Friday, 22 June 2012

Bank downgrade - yawn. Europe downhill. Spain

Banks downgrade
Moody’s has been doing a hatchet job on banks across Europe recently and yesterday saw Moody’s downgrade 15 large international banks. For some reason it came as a shock to many. I do not really get the point. The markets have known for years that something was wrong in the banking sector. The banks are forced to increase their capital base, reducing their profitability. Households are deleveraging, reducing income for the banks. So why is it a surprise that banks are a worse business now than before? The chart below compares global banks (blue line) to global equities (red line). Banks have underperformed the market badly – the market participants have been voting with their feet for years.

The “Flash” PMI for the Eurozone and for some of the larger countries were released yesterday. It was very bad reading, as the European contraction continues. The German index showed an accelerating contraction. German export orders continue to fall rapidly. The only question one can ask is how long it is allowed to continue. I wrote on Thursday that domestic and international pressure on Merkel to change her economic policies were mounting. Yesterday’s data release just confirms that economic policies in Europe must change and the sooner the better. IMF Chief Lagarde seized the opportunity to tell the German government that joint debt would be a very useful element in solving the crisis. I remain optimist that they will. Germany will find it in her own interest to adjust. The only question is when.

For a comparison, look at Industrial Production in USA (red line) and in the Euro-zone (blue line). Europe’s output has been falling whereas the US output has been increasing. The difference? The degree of austerity.

Two international consultancies had been asked to conduct an independent review of the capital injection needed to salvage the Spanish banks. They ended up with a maximum of 62bn EUR. Just some months ago the Spanish government believed that 25bn would be enough. Or at least that is what they said. Two weeks ago the same government asked for 100bn in help from the Euro-zone.

I think the 62bn is good news, on the condition that the two consultancies have built in enough buffers in to compensate for the continued recession in Spain that will increase the credit losses. At this moment it is not important if the necessary capital is 62bn or 100bn. We just need to get to a point where the markets finally begin to believe that the number is final. 

Monday, 11 June 2012

Finally, a move to rescue banks

Spain asked for a bailout from the EU and the other EU countries appear to have accepted it. It is not a general bailout as known from Greece, Portugal and Ireland, but limited to assistance in recapitalising the ailing savings banks. Apart from my firmly held conviction that the method chosen is the most expensive for everybody, it was positive that something happened.  Even if the details will take some weeks to hammer out, I think it is important to understand that this step is more momentous than the three previous bailouts. Finally the EU is moving to resolve the situation with Europe’s sick banks.

Importantly, the oversight with the package appears not to go to EU and IMF, but only to the EU and it is not a general control of the country’s spending, but only a control of the banking sector. It may be an important pointer that we are moving towards a “banking union” with a joint euro-zone banking regulator.

It ought also by now be clear that the crisis is not only about public sector debt. The four countries that had seen the strongest increase in private sector debt in 2000/2007 are also those where the banking sector is in deepest problems. UK, Spain, Ireland are involved in major rescue actions for their banking sector and the economies are suffering from protracted recessions or zero growth.

The fourth, Denmark, has escaped a deeper economic crisis because of a very efficient mortgage financing system, and relatively healthy public finances. But the economic growth is anaemic, the banking sector is still in deep trouble, and more than a quarter of the country’s banks have closed. The largest bank, Danske Bank, only survived through generous government loans.

Greece is in deep trouble because of public over spending to the tune of 15 per cent of GDP. Portugal needed its bailout because of a sclerotic economy and its government is fighting to rush economic reforms which should have been implemented 10/15 years ago.

So the lesson is that 1) bailouts are different from case to case, 2) it is good that EU is finally getting some focus on the banks and 3) private sector indebtedness is at least as important in the current economic crisis as the public sector debt. 

Portugal obtained EU’s accept to spend some 6.6 bn EUR out of its emergency facility to recapitalise the country’s four largest banks. Good news for two reasons: another banking rescue as in Spain, and it appears that the costs can be covered without increasing the emergency facility. It is a sign that Portugal’s economy is moving the right way. 

I still do not exclude that the best solution would be to keep the emergency facility in place until 2014 instead of 2013. We will see.

The German opposition may have some luck flexing its muscle (it controls the Bundesrat and could delay all legislation) and appears to have forced Chancellor Merkel to accept some kind of growth initiative for Germany. That is absolutely fine, it is completely in line with the fact that general elections will take place next year, but it is not enough. We still need more pressure on the government to accept something like the "redemption fund" that would change investors' perceptions of European government debt.

Five steps to European Happiness
Well, not quite. But the events in Spain, Portugal, and Germany are small steps in the right direction. All of them fall within the five requirements I listed back in December 2011. Here is the link to my blog post from back then.

Wednesday, 6 June 2012

Bank rescue. Chicken

Bank rescue
Today is the day where the EU should present its blueprint for salvaging the EU banks. In principle it is simple. We need an EU banking regulator, a deposit guarantee, and a big bag of money. But then the problems begin. Which authority should be given to the EU banking regulator? Who should be covered by the guarantee? And who is to pay? Enough open questions to ensure that it will take quite a while to make the scheme work.

There is one big issue that deserves some attention. EU has had as a principle to “protect smaller shareholders” who are supposedly “innocent” as regards the banks’ reckless lending practices. This principle stands in the way of something very important, the ability of the state/regulator/government to take full control over an insolvent bank.

Only by taking full control it becomes obvious to start the necessary process: to sell the non-performing assets, while the now government-owned banks can continue the activities that are absolutely indispensable in the society, namely payments and lending. 

It would then become possible to obtain an honest estimate of the losses. Eventually, it will lead to much smaller costs for the tax payers.

The key is of course that it is possible to temporarily suspend normal reserve requirements, because there is a deposit guarantee in place. As long as such a guarantee is in place, a nationalised bank can in principle operate without a capital base. 

It obviously requires that all shareholders must be wiped out. On this point I am more adamant that the EU Commission. It is normal capitalist logic that one can lose money through bad investments. There are no “innocent” investors. Protecting small investors should not stand in the way of providing a much larger public good: a restored and restructured banking sector.

The venerable game of Chicken is played in a variety of ways. One is when two young men on motorbikes race towards each other on the white line. He who first veers away from the line is Chicken. If both stay the course, there is no Chicken. Only two dead bikers.

Germany’s Finance Minister Schäuble has given an interview in Handelsblatt. Under the heading “No easy way out for Europe”, Schäuble says “If government debts are made collective, and it leads to lower bond yields in the debtor countries, it would reduce the pressure to solve the problems”. Written in black on white: Germany resists an EU solution because it would remove the pressure on the debtor countries.

Apart from the fact that Mr S forgets that Spain’s government debt is lower than that of Germany, he says in plain words that Germany is playing Chicken with the rest of Europe.

Could that end up as badly as Motorbike Chicken? I am not alone in fearing just that. Germany’s former Foreign Minister Joschka Fischer has written an analysis of the European problem. He ends it with the following warning: “Germany destroyed itself – and the European order – twice in the twentieth century... It would be both tragic and ironic if a restored Germany, by peaceful means and with the best of intentions, brought about the ruin of the European order a third time.”

It cannot be stated any clearer than this.