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from Breakingviews:

Direct bank recaps won’t give Spain quick fix

By Neil Unmack and Fiona Maharg-Bravo

The authors are Reuters Breakingviews columnists. The opinions expressed are their own

If Greece quits the euro, Spain’s banks will be the next weak link in the single currency. Hence, the frantic search for ways to prop them up. One solution, advocated in recent days by France’s president and Ireland’s central bank governor among others, involves the direct injection of capital by a euro zone fund into Spain’s lenders. The appeal is obvious: Spain’s banks would be recapitalised but Madrid’s own debts wouldn’t rise. The country would therefore avoid the fate of Ireland which was dragged down by bailing out its lenders - even though its financial system is proportionately a lot smaller.

But there are complex political and technical hurdles that would have to be jumped before such a solution could work. As a result, direct recapitalisation of Spain’s banks, bypassing the sovereign, doesn’t look like a quick fix.

At the moment, neither the European Financial Stability Facility (EFSF) nor the soon-to-be-created European Stabilisation Mechanism (ESM) are able to recapitalise banks directly. Although the treaty setting up the ESM is moderately flexible, such a move would almost certainly require approval by at least Germany’s parliament. Given that direct recaps would require a potentially vast transfer of risk from peripheral countries to taxpayers in the core, that wouldn’t be easy. If Spain got such a good deal, other countries such as Ireland would want one too.

Before taking on such risks, taxpayers in northern Europe would demand far greater oversight of domestic banks, transferring power away from national regulators. They may also insist on “bailing in” bank bondholders as a way of mitigating their risk. None of this would be trivial for Madrid to concede not least because many bondholders are retail savers. Haircutting them would be politically problematic.

These obstacles may be overcome with time. The European Commission is, for example, already working on a continent-wide scheme for bailing in bondholders if banks get into trouble. But it’s unlikely that everything can be nailed down in time to help Spain manage a Greek exit. The main option would then be for the EFSF to lend money to Spain which, in turn, would recapitalise its banks. If a fix is needed fast, Madrid may just have to put up with a higher debt load.

from Breakingviews:

JPMorgan loss kicks succession race into high gear

By Rob Cox This column appeared in the May 21 edition of Newsweek magazine. The author is a Reuters Breakingviews columnist. The opinions expressed are his own. A time-honored tradition for handling executive succession on Wall Street is the practice of putting two ferrets in a sack, figuratively speaking. That’s when a bank takes two promising managers and makes them co-heads of the same business. The expectation is that, like two feral mammals clawing each other in the darkness, one will emerge victorious. He will become CEO. The other is named deputy vice chairman of Bolivian equities. JPMorgan has yet to officially haul out the burlap sack, but the $2 billion trading loss it disclosed two weeks ago has accelerated the contest to succeed Jamie Dimon at the top of America’s biggest financial institution.

Not that Dimon is leaving anytime soon. His hair may be silver, but he’s only 56 and has every intention of running the place into his 60s. Moreover, the losses from bets on funky derivatives incurred by the chief investment office in London look manageable for a bank that minted a $5.4 billion profit in the first quarter and boasts nearly $200 billion in capital. But as Dimon readily admits, the trades were dumb. They certainly undermined many of his public arguments for resisting additional regulation of the banking industry. As a consequence, the question of who will one day fill Dimon’s wingtips has become a money-industry parlor game.

For clues, look no further than the cleanup crew for the trading snafu. Two of Dimon’s most capable lieutenants, Michael Cavanagh and Matt Zames, have been handed high-profile roles that will help determine their suitability in the eyes of the board, investors, and regulators to eventually run the $2.32 trillion bank. Zames, 41, is taking over the unit that made the crummy trades. Cavanagh, 46, is leading a team of senior officers to “oversee and coordinate” the bank’s response to the affair.

Both are important tasks. Zames must unwind the problem trades while minimizing losses. Given the size and public nature of JPMorgan’s wagers, that won’t be simple. Having run JPMorgan’s bond trading desk, he should be well-suited to the challenge, though it may be his stint at Long-Term Capital Management, the hedge fund that collapsed in 1998, that’s more applicable to the current situation.

But it’s Cavanagh’s job that has far larger ramifications for the bank as a whole. As Dimon says, “Mike will ensure that best practices and lessons learned are carried across the firm.” Read between the lines, and that means the former chief financial officer’s recommendations may include changes to governance, risk management and corporate controls that implicate flaws in Dimon’s stewardship. How successfully Cavanagh can constructively criticize his boss for the greater good of the institution may determine whether he emerges from the sack as bloodied ferret or CEO.

from MacroScope:

Merkel under pressure … but unbending

Some interesting events to  ponder over the weekend, though not many of them came from the G8 summit which, as is customary, was strong on rhetoric but bare of any specific policy measures to tackle the euro zone crisis. However, markets seems to have tired of their panicky last few sessions. German Bund futures have opened lower as investors took profits rather than seizing on any positive news. European stocks have edged up.

It does appear that with the ascension of France's Francois Hollande, the G8 firmament turned into G7 (or maybe 5 since we didn’t hear much from Japan and Russia) versus 1 (Germany) but as things stand we’re still heading for a fairly anaemic “growth strategy” unless euro zone leaders coalesce behind the notion of giving Spain and Greece longer to make the cuts demanded of them. Spain has moved the goalposts further in the wrong direction, revising its 2011 deficit up to 8.9 percent from 8.5 and blaming the overspending regions. That means its already loosened target of 5.3 percent for this year is now even harder to achieve.

Hollande is talking up the case for common euro zone bonds but that will not wash with Berlin for a long time yet. Sources said Monti used the G8 forum to promote a pan-European bank deposit guarantee fund. Good idea but that too will only be conceivable if the European financial sector is on the point of toppling. And who will underwrite it? There is talk too of allowing the EFSF to lend direct to banks to ease the Spanish government’s reluctance to ask for help. That may have a slightly better chance of success but Berlin doesn’t like this idea either. Look no further than the German Chancellor’s take on the summit – it was all a great success, she said. Everyone agreed that we need both growth and fiscal consolidation.

Angela Merkel is one the one with her hand on the purse strings and she knows the markets will only allow so much fiscal loosening. However, the hefty 4.3 percent pay rise secured by Germany’s most powerful union, IG Metall could be a sign that Berlin is starting to loosen the edges of its anti-inflation culture in order to foster a bit of domestic demand. Any profound return to euro zone growth is going to require some internal imbalancing – and that means Germany buying more from its partners to allow them to export more.

No one can accuse Merkel of being disengaged. Despite denials from Berlin, it seems she may have suggested to the Greek president that a referendum on euro membership should be held in parallel with the June 17 elections, a pretty astonishing intervention in another country’s democratic process.

It is certainly true that the mainstream, pro-bailout Greek parties’ only chance of doing better this time is to turn the election into a “euro in or out” poll by explaining why abandoning the bailout will open the exit door. But they have a lot of work to do to regain credibility. Of a series of opinion polls over the weekend, two put the anti-bailout SYRIZA ahead and another gave pro-bailout New Democracy the lead. Since the party who comes in first gets an extra 50 parliamentary seats, the tightness of the race is going to have markets on tenterhooks for the next four weeks. We had a nicely timed interview with SYRIZA leader Alexis Tsipras which ran overnight. He meets French leftist Melenchon today and is talking about building relationships and forging negotiations so Greece can stay in the euro. However, he will not be meeting government officials in France and said the terms of Greece’s 130 billion euros bailout were now a “dead letter” and noted what he saw as the changing dynamics at the G8.

In the meantime, Greeks continue to withdraw their money from the banks, a trend which if it reaches critical mass, could force a European policy response even before the election. If that starts taking root elsewhere, the whole system will be creaking. Spanish banks’ bad loans have hit their highest in 18 years and, with so much tied into a bankrupt property market, no one is quite sure how much worse it is going to get. Late on Friday, clearing house LCH.Clearnet raised the cost of using Spanish bonds to raise funds.

from Breakingviews:

Cyprus’ bank bailout may not be the last

By George Hay

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Is nomen omen? Last month Cyprus appointed an economist called Panicos Demetriades as central bank governor. On Friday, the euro zone minnow committed to pump 1.8 billion euros, or 10 percent of GDP, into Cyprus Popular Bank (CPB) if its second largest lender can’t raise it privately. What’s more, this may just be a holding operation. If Greece quits the euro, Cypriot banks and the state itself will need more help.

CPB’s immediate capital deficit stems from the stress test conducted last December by the European Banking Authority, which left it needing to find 2 billion euros by the end of June. Given that its market capitalisation is now only 211 million euros, don’t count on shareholders lending a hand.

The good news for Cyprus is that CPB’s slightly larger peer Bank of Cyprus is only 200 million euros away from hitting its own 1.6 billion euro EBA target, following a rights issue. The bad news is that just sorting out CPB alone will put a serious dent in the country’s finances. If all 1.8 billion euros is used, the state’s debt would rise from 72 percent of GDP to 82 percent.

And looming over everything is what’s happening in Greece. Bank of Cyprus and CPB each have about 10 billion euros of Greek loans, of which already 13 percent and 19 percent respectively are non-performing. In the event of a Greek exit from the euro, they would both need further capital. Although the central bank’s data from the end of March doesn’t show any deposit flight, the lenders might also require help on liquidity.

Even without a Greek exit, the government’s finances are stretched. Last year it had a 6.3 percent budget deficit and received a 2.5 billion euro loan from Russia, with which it has close financial ties. The IMF thinks the economy will shrink 1 percent this year. In the long run, offshore oil deposits may provide some salvation. But if Athens brings back the drachma, Nicosia will be hard-pressed to avoid its own bailout from the euro zone.

from Breakingviews:

Greek dilemma might come to head before next poll

By Hugo Dixon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

So the world has to wait until June 17 to find out whether Greece stays in the euro? Not so fast. Things might come to a head even before the next poll if deposit flight accelerates.

Greece’s president said earlier this week that 700 million euros had left the country’s banks on Monday. The pace seems to have accelerated, as savers get more concerned that the political mess will drive Greece out of the single currency. Deposit flight is now running at 1-1.5 billion euros a day according to one senior banker. If it continues at that rate, another 20-30 billion euros could have left before election day.

Such an outflow is probably manageable. After all, Greece’s bank support fund is to inject 18 billion euros of capital into lenders next week. The real problem would be if there was a panic and say half of the system’s remaining 160 billion euros or so of deposits tried to flee.

The European Central Bank has already made 127 billion euros of liquidity available to the Greek banks - both directly through its own refinancing operations and by authorising the Greek central bank to offer emergency liquidity assistance. So it would anyway face massive losses and require recapitalisation in the event of a Greek exit. But if those losses mushroomed in a matter of weeks, the ECB’s credibility would be badly damaged.

But stopping liquidity isn’t attractive either. The Greek government would have to impose capital controls even before the electorate had a chance to vote. That conceivably might concentrate the voters’ minds. But it could also stir up anti-euro feelings in Greece and provoke a panic in other peripheral countries.

from Breakingviews:

Botched bailout rebounds on Bankia

By Fiona Maharg-Bravo

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Bank nationalisations are never pretty, but they are generally supposed to reassure savers. That’s why a report that depositors fled Bankia after the government last week took control of Spain’s fourth-largest lender is so troubling. The government has denied the report, and Bankia’s new chairman said depositors can be absolutely calm. Yet the latest share price plunge inflicts further pain on clients who participated in the lender’s IPO last summer.

To be fair, recent nationalisations of Spanish banks, such as Caja del Mediterraneo or Cajasur, have led to some deposits shifting to competitors. And even if the reports about Bankia losing 1 billion euros of deposits were correct, that’s still less than 0.6 percent of the bank’s deposit base. However, given the crisis in Greece and worries about contagion to the rest of the euro zone, it’s understandable that investors are particularly sensitive to any signs of capital flight in other countries.

Yet if some Bankia clients have turned their backs on the bank, this is more likely to be as a result of the bank’s plunging share price than a lack of confidence in Spain’s government to protect their deposits. Many retail customers who bought shares in Bankia’s initial public offering last July have lost 60 percent of their investment - a fall that was exacerbated by the government’s decision to take control of BFA, Bankia’s parent company. Despite various leaks, the state has yet to detail how it plans to recapitalise the bank.

The unhappiness seems to be concentrated on Bankia, which suggests that clients who do defect will move their money to other Spanish banks. The government and Bankia’s new management team could clear the uncertainty by spelling out their plans as soon as possible. But it’s hard to see any plan that doesn’t lead to large-scale dilution of existing shareholders, raising the prospect of a vicious cycle. The government may be afraid to lean on them too heavily for fear of damaging the franchise. But given the steep fall in the share price, it may be a bit late for that.

from Global Investing:

Three snapshots for Thursday

Fears that Athens is on the brink of crashing out of the euro zone and igniting a renewed financial crisis have rattled global markets and alarmed world leaders, with Greece set to figure high on the agenda at a G8 summit later this week. This chart shows the impact on assets since the Greek election:

Euro zone banks now account for only 8% of total euro zone market value - they were over over 20% of the market in 2007:

Japan's economy rebounded in January-March from a lull in the previous quarter, shaking off the pain of a strong yen and Europe's debt crisis on solid consumer spending and rebuilding from last year's earthquake.

from Edward Hadas:

Bad ideas spawn Lesser Depression

On September 15, 2008 Lehman Brothers collapsed in a heap, a bankruptcy that was followed by a recession in most rich countries. As time goes on, the severity of the disruption becomes both more apparent and more puzzling.

When Lehman failed, it was reasonable to expect the pain to be brief and concentrated. While too many houses had been built in the United States, most of the world’s real economy (comprising factories, offices, retail outlets, construction projects) was doing well. The global financial sector was more distorted, even before investors took fright at the decision to let Lehman go under. But by the middle of 2009, governments and central bankers had agreed to provide bankers and brokers with anything needed to keep them healthy.

Optimism was not justified. Although the countermeasures stopped the deterioration, the rich world now seems stuck in a Lesser Depression - many years of poor economic results and a series of financial crises. In the United States, the euro zone, Japan and the UK, real GDP per person is still lower now than it was four years ago. In all of them, GDP growth is currently either slow or non-existent.

The consumption setback shouldn’t cause too much concern - it wasn’t so bad five or six years ago, when real GDP was last at today’s level. But the enduring recession in the labour market is another matter.

In April 2008 the unemployment rates in the United States, euro zone and UK were respectively 5, 7.3 and 5.3 percent. In April 2012, the corresponding percentages were 8.1, 10.9 and 8.4. More refined indicators - youth unemployment, involuntary part time work and disaffected ex-workers - are even more discouraging. The post-Lehman economy is failing a significant number of people in a fundamental way.

Some economists argue that this real suffering is the necessary price to pay to bring order to the financial world. That’s a dubious argument, since people are more important than money and credit. But the ethical debate isn’t necessary. Despite the real economic pain and the official aid, the financial world looks as ill as ever. On the monetary side, policy remains in shock territory - buyers of safe government debt receive negative real returns. Fiscal positions are equally alarming. Deficits everywhere remain at levels more suitable for wartime mobilisation than for a sputtering economy.

The puzzle is why a relatively small problem in the real economy has led to this Lesser Depression, especially when the authorities have followed expert advice throughout. Surely, if the counsel were sound, the depression would have lifted by now.

from Breakingviews:

Murky U.S. bribery law gets a dose of clarity

By Reynolds Holding The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

America’s murky bribery law is finally getting a dose of clarity. Morgan Stanley showed last month how to avoid legal charges for infractions by one of its executives, and an appeals court will soon define whose palm cannot be greased. That’s good news for multinationals sweating unpredictable enforcement of a confusing statute.

The problem isn’t the Foreign Corrupt Practices Act so much as how broadly prosecutors have been interpreting it. And with few companies willing to risk an indictment by testing that interpretation in court, it becomes the law by default.

The definition of “foreign officials” is Exhibit A. The FCPA says they’re employees of a foreign government or its “instrumentality” and can’t be bribed. While the Department of Justice insists “instrumentality” includes private companies owned in part by the state, accused bribers say only firms that perform government functions qualify. Legislative history supports the accused. But a federal judge sided with DoJ last year - until he tossed the case for prosecutorial misconduct.

A federal appeals court will soon weigh in for the first time, deciding whether to uphold the bribery convictions of U.S. telecommunications executives who paid employees of Haiti Teleco, partially owned by the National Bank of Haiti. The court’s ruling will be the most authoritative statement yet on what constitutes “foreign officials.”

Most companies, of course, try to dodge trouble before it happens, often by creating costly FCPA compliance programs. But prosecutors have never said what sort of programs might forestall charges. That changed last month, when DoJ and the Securities and Exchange Commission let Morgan Stanley off the hook for a managing director’s bribes because its anti-bribery policy was so strict and comprehensive. By listing the policy’s features, the watchdogs finally gave firms a blueprint for avoiding liability for the actions of a few bad apples.

But it shouldn’t be up to prosecutors to make the law. That’s Congress’ job. It still needs to amend the FCPA to define “foreign officials” more precisely and, like the UK and other countries, make top-notch compliance programs a defense to bribery charges. Unfortunately, legislation to that effect has stalled and is even less likely to pass since bribery allegations emerged against Wal-Mart in Mexico. Lawmakers say they don’t want to appear soft on bribery. They prefer, apparently, to look merely irresponsible.

from Breakingviews:

Dodd-Frank opponents return to the drawing board

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

JPMorgan has given financial reformers at least two billion reasons to insist on more aggressive oversight of the banking industry. In the wake of last week’s trading loss, presidential contender Mitt Romney and other Republicans will have to rethink their rhetoric around gutting the Dodd-Frank Act and, more specifically, its Volcker Rule provision. Voters may no longer believe that big banks can manage their own risks, which leaves making banks smaller the alternative to tighter regulation.

Jamie Dimon reiterated over the weekend that JPMorgan’s loss at its chief investment office came from mistakes made hedging its loan portfolio. The trading led to more - not less - risk. But portfolio hedging isn’t the sort of activity limited by the Volcker Rule, which is meant to prevent banks from betting with capital secured by customer deposits. Still, that hedging went awry. While the bank’s capital can handle the hit, the episode has critics rightly complaining that even a bank as seemingly bullet-proof as JPMorgan is too complex to manage its own risk.

And that presents a political problem. Dimon has been outspoken about the flaws of Dodd-Frank, and Republicans have largely nodded in agreement. Presidential hopeful Mitt Romney has promised to repeal much of the 2010 law if elected. This episode shatters that strategy. The GOP shift may already have begun. On Friday, Senator Bob Corker called for a hearing to learn more about JPMorgan’s loss and what such mistakes mean for taxpayers. As recently as February, he was pushing to weaken the Volcker Rule.

Republicans will need to come up with a strategy to end too big to fail without increasing the government’s footprint in finance. If embracing Dodd-Frank is not an option, do not be surprised to see many in the party adopt a more radical idea, and one embraced by Dallas Fed President Richard Fisher: breaking up the banks.