Don't Fear Cyprus: Market Weakness Brings Buying Opportunity

Includes: SPY
by: Pat Stout

The fear over a bank run in Cyprus is misplaced. Here is why. The small depositor with insured deposits of under €100,000 is covered. Small depositors thanks to the insurance coverage should not lose a single euro.

The nearly two-week closure of financial institutions should result in some withdrawals. That is to be expected and understandable. Who does not like having some walking around money in their pocket?

The uninsured deposits are taking a haircut. The money is gone. Taking a part, or all, of the remaining money out of the financial institution will not solve anything. Besides, where would the funds go?

Investors may want to use a media-induced sell-off -- should one take place -- as a buying opportunity. Expect CNBC to show lines at the banks and ATM's. Expect reports saying the ATM's are not working correctly as some attempt to withdrawal the maximum amount of funds from multiple ATM's. Expect bad news.

History of a Big U.S. Bank Failure.

Do you remember the Continental Illinois Bank? It was the nation's seventh-largest bank with $40.67 billion in assets at year-end 1983. Foreign office deposits were 40.43% of total assets. Total equity capital was 4.50% of total assets. In July 1982, Penn Square Bank failed when many speculative oil and gas exploration loans went bad. Continental had a $1 billion exposure to the loans. Continental was also hurt by the 1982 Mexican default. Continental increased the use of foreign money markets for funding after the Penn Square failure. On May 9, 1984, Reuters asked Continental to comment on bankruptcy rumors. It was a tough time for Continental Illinois. In September 1984, permanent assistance was provided.

FDIC article:

A later account by William Greider, however, suggests that the regulators did informally attempt to do more after Penn Square but believed it inadvisable to impose a formal action, such as a cease-and-desist order. According to Greider, in 1982 Federal Reserve Board Chairman Paul Volcker advised Continental.s directors to make changes in both management and lending policy, but the directors refused. FDIC Chairman William Isaac remembered that .when Volcker and Conover presented their recommendations to the Continental Illinois directors, . . . the directors said to them: .Well, this will be the end of the bank and you will be to blame.. . Isaac noted that it would have been difficult for a regulator to proceed in the face of the directors. refusal. .It takes real gumption for a regulator to sit there and say, .I.ll take the responsibility. . .. talking about one of the biggest banks in the world. No one knows what will happen.. Michael Bradfield made the same point about any Federal Reserve attempt to deny a bank access to the discount window as a way of forcing its hand, noting that .the consequences of refusing to supply liquidity support to a bank are too severe..

It appears, therefore, that in 1982 regulators believed more should have been done but were unwilling openly to require the removal of Continental.s top management or take other formal actions, such as demanding a dividend cut. However, it also seems likely that, as Bradfield noted, by the time Penn Square failed, the damage had already been done.43

With regard to Continental Illinois, the regulators. greatest concern was systemic risk, and therefore handling Continental through a payoff and liquidation was simply not considered a viable option. Continental had an extensive network of correspondent banks, almost 2,300 of which had funds invested in Continental; more than 42 percent of those banks had invested funds in excess of $100,000, with a total investment of almost $6 billion. The FDIC determined that 66 of these banks, with total assets of almost $5 billion, had more than 100 percent of their equity capital invested in Continental and that an additional 113 banks with total assets of more than $12 billion had between 50 and 100 percent of their equity capital invested.

The banking situation in Cyprus reminds me of when Continental Illinois Bank ran into trouble. The U.S. financial markets survived the event.

How did the financial markets respond?

On May 17, 1984, Continental Illinois received temporary assistance. On September 26 1984, it received permanent assistance. From May until September, the S&P 500 declined and treaded water. The chart below is indexed at 100 for September 26, 1984.

Click to enlarge
(Click to enlarge)

Should history repeat as expected then the chart would suggest a limited downside with a nice upside. Therefore, use any Cyprus induced weakness to add to your favorite positions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.