Friday, 26 February 2016

Follow-up on Italian banks

In a letter to Financial Times on 23 February, the Director-General of the Italian Treasury provides some info directly related to my previous post.

Vinzenco la Via writes that:

"Between the beginning of 2015 and the beginning of 2016, the Italian government introduced radical changes in the banking sector (...) The new system will exploit economies of scale, allow better use and allocation of skills, and permit better market access, while improving the management of non-performing loans.

Vinzenco, I love what you write.

My only question is: Why did it take you so long??? Where were you between 2008 and 2015?

I know. You were fighting the deeply entrenched interests in the financial sector which had put personal interests ahead of the common good. And various governments had been unwilling or unable to make a serious push to force the banks in this direction.

Has anybody got the guts to make an analysis of the costs to the society of not acting with far more resolve? I'm just asking..

Now I am curious about what happens in the French banking sector. Not to mention in what remains of the partially reformed savings bank sector in Spain.

Tuesday, 23 February 2016

Euro-Tarp? Maybe... look at Italy

In the dying days of the Bush administration, then Secretary of the Treasury Hank Paulson introduced a US 1tn program called  the Troubled Asset Relief Program, or TARP for short. Translated into plain words, it was an offer to the banks that the Federal Government would buy the worst stinking pieces of bad loans the banks carried on their balances. And it was clear that not too many questions would be asked.

It was a variation of one of the elements in the famous rescue of the Nordic banking sector in the 1990's. At that time, banks signed up to be rescued, the insolvent ones were taken over by the Finance Ministries, who then combed through the bank balances, hunting for the worst stinking pieces of bad loans. The bad loans were then folded into a company which was floated on the market with a time limited loss guarantee from the government.

In the Nordics, shareholders lost their investments and boards and management lost their jobs. In the US the management largely kept their jobs while the shareholders saw their holdings diluted severely.

However, in both cases, the action contributed to "clean out" the bank balances, meaning that the banks relatively quickly could get back to the core business of a bank: to receive deposits and lend money.

Not so in Europe. 8 years after the onset of the crisis, and two "asset quality reviews" later we are stuck in a situation large European banks are sitting with unrealised losses, which - if they were realised - would lead to the demise of the banks in question. I - and several others with me - have a sneaking suspicion that this state of things holds back European bank lending in a significant way.

Last week, the ECB gave a startling confirmation of the gravity of the situation.

Since 2015, the ECB has tried its own version of quantitative easing or QE. This of course refers to the programs whereby central banks in the US, UK, Japan and Canada have purchased enormous amounts of their own government bonds in the market. Some covered bonds, such as mortgage backed bonds have also been purchased. All in the purpose of forcing down interest rates, particularly in the longer maturities.

ECB faces a particular problem in implementing a QE, since its statutes prevents it from financing the individual governments by buying their government bonds. A compromise was found, whereby government bonds were eligible if bought in proportion with the shareholdings in ECB of the individual countries.

It would of course mean that ECB was forced to buy mostly German Bunds - even if it is a relatively small bond market. There are tons of e.g. Italian bonds on the market, but ECB cannot buy that many of those. Then there is some agency debt out there, but having to buy 60bn EUR worth of bonds each month seems to be a problem.

So ECB has had a brainwave: Let us buy some of the worst stinking pieces of bad loans the banks have been carrying on their balances. In casu the Italian banks, who suddenly admit to have a small sum of 225 bn EUR of bad debts they would really, really like somebody else to buy from them.

Which is possible for ECB if the Italian government is guaranteeing the debt. Once that obstacle is cleared away, we can start guessing which other banks are sitting on a mountain of bad debts.

In other words, the ECB QE program is now morphing into a Euro-Tarp. I am sure that the Germans are shaking their heads or even worse. I do not really care. The TARP program gave the US banks a headstart to recover even if bank regulators had to hold their noses while buying the bad debt.

Here in Europe we have had a very peculiar attitude. We want to punish the banks for doing a dirty on us all, so we want them to recover without any help. But we do not want to punish them so badly that the boards and bank managements were actually kicked out. So the "Swedish solution" was also excluded.

The result has been that it has taken waaay too long time for credit growth to return to Europe. It has held back consumption and investment. When we will be writing the story of the financial crisis in Europe, the lack of dealing properly with the banks will stand out as a monumental error.

So monumental that it will almost be on a par with the German insistence on draconian savings programs to curb government debt creation in an environment of weak consumer demands.

Monday, 22 February 2016

Cameron's nightmare - and EU's

So the UK got a watered-down set of modifications to the various EU agreements, delivered with sufficient gravitas that Cameron could declare victory and go home and call the promised referendum to take place on 23 June.

Anybody just vaguely familiar with EU's workings knew already that nothing substantial could be negotiated in a few months. Substantial changes require changes to the treaties, and with 28 member states it will take at least 5 years to change as much as a comma.

But now the referendum has been called - with potential disastrous consequences for EU, Europe and not the least, for the EU.

EU created peace
It is worthwhile to remember the historical roots of the EU. Since Germany created itself as a national state under the stewardship of Bismarck, the country always had the uncomfortable geopolitical situation of having strong and often bellicose neighbours to the east and to the west: Russia and France. Bismarck saw this clearly and built a national strategy on the necessity to be able to fight a two-front war. This national strategy touched upon education, infrastructure, industrial production and defense. The strategy required speed, mobility and technological and tactical advantages. It is probably not wrong to claim that Germany's situation today is a direct consequence of the geopolitical situation and of Bismarck's response.

After Germany had tried to "solve" the geopolitical dilemma twice, each time ending in defeat, the US influence over Europe led to a major geopolitical change. By putting Germany under the US nuclear umbrella and by uniting Germany and her erstwhile enemy France in a close political and economic cooperation, Germany could finally forget the need to fight two enemies at once. The existence of the EU changed important geopolitical parameters.

EU is in other words the political and economic "leg" of the post-WWII re-organisation of the European map. Together with NATO, EU has been spectacularly effective. So much so that people today forget how efficient the combo has been in preventing war in Europe. The 70 years of peace in Europe since 1945 has been one of the longest and most prosperous periods in the continent's war-torn history.

The Britons have always had an ambivalent relationship to EU: why participate in the club of losers (of WWII) when we were one of the victors? For centuries Britain managed to survive nicely by playing the other European nations against each other and profiting from her naval superiority.

And now?
Fast forward to today. Many brits appear to have forgotten entirely that they do not any longer dominate the seas. They do not any longer have colonies. And more seriously: The Americans do not any longer consider the "Special Relationship" between USA and Great Britain as particularly special. President Obama even told the Brits directly that Great Britain would be more useful to the USA inside the EU than out.

Europe has also lost in importance on a global scale. The larger powers do not any longer focus on the Europe. Instead it is China's growth, Russia's possible reemergence as a major player and the continued global dogfight over access to oil and minerals that dominate. Britain may have been good at manipulating the other European nations into wars for 400 years. That ability is just much less marketable today.

Zbigniew Brzezinsky, a former national security adviser to US president Carter put it brutally: Great Britain is not a geostrategic player… Its ambivalence regarding European unification and its waning special relationship with America have made Great Britain increasingly irrelevant (The Grand Chessboard: American Primacy and Its Geostrategic Imperatives (1998)).

A tactical error
In 2013 Prime minister Cameron feared a major incursion on traditional Tory ground by the UK Independence Party. In order to placate the notoriously loud Euro-sceptical wing of his party and in order to convince euro-sceptical voters of his own credentials in this department, he promised a referendum on "in or out", in case he was re-elected as PM.

At that time, not much looked as if it would ever happen. The Tories were lagging Labour in the opinion polls, UKIP seemed to be a threat, and the Lib Dems still had some credibility and were not at all foreign to threaten Cameron to switch sides if needed.

And then things began to pear-shaped. First there was the 2014 Scottish referendum on independence. Scotland was deeper divided than expected and the outcome too close for comfort (55% voted to stay in the UK, 45% against). The next act was the 2015 general elections. The Conservatives had nearly no representation north of the border. So Scottish voters who wanted to vent their frustration hit Labour hard. The party was viped out in Scotland and that alone was enough that an expected national majority evaporated. UKIP did worse than expected because of a very weak party organisation, and the Lib Dems were hit badly by the law saying that the junior partner in a coalition partner most often suffer badly at the next elections (ask FDP in Germany).

Suddenly Cameron had a majority in Parliament - and had given a promise to the right wing of his party to make a decisive referendum after a round of negotiations with the EU. He had solidly painted himself into a corner with no way out. Except of course by resigning, which is not on the cards for now.

The European refugee crisis has changed the dynamics in Europe as well as in the UK. By many voters not steeped in history, "migrants" of any colour and shape are seen as the result of Europe's open borders and flagrant disrespect for national values. Europe has certainly not handled the refugee crisis in a reassuring way, and it has given wind in the sails to illiberal nationalist parties across the continent.

Also in the UK, this particular political mood has gained strongly despite the weakness of UKIP. It is visible in the fact that Cameron's negotiation strategy has been to gain concessions on "migrants" even if the people in question are far from being refugees. Most often they are quite skilled labourers who quickly find jobs, particularly in the UK construction sector.

So the refugee crisis has in Cameron's strategy morphed into a general "bash the migrants" policy - which obviously annoys the eastern European EU members.

How bad could it end?
We may be heading towards one of those rare moments in history where one man's actions actually matter.  Cameron's wrong reading of the situation inside his own party in 2013 could now lead to the following scenario:

Were UK to leave the EU, Cameron will be toast having campaigned for UK to remain in the EU and will have to resign. His own party, the Conservatives, will suffer a deep division that will take decades to heal.

Both the EU and the UK ends up weaker and destabilised.

Egged on by national conservative movements, more countries will ask for substantial opt-outs, in particular in the fields of EU law and integration. Scotland will request independence from the UK as the Scots are firmly in favour of a continued EU membership.

The EU may end up being split and the UK may be torn apart. That could be the parting shot for independence movements elsewhere, in Catalonia, in Belgium and who knows, in Wales?

Cameron may still go down in history as the man who made the worst tactical gamble possible and refused to see the implications of it until it was too late.

And over in Moscow, Putin and his inner circle will be all smiles.

Friday, 19 February 2016

Same old, same old

Famously, the rapper Eminem declared "I'm back" on one of his albums and reviewers noted with some surprise: Has he been gone at all?

I have not been away, I have been working my blog under the name "Connecting the dots" and it is likely to reappear soon under that name soon. But until that is in place, I will publish my opinions here.

When I review what I wrote in 2012, it is surprising to see how little has changed:

QE is still in place, except that ECB has now replaced FED as the driver. Economic growth is still way weaker than politicians hope, and the reasons are the same: consumers are still saving too much and the European banks still carry too many bad loans on the balance in order for them to lend freely.

Japan remains an unmitigated disaster. Seen from the helicopter it is incredible that anybody is still surprised to see that a country with a rapidly shrinking population is experiencing negative growth.

The German establishment is still fighting against a reasonable European monetary policy, based on a mixture of angst and a rigid belief that rest of Europe must become like Germany in order for healthy economic growth to return to the continent.

Egged on by the Tea Party, US Republicans have taken further steps away from economic sanity - one would have sworn that it was impossible. The only good thing is that the political paralysis has created a situation where the economy has been able to recover healthily, undisturbed by ideological incursions.

A couple of things are new, though. Some countries have negative interest rates, Denmark, Sweden, Germany, Switzerland. Oil has fallen to comfortable levels. Russia is trying to reestablish Soviet era glory on the backdrop of an impending economic disaster.

And then over to a subject as relevant today as in 2012: The European monetary policy and in particularly the impact of the debt crisis on certain South European countries. Italy is of course the 800 pound gorilla in the room with a government debt in excess of 130 per cent of GDP and more than 2,000 bn EUR.

Add that Italian banks still drag a ton of bad debts along. 8 years after the onset of the financial crisis, many banks in Europe's south (broadly defined) have still not managed to write off the bad loans and move on.

Italy, German wise men and haircuts

I found this article and it is interesting reading. Apparently the German Council of Economic Advisors now recommend that before the institutions of the Eurozone will help a country with a bail-out, the holders of the country's debt will have to take a "haircut", i.e. a programmed loss of a certain percentage of the bonds. Rumours are that Finance Minister Schäuble is backing the proposal.

This breaks with a tradition that has survived even the Greek debt crisis: Eurozone countries holding debt of another Eurozone country will not suffer losses on that debt. Private debt holders, however, can lose money, as they did in the case of Greece.

By now gingerly suggesting that other countries must suffer a loss before help can be granted to a country in need, Germany will make sure that they will not be the only ones to insist on budget discipline. They simply obtain that everybody else will also stand to lose money. The effect is of course to avoid that Germany is the only villain to insist on budgetary discipline.

If the proposal is accepted by the other Eurozone countries, Germany will not be alone in resisting "frivolous" proposals from left-wing or populistic new governments in e.g. Portugal, Spain or, oh horror, Italy.

The Germans are understandably tired of being portrayed as latter day nazis imposing iron discipline on freedom-loving countries with young and dynamic governments, as it happened in Greece. The German proposal would remove the focus from Germany as the sole source of budgetary rectitude. Everybody else would have an incentive to put pressure on countries who habour pipe dreams of breaking with austerity demanded by the Eurozone.

It is intelligent, at least seen from a German point of view. To me it again looks as if Germany in its rigid adherence to the belief that every Eurozone country should become a mini-Germany continues to impose rules that simply imposes more instability in the name of stability.

The proposal will give other governments an incentive to put pressure on "irresponsible" governments. It will also give all investors a motive to sell government debt in the affected countries as soon as the word "bail-out" is mentioned.

Ideology continues to stand in the way of ending the economic crisis. Ideology prevents an economic policy that will support economic growth in Europe. Wonder if anybody has calculated the price Europe has paid as a result of a sluggish recovery over the past years.