, the advice of Warren Buffett, the most successful investor in history who says that his ideal holding period for shares is for ever.