Lack of capital or capabilities?

After the massive warnings from credit rating agencies about the deteriorating creditworthiness of financial institutions and new suggestions for better capitalization and additional injections of liquidity to sustain stability, an open question remains whether additional capital can restore self-sustainability of financial sector. Moreover, during the past several years financial system became more vulnerable and less significant for recovery of economy.  Further shortages of funds simply remind that currently held capital is not enough to fulfil all desires.

Spain's credit rating was downgraded by Fitch from A to BBB in 7 June and 28 Spanish banks’ credit ratings were downgraded by Moody in 25 June. The yield on 10 year Spanish government bonds increased above 6.5% and independent auditors revealed that Spain’s banks need 62bn euro support. Worsen situation caused Spain to ask officially support on Monday. The next country which possibly will need bailout is Cyprus. Fitch downgraded the country's credit rating to BB+ from BBB- and it could potentially require 4bn euro to recapitalize its banks, heavily exposed to the Greek economy.

As a response to the prevailing negative outlook, a proposal Towards a Genuine Economic and Monetary Union was introduced by President of the European Council, Herman Van Rompuy on Tuesday, 26 June. The plans for further banking, fiscal, and economic union could meet a tough opposition at EU summit on Thursday and Friday, 28-29 June. Angela Merkel refused to accept common liability and to introduce eurobonds.

So, could political union be sustained by sharing and implementing the best practices those strengthen banking system, enhance fiscal discipline and develop economic potential? Moreover, will EU’s leaders stick to the additional capital needs and common  debt of euro zone countries - eurobonds; or will the debate turn towards measures those enhance capabilities to contract in at least painful way and enforce recovery with a new strength.

How easily euro could be broken?

Central banks of the world’s major economies prepared contingency plans to stabilise markets in case anti-austerity parties won elections in Greece on Sunday, June 17. Moreover, leaders of the G20 meet in Mexico on Monday, June 18 to discuss Europe’s debt crisis and clarify contributions to the pledged IMF‘s fund worth of $430 billion US.  It is expected that additional cash injections into the financial system may calm public panic; however, could euro, the second largest reserve currency, be broken easily?

Prolonged political tensions in Greece intensified considerations whether it is able to meet bailout obligations. Moreover, it was announced that in the middle of May the ECB stopped providing liquidity to some Greek banks because of insufficient capitalization, overseas banks reduced reserves holdings in euro and Greeks rushed to withdraw money from domestic banks or transfer deposits to more stable ones. Euro deterioration to 1.24 against US Dollar last week and international mistrust in European currency strengthen the worst scenario – the end of euro.

It could be interesting to observe how European banks follow the news of deteriorating assets. Euro might collapse if European banks hurry to stabilize deteriorating assets by ridding of devaluated euro. However, the other scenario is also possible. Self market regulation mechanism may come into force and European currency may survive as long as European goods are traded in euro.

Goodbye to volatility, hello to arbitrage!

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The US Securities and Exchange Commission approved two proposals those are designed to curb volatility in individual securities and the broader US stock market on 31 May, 2012. The national securities exchanges and the Financial Industry Regulatory Authority will implement the approved proposals by 4 February, 2013, for a one-year pilot period, during which the assessment regarding any additional modifications will be made. So, what are the chosen market control measures and how will be the effect estimated during the pilot period?

One of the approved initiatives establishes a “limit up-limit down” mechanism that prevents trades in individual stocks with a specified price band, which would be set at a percentage level above and below the average price of the security over the immediately preceding five-minute period. According to the news released by the US SEC on 1 June, 2012, for more liquid securities — those in the S&P 500 Index, Russell 1000 Index, and certain exchange-traded products — the level will be 5 percent, and for other listed securities the level will be 10 percent. The percentages will be doubled during the opening and closing periods and broader price bands will apply to securities priced $3 per share or less. This new mechanism will replace the existing single-stock circuit breakers that the Commission approved on a pilot basis after the market events of May 6, 2010.

The other initiative updates existing market-wide circuit breakers those halt trading in all exchange-listed securities throughout the U.S. markets. The existing market-wide circuit breakers were adopted in October 1988 and have been triggered only once, in 1997. The new requirements according to the US SEC involve a reduction of the market decline percentage thresholds needed to trigger a circuit breaker to 7, 13, and 20 percent from the prior day’s closing price, rather than declines of 10, 20, or 30 percent; a shortened duration of trading halts that do not close the market for the day to 15 minutes, from 30, 60, or 120 minutes; a simplified structure of the circuit breakers so that there are only two relevant trigger time periods instead of six, those that occur before 3:25 p.m. and those that occur on or after 3:25 p.m.; a usage of broader S&P 500 Index, rather than the Dow Jones Industrial Average, as the pricing reference to measure a market decline and a requirement to recalculate the trigger thresholds daily rather than quarterly.

However, I wonder how the authorities will measure the effect of attempts to protect domestic markets from excessive volatility. Imposed trading halts those close domestic markets creates an arbitrage opportunities for the companies’ securities traded in other opened stock exchanges. So, these efforts to control volatility may deepen market distortions and could be welcomed as risk free opportunities.