Notes From Underground: A Single Spark Can Start a Prairie Fire (Mao)

Posted at 11:23 AM (CST) by & filed under Yra Harris.

Dear CIGAs,

The tinder of the financial world has dried under the roaring blaze of asset appreciation. Global bond and equity prices reflect that all is well and the world’s major central banks have control of the world’s finances. But in the parlance of Mao, a single unexpected spark can initiate a huge fire. (Also, it is important to note that Mao never missed a PMI number either.) Financial history is replete with events of which investors and bankers were never aware of the depth. It was only in 2007 that Chairman Bernanke called the housing situation and its financial repercussions, “well contained.” Today, the news brought two events that can have far greater impacts than the markets’ calmness revealed.

NUMBER 1:The situation in Iraq with the seizing of the its second largest city, Mosul, can ignite a wider war then the news and markets believe. The ability of the radical Sunni extremists to easily defeat the Iraqi Army in a key area will bring added pressure on Turkey, and probably Jordan, to raise its level of military involvement to prevent the ISIS group to attain a larger hold over critical OIL areas.F or the Sunni insurgents, OIL means money for supporting its military operations. Also, controlling a large population area like Mosul will bring in “taxes” from shakedown efforts. The ISIS group is also pushing toward an area of Kurdish control,which may initiate military action from the well-financed and trained Kurdish militias. The Iraqi situation can quickly escalate and bring in many regional actors into a potentially volatile situation.

NUMBER 2: S&P placed the Austrian banking system on watch after the state moved on Hypo Alpe Adria debt holders. Following the template established by Dutch finance minister (and Eurogroup president) Jeroen Dijsselbloem after the Cyprus Bank BAIL-IN, Austria has asked subordinated debt holders of Carinthian guaranteed debt, to help pay for winding down the nationalized bank HYPO APLE ADRIA.The established TEMPLATE has been forgotten by investors. Remember that depositors in Cypriot banks were forced to bear some of the costs of winding down insolvent institutions. Austria has just let creditors and depositors know, again, that the EURO stops with them. The amount of the bail-in is only 800 million euros but it is a reminder that risk is not being properly priced.European banks have been large sellers of COCO bonds, which are dependent upon the banks and regulators to determine when a bank is undercapitalized, thus resulting in a bond being converted to equity (and aptly named Contingent Convertible or COCO bond).While all attention is on Spanish, Italian and other peripheral banks, Austria presents the world markets with a credit event.

Earlier this week the brilliant financier Wilbur Ross announced that he sold his large stake in the Bank of Ireland to Deutsche Bank. Mr. Ross acquired his shares in the Bank of Ireland at the height of the Irish banking crisis and made a very large return on his opportune investment. Maybe, Wilbur is aware of the Dijsselbloem template and thought it was time to take the money and seek other venues. At least Wilbur Ross was well remunerated for the risk he took in the Bank of Ireland. Can recent investors in European sovereigns and banks say the same?

***The Reserve Bank of New Zealand, as expected, raised its Official Cash Rate by 25 basis points to 3.25 percent. The language by RBNZ Governor Graeme Wheeler was a bit more hawkish than anticipated and the KIWI rallied against all currencies. Wheeler raised rates even as the KIWI has remained strong, but believes that softening commodity prices will eventually weaken the currency. The RBNZ seemed more worried about rising inflationary pressures and thus deemed a raise in rates to be more important. How refreshing that a central bank doesn’t move its thresholds to fit some illusionary targets?