The global credit crisis will have a profound impact on Cyprus, but with some delay, as the hard and long process of de-leveraging risk begins, according to a markets expert.
Chris Pavlou, TFI Public Co. Vice Chairman and CEO, said that global banks and financial institutions will proceed to shrink their balance sheets and return to their core areas of activity.
He is one of the few persons in Cyprus who has lived through many crises throughout his years as a senior executive at HSBC, which makes his experience and knowledge of markets invaluable.
In an exclusive interview with the Financial Mirror, Pavlou said the crisis now affecting US/UK banks and financial institutions is global and one way or another it will have a huge impact on all countries, including Cyprus.
CHRONOLOGY OF CRISIS
Pavlou said the first crisis that he experienced was the confidence run on banks and the currency of Hong Kong in 1983-85 before the UK handover of the colony to China, which he blames on the arrogance of the then British government under Margaret Thatcher.
In the early 1990s the property and stock market bubble in Japan burst as it became too obvious that the over-leveraged positions then built up in Japan could not be sustained. The slow pace of unwinding of leverage that followed due to the misguided decision of the Bank of Japan to tolerate inefficiencies at Japanese banks that were reluctant to reduce risk, resulted in heavy losses that went on for a decade, also referred to as the “lost decade”.
“In 1998, I witnessed a property being sold at 14% of its 1990 value and that to a subsidiary of the seller,” Pavlou recalled, stressing how important he considers policy measures by authorities in responding to crisis to be.
Then followed the 1997-98 Asian crisis when “hot money” invested by foreign investors in search of high returns suddenly abandoned the region resulting in a massive devaluation of currencies and a melt-down in stocks.
“The Asia crisis was regional, just like the run on Russian banks and the LTCM bankruptcy, which were contained and dealt with quickly.”
The 2008 crisis is a global issue since all banks in the world are affected either due to direct exposure to sub-prime loans or because margins increase and the inter-bank market ceases to exist.
GREED TO BLAME
Pavlou said that greed is mostly to blame for the crisis and that this is the ugly face of capitalism as traders and bankers invented financial engineering in order to invest in sub-prime loans and then bundle them together and sell them to others in an effort to maximise profits for higher bonuses.
“The problem is that directors did not understand the risk that their traders were taking, the CEO was happy because his bonus was also rising and the regulators also failed in identifying the risks that the banks were taking.”
“Everybody was in on the act,” Pavlou said.
He explained that the first signs of tension appeared when investment banks were issuing negative reports against others, leading investors to establish short positions and driving share prices lower. More importantly, a major warning sign came when the London clearing banks stopped lending to one another because nobody could trust the other, with Pavlou adding that despite the massive injection of billions by central banks, the situation has not yet returned to normal.
IMPLICATIONS
While Pavlou welcomed the US Treasury rescue plan to assume responsibility for the affected loans, he said that banks will now start the long and hard process of unwinding risk and exposure built up over the past decade as they rush to rebuild their balance sheets and shore up capital.
“Banks will sell assets in their attempt to return to their core activities. This will result in massive layoffs, mostly in the financial industry, but also higher funding costs for the small to medium sized companies as well as the public who will find it increasingly difficult to get affordable loans to buy homes,” he said.
In the event that the mortgage crisis deepens in the UK, then ultimately this will have an immediate impact on the Cyprus housing market as well as on tourism, considering that the UK supplies about 50% of total arrivals and Britons nationals buy most of our holiday homes.
With many Cyprus professional firms active in overseas markets, mostly in the financial services sector, the slowdown and de-leveraging occurring in foreign markets could result in less work for the Cypriot lawyer, accountant and consultant.
The negative impact however, will be less than feared if the action plan introduced by the U.S. authorities proves successful.
Countries, companies and individuals with cash will emerge out of the crisis in a stronger position if they decide to utilise the opportunity and invest in relatively cheap assets. But for now, Pavlou argues “cash is king”.
FX MARKETS TO BENEFIT
With the US and UK authorities imposing restrictions on short selling stocks and trading coming under scrutiny, speculators are likely to rush to the foreign exchange market, which according to Pavlou is the world’s second oldest profession (money exchange) and the most liquid at all times.
“Daily volume is probably up by 50% from last year’s daily average of $2.5 trillion as the FX market is the only place where there are no restrictions on going long or short and on high leverage. At the touch of a button, you can get in or out thanks to the most efficient and liquid trading systems in the world,” Pavlou concluded.
