The postmortem on the Cyprus crisis will be ugly

 

Nils Pratley The Guardian, Friday 22 March 2013 20.51 GMT

The handling of the crisis has been farcical, and has undermined confidence in Berlin's and Brussels' firefighting skills

Protesters outside parliament in Nicosia. The cabinet was set to approve a 'Plan B' bailout deal with the EU and IMF. Photograph: Patrick Baz/AFP

• Assume the crisis in Cyprus is patched up this weekend or on Monday – it is still the way to bet because both sides have too much to lose. After its struggles in Athens and elsewhere, the eurogroup surely won't let a member of the single currency fall out for the sake of a few billion euros.

Equally, the Cypriot government must know what a hole it is in. There is no salvation from Russia; and, by threatening to cut off liquidity from the country's stricken banks, the European Central Bank has put its credibility on the line. The main ingredients are all there for another serving of euro fudge.

But what would come next? For Cyprus, the immediate future is bleak. In effect, Germany is telling the country to find a new occupation. Bloated offshore banking, with a speciality in Russian deposits, doesn't fit the shiny new euro model of banking union. Try tourism, perhaps. Cypriots might complain these rules were not made clear when they joined the euro only five years ago. They'd be right. But their best strategy today is to stay within the club and, like Greece, try to negotiate better terms another day.

It's the reaction outside Cyprus that matters for the future of the euro. Investors' postmortem on the mess could be dangerous. Two points will stand out:

First, the handling of the crisis has been farcical, and has undermined confidence in Berlin's and Brussels' firefighting skills. Woe in Nicosia was inevitable once the last Greek restructuring whacked bondholders, including Cypriot banks.

Yet, with ample time for all sides to prepare, the banks have been closed for a week and the negotiations are going down to the wire. True, Cypriot politics aren't easy. But next time it might be Italian politics.

Second, confidence has been shattered in the notion that eurozone depositors with less than €100,000 are sacrosanct. Under plan A the eurogroup was prepared to trample on the one principle that was understood across the continent.

There's no knowing the damage that will do. And how will bigger depositors in Spanish and Italian banks react? If their instinct is to seek safety elsewhere, a lot more trouble is in store.

• It is now government policy that house prices must not be allowed to fall. That is the main lesson to be drawn from George Osborne's Help to Buy scheme, which is really an adventure into sub-prime lending. If you can't meet a bank's demands for a deposit the government will help to bridge the gap by giving a guarantee for up to 20% of the mortgage on homes worth up to £600,000.

Pitched as an appeal to an "aspiration nation," this policy is partly born of the terror of offending the constituency called current homeowners. The most logical way to cure Britain's housing shortage would be to order the construction of more homes, let's say a million. But an increase in supply of that order would, in the absence of meaningful growth in wages and affordability, cause the value of the current houses to fall. Great for first-time buyers; not so good for attracting the votes of established owners.

A serious fall in house prices would also risk creating a fresh round of provisions at major banks and mortgage providers.

To date, lenders have escaped big residential-related losses because house prices have not collapsed. Since the peak the fall has been about 15% in real terms; the banks' big UK losses on property lending have mostly been on the commercial side. But another fall of 15% would cause heavy provisions.

Thus Help to Buy is deemed the best policy in the locker if something must be done to make homes affordable for those without sufficient savings. In the short-term the dangers are probably not severe, especially if the government really is determined to liberalise planning laws (though believe that when you see it) and if it can exclude remortgaging and second homes from the subsidies (technically tricky, to judge by ministers' wishy-washy statements).

In the long term though, creating government-backed mortgages to encourage high loan-to-value lending is plainly irresponsible. It risks an almighty crash on the day, admittedly far off, when interest rates rise.

"Had we been asked to design a policy that would guarantee maximum damage to the UK's long-term growth prospects and its fragile credit rating, this would be it," concluded thinktank Fathom Consulting. Fair comment.

• Last July Peter Marks, chief executive of the Co-op, pledged to mount "a real challenge to the status quo" in the banking world. He had just secured an agreement to buy 632 branches from Lloyds at what appeared to be the knock-down price of £350m; Lloyds even agreed to underwrite the debt to fund the deal.

Eight months on, Marks' real challenge is getting the deal out of the starting gate. "We're trying to conclude this transaction in very difficult economic times," said Marks. "That's what makes it more difficult. We're trying to establish what the risks are and to mitigate those risks."

Put like that, it sounds as if Co-op is not remotely close to being able to sign on the dotted line. Instead, it seems to be struggling to raise the capital – perhaps as much as £1bn is needed – to support a bigger banking operation. The life and savings business was sold this week, freeing up £200m, and general insurance is now on the block.

Is this prize really worth the hassle? The Co-op is still digesting the Britannia Building Society, which was blamed for £370m of bad loan losses this week. Then there was £150m for PPI mis-selling and the same again for a writedown of the value of the IT systems. Add up that little collection, plus the decline in profits from the "core" banking operation, and the unit recorded a loss of £662m. The capital position is healthy but this does not look like a business capable of integrating those branches very soon.

Marks is retiring in May, to be succeeded by ex-B&Q man Euan Sutherland. The handover gives Co-op members the ideal opportunity to demand a review of the Lloyds plan. Ambition is a fine thing; over-ambition is not.

• As Warren East announced his departure after 12 years as chief executive, there was a reminder of ARM Holdings' stunning achievement: 95% of the world's smartphones contain microchips designed by ARM and the company is now worth £13bn. Great stuff, and a phenomenal investment for anyone who bought the shares at almost any point in the last decade.

But the highest point for the shares was actually in 2000 when the price, albeit briefly, topped £10. Don't blame ARM, which has done nothing wrong: pre-tax profits have risen from £35m to £276m since the turn of the century.

It was the madness of the dotcom era stock market, pricing ARM as if global domination had already been achieved. What were investors smoking back then?

The postmortem on the Cyprus crisis will be ugly | Nils Pratley | Business | The Guardian