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Edward Hugh is only able to update this blog from time to time, but he does run a lively Twitter account with plenty of Spain related comment. He also maintains a collection of constantly updated Spain charts with short updates on a Storify dedicated page Spain's Economic Recovery - Glass Half Full or Glass Half Empty?

Saturday, February 07, 2009

Italy Needs EU Bonds And It Needs Them Now!

You see, this isn’t a brainstorming session — it’s a collision of fundamentally incompatible world views.
Paul Krugman

As a wise man recently said, failure to act effectively risks turning this slump into a catastrophe. Yet there’s a sense, watching the process so far, of low energy. What’s going on?
Paul Krugman
First, focus all attention on reversing the collapse in demand now, rather than on the global architecture. Second, employ overwhelming force. The time for “shock and awe” in economic policymaking is now.
Martin Wolf

OK, I think no regular reader of this blog could seriously suggest I have much sympathy for the sort of views you normally find being propagated by Italy's Finance Minister Guilio Tremonti, but when he starts to send out the kind of red warning light danger signals that he has been doing over recent days, then I think we should all be taking note, and when the republic is in danger, then its all hands to the pumps, regardless of who is sounding the alert. This is not a brainstorming session, it is a real flesh and blood crisis.

Perhaps few of you will have noticed it, but our erstwhile logician has been getting extremely nervous in recent days, and most notably chose his visit to Davos to indicate that he personally would look extraordinarily favourably on any move to inititiate the creation of EU bonds (for a brief explanation of why these are important, see Wolfgang Munchau's argument in favour of such bonds here. (Or the longer version here)

Italy's Finance Minister Giulio Tremonti has said he favoured the issuance of government debt by the European Union. "Now my feeling -- I am speaking of a political issue not an economic issue -- is ... now we need a union bond," Tremonti said at the World Economic Forum in Davos. Countries in the euro zone currently issue sovereign debt in their own name, rather than regionally. Bond traders concerned about the mounting public debt of Italy, Greece and Ireland have pushed down the value of their government bonds, sparking speculation they might be driven out of the euro zone.

Now why would he be arguing this? Well the state of Italy's own banking sector would be one part of the explanation, and the fact that the Italian government is in no position to mount a rescue operation on its own given the size of its existing debt to GDP commitment, would be another. In particular, and as I have been arguing, Unicredit - and its Eastern Europe exposure - is a huge worry.

Indeed the situation is now so delicate, that according to this Reuters report last week, Unicredit really doesn't know which government to turn to. The Italian one perhaps, or the Polish one, or "it could consider doing it in Austria".

Italian bank UniCredit is considering requesting state support in Italy and Poland, a source close to the bank told Reuters on Thursday. "The bank does not exclude possible state support in Italy and Poland," the source said on condition of anonymity. In an extract of an interview to be published in Germany's Handelsblatt newspaper on Friday, UniCredit Chief Executive Alessandro Profumo said the bank could consider "state support as insurance against unpredictable events." If the bank does seek state aid, it could consider doing it in Austria, for example, he added.

UniCredit SpA is considering asking for government capital amid the credit crunch, Chief Executive Officer Alessandro Profumo said. “State support as insurance for unforeseeable events” is conceivable, Profumo told Handelsblatt newspaper in an interview at the World Economic Forum in Davos, Switzerland. A UniCredit official confirmed the comments to Bloomberg. Italy’s top bankers met with central bank Governor Mario Draghi last week to discuss the financial crisis, which has caused bankruptcies and government bailouts across the world, while stocks have plunged and credit markets have seized up. UniCredit and some of its rivals have tumbled in Milan since the start of 2008 amid concern about the strength of their finances.
Bloomberg 29 January 2009

The announcement that Unicredit was seeking state aid came on the same day that the bank admitted that investors had placed orders for only 0.5 percent of the shares they were offering in a rights issue. The bank received orders for a mere 14.3 million euros of stock out of a total of 3 billion euros, and the plan was to sell leftover stock in the form of convertible bonds, but even this hit a snag, as

The shares were offered at 3.083 euros apiece, or over twice what they were trading for in Milan at the time (around 1.408 euros). Shareholders, including Allianz SE and the Central Bank of Libya, are among those who agreed to buy the convertible bonds, according to the bank offer document. Shares of UniCredit have dropped 54 percent since October, when the rights offering was announced, amid concern the capital raising won’t be sufficient. But even the bonds issue is running into trouble, since Il Sole 24 Ore reported that Unicredit may raise only 2.5 billion euros rather than the full 3 billion euros because because investor Fondazione CariVerona, which holds a 5 percent stake in the bank, reportedly hasn’t received approval from the government to buy the securities, however, the reason they have not received approval may well be that they have not yet applied since the Italian Treasury, in what is a rather unusual step, said on Thursday announced that they had yet to receive a request from CariVerona to sign up for the bond issue. All this suggests, of course, that Tremonti's warning about an imminent bailout could be a piece of brinksmanship, designed to presssure CariVerona to stop playing "positioning" games and come up with the money, but irrespective of whether or not this is the case, some sort of rescue operation for Unicredit surely cannot be far away at this point.

And the fact that Bulgaria's Finance Minister Plamen Oresharski was running around last week assuring everyone that Bulgaria's banks have not asked for state rescue aid so far, and that the government is not worried about the banking system's health for now, is hardly helping to calm already troubled nerves. About 80 percent of the 29 commercial banks operating in Bulgaria are foreign-owned, with the biggest lenders being run by Italy's UniCredit, Hungary's OTP Bank, Greece's National Bank of Greece and Austria's Raiffeisen.

And only today Tremonti has warned that the announcement of more EU bank bailouts is imminent, and maybe as early as this weekend.

European governments may have to bail out more banks as soon as “this weekend,” Italian Finance Minister Giulio Tremonti said today. “So far in Europe there have been more than 30 bank bailouts and I can’t rule out that there will be more this week- end,” Tremonti said, speaking at a press conference after today’s Cabinet meeting in Rome.

So how should we address this danger, imminent or otherwise? At this point in time I have four proposals:

a) The creation of EU bonds
b) The introduction of quantitative easing by the ECB (quantitative easing is the monetary policy which is currently being applied in both the US and Japan, and probably soon in the UK too).
c) Letting those members of the East who want to join the eurozone immediately do so.
d) A new "pact" - one which would be much, much stronger than the old Stability and Growth Pact - to be signed by all countries who enter the EU bond system, a pact which gives direct fiscal remedies to Brussels in the event of non-compliance together with a substantial dose of effective control over the economies of individual countries - since nothing, Mr Sr. Tremonti, ever comes completely for free.

Obviously all of this is quite radical, and indeed fraught with danger, but these are hardly normal times. In all of this (d) is obviously the most important part, as any protection given to EU member economies by the Union must be credible and serious. So no country could or should be forced in, but it should also be pointed out to those who chose sovereignty and remaining on the fringes to participation that they would run an enormous risk. Since almost all EU economies seem vulnerable at this point, anyone staying outside could rapidly see themselves exposed to the risk of forced default, since lack of protection is simply an invitation to attack. Letting ourselves get picked off one by one is not an appetising prospect (Latvia, Hungary, Greece, Austria, Italy, Spain, Ireland, the UK, Romania, Bulgaria.........).

Clearly those who wish to remain "dissenters" should have the liberty to do so, but they should bear well in mind that should they do so they could very easily end up in a group - possibly lead by Diego Armando Maradona - together with Yulia Timoshenko (Ukraine), Cristina Fernadez (Argentina), Rafael Correa (Ecuador) and (possibly) whoever is the new prime minister in Iceland, bankrupt, and without the aid of international financial support to help deal with their mess.

Perhaps readers may think I am being rather shrill here, and perhaps at this point Tremonti (for whom I have no afinity, elective or otherwise, see linked post above) is only playing brinksmanship, but if he isn't, and Unicredit is about to need bailing out, then push does quickly come to shove, since the EU leaders agreed on October 12 in Paris to bail out systemic banks, and Unicredit is a systemic bank. So will will need to know how they plan to stand by their commitment, and if they don't, well then everyone of us stands exposed, since credibility rapidly falls towards zero.

Maybe this is a false alarm situation, and Unicredit will not need bailing out this weekend, or the next one, but one day it will, and one day Spain's huge non performing loan and household debt default problem is going to need sorting out. So I think this is a line in the sand situation, and we are much nearer to having to make up our minds which side of the line we are on than many seem think.

To paraphrase Paul Krugman again, in flirting with the idea of whether the first to default should be Greece, or Hungary, we truly are flirting with disaster.


Anonymous said...

Edward, pray calm down. A disaster, you say? What disaster? Will ten, or maybe thousand people die? Surely not. Will locusts descend on poor northern Italy? Again, surely not. So what will the disaster look like? One big bank laden with debt will fail. Oh yes, a lot of common people will lose part or most of their deposits. Tough luck. Happened hundreds of times before, the world is still turning.

Everything is better than having Germany, the Netherlands, France, Austria and even the Czech Republic paying for the insanity of UniCredit management, taken over by the Italian government.

I am afraid that the day must come when at least somebody pays for his sins. Otherwise, we will never learn.

PS I still have a few hundred thousand USD at my UniCredit account. Thus, hopefully, I can not be seen as "biased" against this lamentable institution.

Edward Hugh said...


"A disaster, you say? What disaster? Will ten, or maybe thousand people die? Surely not."

No, certainly not. Although be careful, this whole economic crisis does have a human dimension. One million extra people became unemployed in India in December, so more children in the north of India will surely die. This is a global crisis, and if our economic institutions fall apart then others will suffer. Suicide in Latvia is on the rise, alcoholism across virtually the entire CEE I imagine. But I don't use these kind of arguments since they are simply emotive.

"So what will the disaster look like? One big bank laden with debt will fail. Oh yes, a lot of common people will lose part or most of their deposits. Tough luck. Happened hundreds of times before, the world is still turning."

This is the attitude I think we can't take Hynek. We agreed on October 12 in Paris that no systemic bank would be allowed to fail. Unicredit is systemic - ie its like another Lehman brothers.

The debt from Unicredit would have to be assumed by the Italian state, like Parex has been assumed by Latvia. I have no idea what the actual exposure is, but it would be tens of percentage points of Italian GDP.

Italy debt to GDP is already 105% and rising, and credit downgrades are already inevitable. If Unicredit falls this would, in my cold, calm and objective judgement, simply drive Italy onto a dynamic where sovereign default would be inevitable.

But things wouldn't end there, since Unicredit is the largest lender in the CEE, so the banking system in all those countries would be turned over.

And behind Italy would come Austria, where the banks have massive obligations in the East - remember, if Unicredit fails it will be due to defaults in the East, not in Italy.

Then comes Hungary's OTP, and Hungary is gone.

And we haven't even gotten round to Spain, Portugal, Greece the UK and Ireland yet, where a very different set of problems are working their way out. So all this madness had to be stopped, and it has to be stopped now.

A line does have to be drawn in the sand, NOW.

I'm sorry if you find all this alarmist, but it is backed by quite careful analysis. More posting to come on all four points.

rytu said...

I'm an Italian living among Latvia and Russia. I saw from a very close look Parex bailout and what is happening in the latvian and Russian society.
Actually I don't know how big is Unicredit's exposition in CEE countries on the total, but I presume it'd be not so big (total CEE GDP is a small fraction of the countries's where Unicredit is very strong, Italy, Austria and Germany). So I guess it can afford losses in those markets.
What I'd like to know is why an eventually Unicredit bailout should be taken on Italy's debt.
I think it's more correct each country have to rescue it's financial system and bailout the local branches, according to the local situation and exit strategies (devaluation, deflation....)
I'd favourite a liberal approach, but it's only my humble opinion, anyway I think bad banks should have to pay for bad policies, households should have to pay for their reckless borrowing, governments should have to pay for communicating the sunstainability of currency pegs and expantion policies.
I'd like to see these kind of attitude, negotiating a volunteer currency convesion and a longer repayment time for forex loans, sharing the losses and extra costs among banks borrowers and government.
otherwise the ones who acted properly will not see any advantage in acting the right way.
what do you think on this? do you think it's a reasonable approach? and a realistic one?

Charles Butler said...

It was pure brinkmanship and was not directed at the EU, but to the home crowd which was playing hard-to-get. 6 billion private euros showed up in short order. A great deal of Unicredit's problem is a result of infighting amongst the board of directors.

Edward Hugh said...

Hi Charles,

"It was pure brinkmanship and was not directed at the EU, but to the home crowd which was playing hard-to-get."

This is entirely possible. It still doesn't conflict with the fact that they are inserious trouble, and that as the defaults keep coming in they are going to be struggling.

"6 billion private euros showed up in short order."

Well this weekend they seemed to have been only short of 500 million, and 250 million came from the Libyan government.

Libya's central bank will fill half of a 500 million euro ($645.5 million) gap in bank UniCredit SpA's (CRDI.MI) 3 billion euro capital raising measures, newspapers reported on Monday. Shareholders Fondazione Cassa di Risparmio di Torino (CRT) and Carimonte Holding will also take up about 230 million euros of the shortfall, Il Messaggero newspaper said. La Stampa said Libya's central bank would hold about 7 percent in UniCredit after the capital increase and become the biggest single shareholder.

The other 3 billion you are referring to seem to be coming from money not paid out to shareholders.

In addition to the capital increase, it will pocket 3.6 billion euros by paying out shares instead of cash to investors -- including the foundations which rely heavily on dividends for funds -- on 2008 results.

But at the end of the day, if you were Italian would you put your money in a basically bankrupt bank which was about to be taken over by the government and see its shares lose all their value. Only the Libyans seem willingly going down this road, and it would be interesting to know what they are getting in return.

As Reuters comment (and I agree):

UniCredit used to be seen as a beacon of international ambition among its conservative domestic peers, but the global credit crisis has turned the tables and now its exposure outside Italy is viewed as a vulnerability.

Edward Hugh said...

Hi rytu,

"I'm an Italian living among Latvia and Russia. I saw from a very close look Parex bailout and what is happening in the latvian and Russian society."

Oh, well this must have been very interesting. This is a very shocking affair, since it seems it can basically permanently bankrupt the whole country. Looking through the IMF standby loan document, I was amazed to find that as a result of this bailout national debt to GDP will rise from 8% in 2008 to 50% in 2010. Given the rapid population ageing they have coming and the serious economic growth problem they will now have, my feeling is that they will be unable to recover from this and will have to do sovereign default.

"I'd favourite a liberal approach, but it's only my humble opinion, anyway I think bad banks should have to pay for bad policies"

Well, exactly, but how do you make a bankrupt bank pay. This is the issue. The thing is the only "crime" of those Latvian citizens caught up in the Parex problem were those who happened to have their money on deposit there. Now such were the covenants on the syndicated loans contracted by the banks, those who provided them seem to have first call on any funds put into the bank over and above the depositors. I think all of this is grossly unfair, sending a whole country into bankruptcy because of the decisions and speculation of a few people in a bad bank, this is why I think the EU have to help them. We simply cannot accept this kind of injustice in our midst in the EU.

"but I presume it'd be not so big (total CEE GDP is a small fraction of the countries's where Unicredit is very strong, Italy, Austria and Germany). So I guess it can afford losses in those markets."

Well, CEE income was 23% of Unicredit income at the end of 2008, so it is about a quarter of its business, which is quite a lot.

"What I'd like to know is why an eventually Unicredit bailout should be taken on Italy's debt."

Well the problem are the loan defaults (for example in Ukraine it is estimated that 60% of housing and commercial loans are going to be in default, Russia will hardly be better) if these don't go onto Unicredit's balance sheet then I don't know where these numbers are going to go. The German banks took a huge hit from the US sub prime meltdown. Italy's will possibly be even bigger in Unicredit from the CEE. The thing is the US sub prime meltdown was very rapid, due to the multipliers in the CDs etc, while the defaults which follow devaluation and deflation in the East will be slower (more like Spain) and will eat away the vitals of the banks as the default rate rises, maybe over two or three years, at the end of which Unicredit will be well and truly done, I mean they are wobbling now. And of course you have at least a two year recession in front of you in Italy, and this will not be without bankruptcies etc.

But I'm not sure what you expect to happen. Should the Italian government simply say the Unicredit is a bad bank, let it go, and the Italian depositholders lose their money, is this what you are advocating?? I don't relly understand. Should we all go back to year zero and start again?

"what do you think on this? do you think it's a reasonable approach? and a realistic one?"

Well basically, I don't, think it realistic. I mean we are talking about systemic problems, not bad decsisions. The people of Spain were not responsible for the decisions of the ECB (or no more responsible that the rest of Europe's citizens) and they should not be singled out by losing their jobs, and their homes, and finally having a sovereign default simply because a one size fits all monetary policy (which few of them understand) didn't work.

Also, looking at what happened after Lehman Brothers went, nor do I think it realistic to let one European state after another default, ultimately breaking apart the eurozone, with unknown consequences for the entire global financial system. It is my view that we have to avoid this outcome at all costs.

Anonymous said...

Hello everyone and thanks again to Edward for this and other similar posts, because imho they aim directly at the heart of the current crisis.

I guess that at the moment we should really draw a line in the sand. Essentially, we should decide whether we are ready to accept losses now or transfer them to the future generations.

If we decide that enough is enough and that there will be no more taxpayer money poured into the apparently bottomless pit of UniCredit and similar institutions, some of them (but not all of them) will fail and most of us depositors will take a hit. At the same time, EU GDP will drop and we will be worse off. However, we will have the opportunity to learn again that i) banking must be done prudently, ii) we can not afford to have banks that are too big to fail, because they will simply extort us, iii) recklessness, hubris and mismanagement at the level of top corporate management is not tolerable and must be punished (by prison terms, if necessary), iv) state regulators must do their jobs and not look away, and v) credit is a fine thing, but good old unfashionable capital is better.

On the other hand, we may decide that we do not wish to take losses now and would like try to transfer them all on the state level. If a nation state is not enough, then we will create an even bigger state. And, we will all sit and pray that such a megastate will miraculously absorb the losses and save us from harms way.

The obvious risk of the latter approach is that the now unrealised losses will be realised in the future, for example in the form of massive taxation, growing unemployment and economic decline, plus political control over most of the economy. This would, in effect, be fairly similar to what we had here for four decades, and what ruined the once thriving Czech economy almost beyond repair.

In my opinion, there would also be a risk of massive inflation, return of protectionism and violent nationalism and the resulting significant risk of the eventual uncontrollable breakup of the megastate, with all the possible dire consequences.
Sure enough, I can not imagine France fighting Belgium, but I can all too well imagine some of us Easterners doing nasty things to one another, plus innocent bystanders.

So in my opinion, we should get ready, take a hit now and start learning again how to run a prosperous economy, not a Ponzi scheme.

Best wishes from Prague.

rytu said...

Hi Edward,
sorry for not being very clear at the beginning of my post. I was reffering to Unicredit case not to Parex's one. For sure they are completely different.
I agree Latvian government had to solve some of Parex's problems but I'm not sure they way they took is the proper one, I mean depositors must be saved because they did not take any risk in putting their money in the bank and also to prevent financial system's reputation to melt down with all the people taking off money to put in the pillows. But apart of that, I assume the government doesn't have to go.
We now see that Parex bank, Latvian Central Bank and the government are very short in information regarding parex's liabilities, toxic assets, total amount of money they need to save the bank etc... and for what? just to keep things going on as usual? (little example, in december Parex bank issued a huge loan, with state money, to "Global Fashion Gruop" just one week before the company was filed for bankrupt).
So my approach would be: first the bank that asks to be saved take out all the information about their losses and their nature (it's astonishing that after 2 years I still hear that none knows how much the toxic assets are and where they are, who they hold. and we are talking about systemic banks with ipercontrolled and certified balances, by many different institutions), I mean the same you'd do when you ask a bank to give you a loan or to a company to buy you out. After that you have to divide the assets that have to be rescued (depositors, loans in bonis ...) from the others than may afford losses based on the risks they assumed. I understand that there are some "grey" positions, as for the investors who put their money on AAA certified instruments, virtually risk free, and now they have zero value in their hands, but not all are this way.
Coming to Unicredit, I've to say I always looked positively to Profumo's attitude and strategies, i.e. expantion abroad, investing in emerging market, pulling off from the Italian "relational capitalism", but in the last years he gave false or unclear information to the market, so basically he did a good job, he earned a good money for that, but now it's time someone else goes there and put the things out.
After that we see what we have to do. and decide who deserve to be saved and who it's better to lay down.

I think there are some systemic adjustments to do, but all these claims of new world rules and a general bailouts lack of perspective. First of all we need to come back to something that once was said to be the basis of the anglosaxon societies, accountability, today we see every system lack of it.
I think we need few rules, basically we have them, the problem is that they were not applied and/or the institutions that had to check simply failed to do it (remembering the fabulous net profits, or the AAA ratings...).

Coming to our case, Unicredit, it's fare it need to write all the CEE losses in its balance sheet, but we also need to see that every branch just operates with it's own rules, basically not because bank policy but because they have to act according to local rules and laws, and any branch has its own problems. Baltics have different problems than Poland or slovenia or Slovakia, or CIS coutries. So I agree all of us have to help CEE coutries, the point is how. We need to know if the banks created the problems to those coutries or CEE states created problems to the banks. i.e. I think that the foreign banks helped the baltic states to be where they are now, I mean almost at western european level and not in the group with Armenia and Georgia, just to mention 2 ex USSR republics. For sure their lending policies were "insane", expecially in the last years, so they have also to write some losses in they balance sheet, for many years, and this is not a problem so huge as the bankers may think (FIAT's CEO Marchionne says that for an Industrian CEO a loss is always a thing that may happen, it's a part of the business, for a Bank CEO it's simply impossible, it does not exist in their minds). Expecially after years of big profists (as you said CEE profits represents 23% for Unicredit, I could be wrong but I don't think CEE represents also 23% of the Unicredit's turnover).
Also the people who borrowed without any perspective of the risks have to pay for that, in terms of major expenses and minor wealth in the future.
But forex lending is a direct consequence of the governments (and the people that elected them), so if the debts has to go to 50% or above of the GDP that's what they have. EU, IMF, MB have to help those coutries, but I'd do this way. otherwise what do we have now? In Latvia the peg is still there, and we have -10,5% in GDP now, probably they will spend all the 7.5 billion loan they took without solving the problems, banks are still showing 2008 balance sheets with good net profits with no sense of humour, no perspective of any business to be started there.
So I think each coutry have to intervene in their economic system, and them in their financial system, because there are countries were the production system is good and others where it's simply collapsed, and they need different medicines.
i.e. Unicredit in Italy is simply a sane institution, and more important the financial system is quite strong. Italy will not face bankrupcies like CEE or Spain, Italian "cajas" are full of money not like the Spanish local banks, Generali is probably the best insurance company in the world now. In Italy they have, one of the few in the world, the FITD interbanking fond for deposits protections, and now the deposits are ALSO baked by the state.
So coming to the worst event, I return to what I said at the beginning (but it's the opposite of what is happening), new executives, all the info on the desk, protection of depositors and other privileged figures (this is assured in any case in Italy), some state baking but after that a bad bank should go down, they have to sell all the shares in industrial companies, then they have to sell all their fonds, all the foreign branches, if not sufficient, divide what remains and sell it to all the other Italian banks that have the money to buy and to run the business.
So it's true it's almost sure the banks cannot fail, but we have to decide how to do it. we had few cases in the past years, but even a moloch like unicredit, can be absorbed by Italian system (105% of debt on GDP, but also a very low households and companies' debt level; public and private wealth of around 900% of GDP...)

Sorry for the lenght of my post, but I had many ideas, probably I did not put all of them is the right frames and I miss many information as I'm not an economist, also we had a lot of beef here, Baltics, Italy, Parex Unicredit.

Thanks for your time and for the excellent work of your blogs

rytu said...

Hi again,
just to say I mostly agree with Hynek Filip, there will be losses, there will be a GDP contraction and a new businees model, that probably will be the same old fashioned one. Finance is good, speculation is good, I like it when it explicits and actualizes market tensions and imbalances, but capital is capital. Sometimes running a business with huge leverage and debt can be better than with own capital, but this can't be right in every case as everyone seemed to believe till some days ago.

I don't see a close risks of a macro monster state, what I really see is the Scandinavian example. Everyone now looks admired to how they bailed out their banking systems in the 90s, but we have to keep in mind that:
1. it's very difficult to find elsewhere their moral standard. I even don't want to imagine how an Italian administration, or Spanish or from CEE can manage real estate assets taken from the banks. In the Scandi states they say they did even plusvalences, I don't know if it's really true, but I remember how in Italy the apartments were sold, to the friendo of friends for ridicolous amounts.
2. must important, the Scandinavian states had a severe GDP contraction, they had to change their society models, and above all they are at the same point, again in need to bail out the banking system, as they did not learn anything from the past. we are looking at a clear moral azard, they banks don't need to be run prudently as there will be someone else to cover the losses, in the 90s, in the 2009, and another time in 15 years, in another place of the planet with another bubble.

I'd have liked to see what would have happened to the commodities and energy's speculation without this crisis. Again, I'm not against speculation, it's very useful generally, what make me wonder it that there are some bank that can predict oil price at 200$, the same bank has a trading division that can move as much money (not real money but just paper) to influence the market, and at the end they are also the market regulators and controllers.
I'm a fans of free market, but this is not it. I don't like to limit company's dimension, untitrust it's enought and even too strikt in the EU model, but even you are too big, you can't play more than one role, you take your decision and earn or pay for them, by losses or by prison in case, as Filip said.
Accountability is a good basis for prudence

Edward Hugh said...

Hi Hynek and RTYU,

Just to say I am reading what you say. Since you so much it is hard for me to simply come back just like that since time is pressing. Do keep checking back, although it may be the weekend before I find the time.

What I would say is that it is interesting that one of you is Italian and the other Czech. Do none of the Spanish readers to my blog have anything to say about all this, since obviously Spain stands to be either the largest beneficiary (I calculate you need somewhere in the region of a 500 billion euro fiscal injection to put things straight) or biggest loser in the short term.

Of course, as Hynek and RTYU argue, you can then be "reborn" over a five to ten year horizon. So which is it to be?

Edward Hugh said...

Hey Charles,

Look at this. They can't even raise the small change to finance Core Tier 1, Intesa Sanpaolo (their rivals) have to lend the money to keep them afloat. I don't know what you call this, but I call it really strapped for cash.

Reuters today:

Libya on Monday confirmed it would subscribe to 250 million euros of the overhang, while CRT foundation said in a statement 190 million euros would be plugged by it and other leading shareholders. But the two foundations only put up 60 million euros of cash into a special vehicle to subscribe to the outstanding issue, with 70 million euros coming from debt and 60 million in convertible bonds, the source said on Tuesday. UniCredit's domestic rival, Intesa Sanpaolo, had said earlier on Tuesday it was discussing financing with Carimonte and CRT to allow them to subscribe to the issue.

My feeling is that Unicredit are as bankrupt as you once suggested Lehmann Brothers was. The n they were allowed to go, and just look what happened in September, the whole global economy started to slide off a cliff.

Anonymous said...

Hello again. As we are discussing the Spanish watch posts, I just wonder when a major Spanish bank will start feeling the same pain as UniCredit. Who is going to follow the UniCredit example? Santander? At the very least, the Czech subsidiary of Santander is a bunch of clowns (sorry for that, but I just lack the appropriate vocabulary), whilst the Czech UniCredit seems to be a decently managed financial institution (I have done quite a bit of debt collection and/or portfolio review for both).

Now, I would like to expand my remark re the necessity of mismanagement being punished.

As you may know, the Czech banking market is dominated by three big banks, these being CSOB (owned by the Belgian KBC), CS (Erste Group) and KB (Societe Generale). The Czech UniCredit is, in fact, much smaller than any of the top three.

From 2000 to 2003, I was head of section at KB, responsible for collection of small corporate debts and all loans to bankrupt, liquidated and fraudulent entities. At that time, the nominal amount of the portfolio under my watch accounted for some 10-20% of KB loan portfolio. So, I may be a bit too accustomed to banks having far too many bad loans :)

On the other hand, it is useful to know a few accountability-related facts from the KB story:

The bank accumulated total losses of some EUR 3 billion, was saved by the state at the cost of about EUR 2 billion and was sold in 2001 to SocGen for a bit more than EUR 1 billion.

In 1999-2000, that is prior to the sale to SocGen and as part of the state bailout, eight of the nine KB directors were fired. Of the deputy-directors and section heads, about 80 per cent were forced to leave. In risk management and debt collection, all (all without exception) managers way down to the level of Board - 3 were replaced.

Moreover, six of the former directors, several deputy directors and section heads, plus a few other staff, were charged with serious criminal offences (such as criminal negligence or participation in credit fraud). Even though just one trial has been completed to date, there have already been fairly stiff prison sentences.

At the same time, the only task of KB bad loan departments of that time was to get the money back as soon as possible. There were no limits on foreclosures, bankrupties, liquidations, executions, out-of-court collection and whatever else can be used to get the money from the delinquent debtor back to the bank. You simply went after the debtors with whatever you could find in the book. Interestingly enough, this went on under the French management until the bank was stabilised to their full satisfaction.

My point is that I can pretty well imagine the same approach being applied to various UniCredits and banks and cajas across Europe.

You need the state to step in?

Fine, we step in, all of you step out now, no bonus to most, police interview rooms to some. Your risk management staff is unemployed as of now, your non-performing assets will be reviewed with a microscope, and may God have mercy on those who bought some crap paper and relied on its triple-A rating. Finally, your debtors will be made to pay with all means available.

I would suppose that the eurozone banks are still much better off than my employer ten years back, so this kind of treatment might not kill them, and might even save us all some money.

Edward Hugh said...

Hi again Hynek,

"I just wonder when a major Spanish bank will start feeling the same pain as UniCredit. Who is going to follow the UniCredit example? Santander?"

Well the thing is this, the fiscal situation of the Spanish State is still much better than the Italian one. Debt to GDP is still quite low - around 39% in 2008. So, following the decision of the main EU states in Paris on October 12 no bank will be allowed to fail, and especially a systemic one like Santander till the state runs out of borrowing capacity. The difference with Unicredit is that the Italian state has already run out of borrowing capacity, and so either Unicredit goes broke, and the whole credibility of EU commitments falls, with an accompanying sharp drop in the euro and increasing speculation about which will be the next bank to go and a general atmosphere of financial panic, or.....

The EU will back up its commitment, Unicredit will be rescued, and the most likely mechanism will be EU bonds. At least this is how I see it, I don't think there is a third choice here, either let Unicredit go like Lehmann Bros went, and maybe Deutsche Bank soon after (for example, and don't laugh the cds on Deutsche bank are hardly a laughing matter), or start getting the cheque book on the table.

Any melt down in Spain would be a virtual mortal blow for the German banking sector, after the beating they have already taken in the USA, and the internal bankruptcies they are facing with the very sharp GDP decline they are having (obviously the Czech Republic is simply gone by this point, down there with Ecuador and Argentina given your export integration with Germany). Of course it doesn't have to be like this, but if people want it that way, that's the way it will be.

Also Austria will be right out after Unicredit, since their banking system will never stand the shock from the East without Brussels support.

Spain's banks will start to fall like flies, in my opinion, around 2011, as the ability of the Spanish government to keep funding them starts to get very restricted.

They should stagger through to that point, because I doubt the government would let them fall before they had run out of ammunition.

Anonymous said...

Well, since Angela Merkel announced that EUR 3000 per car will be paid to those who exchange their old cars for new ones, and since the koruna went down to CZK 28 per euro, our export dependence on Germany looks much better. In fact, the German poor go for the euro handout in vast multitudes, but then they buy cheaper Skodas or Czech made Peugeots (Skoda actually cancelled most production cuts and is running at a fine tempo again, while the Toyota/PSA joint plant near Prague apparently did not have to make any production cuts at all). Such may be the effects of well meant state interventions into the economy - you spent the cash, but somebody else (eg Toyota, the Czech taxman, and the Polish workers in the Kolin plant) pocketed it. A real nice try, Frau Merkel, please do try again...

Back to Santander. You made a most interesting point that the Spanish government will probably keep the banks on life support till 2011, that is until it runs out of money. It actually corresponds with the Czech banking story of the nineties, when the government tried to find every possible excuse to keep the banks afloat. It also took the ministry of finance some three to four years to realise that there is no way out and that the banks must be i) stripped of the most toxic assets, ii) relieved of the incumbent and mostly incompetent management, iii) sold asap.

Anonymous said...

Hi Edward,

finally one spaniard on the comments on Spain, ;)

regarding this comment:
"Spain's banks will start to fall like flies, in my opinion, around 2011, as the ability of the Spanish government to keep funding them starts to get very restricted.

They should stagger through to that point, because I doubt the government would let them fall before they had run out of ammunition"

So probably the banks will not manage to clear their balance sheets by 2011, also Spain public finances are exhausted and can not longer support them. Do banks really know they are going down?? Incompetency is spread, but most powerful people are not that stupid. So they are just buying time? For what?? Who is winning/interested with this scenario? Banks going under with the state behind seems doom day. Citicens would prefer banks going down if we can manage to save the state from bankrupcy. How likely is this scenario to happen, 50/50? 70/30? Revelions in street are certain if the situation is that clear. And also, what can normal people do? pray hopelessly?

In any case, better know what's comming. There is a saying in Spain: "Un hombre informado es un hombre libre", which translates in "a well informed man is
a free man". This time, seems that even being informed will not be enough.


Edward Hugh said...

Hi Hynek,

"It actually corresponds with the Czech banking story of the nineties, when the government tried to find every possible excuse to keep the banks afloat. It also took the ministry of finance some three to four years to realise that there is no way out and that the banks must be i) stripped of the most toxic assets, ii) relieved of the incumbent and mostly incompetent management, iii) sold asap."

Very probably. I largely agree. The problem is (iii) at this point, since this crisis is a global one, and while some banks are better than others, no-one will want to buy banks at the moment until they have had the de-tox, and in Spain even less so, given the incredibly bad macro outlook (again, remember at this point the CR was just about to get a strong burst of catch up growth, all Spain is going to get is a large and long lasting correction and then a pensions crisis).

Basically, someone would only buy Santander to strip out their best assets (the Brazilian bank) and the resell. The domestic retail outlook in spain is very bleak, and the UK can hardly be better.

Edward Hugh said...

Hi Jaime,

"finally one spaniard on the comments on Spain, ;)"

You know, my feeling Jaime, talking to people, and looking into their eyes in the metro, fear is the big problem in Spain at the moment. The people who religiously support political parties are stupidly putting the view of their party, and blaming the others (and thus are obviously not interested in a blog like this), or know that most of this shouting (and tertullias) is a load of nonesense and waste of time, but drawing the conclusions that we are going to a very serious situation, and no one at the top, on either side, Knows what they are doing is, well, frightening, and actually, even though people outside don't realise this, a lot of Spanish people are actually quite timid, so they look on in horror, but stay silent. The ones with the biggest mouths are usually the ones who understand the least.

"Do banks really know they are going down??"

Oh, they know the risk at the BdE, but what do they do. The politicians rule. I have a friend who works in a university department here, and is a specialist in bankruptcy and write downs, and he has been commissioned to do a study as to whether it is better to buy up and hold bad assets (like unwanted houses, debts), as they did after 1992, to resell on the upside, or do fire sales now and get the thing over with (as they are doing to some extent in Ireland. So they do realise the danger, but they just don't know what to do.

And builders and developers have too much influence over politicians of both parties.

So it really is a big mess, "un quilombo" as the Argentinians say. As in:

¡Vaya Quilombo!

"How likely is this scenario to happen, 50/50? 70/30?"

I don't know. Very hard to quantify. All I can say it is very likely to happen if there is no serious move at EU level.

Basically the problem is, it is a much more interesting investment at the moment to bet on widening sovereign spreads in the Eurozone that it is to invest in plant and equipment in Spain, and that is how bad things are.

If they can leverage the thing wide enough to break te eurozone apart, then there are riches more than the heart can dream of to be made in a very short period of time for those who would play the currency swings on a eurozone break up. This would have to be the quickest way to get rich in town at present, which is why we must make sure it doesn't happen.

A few people making massive profit from the ruin of millions is never a good idea.

Edward Hugh said...

Also, since it is very much to the point, I am putting up Martin Wolf's piece from today's FT.


Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. Today, the new US administration can disown responsibility for its inheritance; tomorrow, it will own it. Today, it can offer solutions; tomorrow it will have become the problem. Today, it is in control of events; tomorrow, events will take control of it. Doing too little is now far riskier than doing too much. If he fails to act decisively, the president risks being overwhelmed, like his predecessor. The costs to the US and the world of another failed presidency do not bear contemplating.

What is needed? The answer is: focus and ferocity. If Mr Obama does not fix this crisis, all he hopes from his presidency will be lost. If he does, he can reshape the agenda. Hoping for the best is foolish. He should expect the worst and act accordingly.

Yet hoping for the best is what one sees in the stimulus programme and – so far as I can judge from Tuesday’s sketchy announcement by Tim Geithner, Treasury secretary – also in the new plans for fixing the banking system. I commented on the former last week. I would merely add that it is extraordinary that a popular new president, confronting a once-in-80-years’ economic crisis, has let Congress shape the outcome.

The banking programme seems to be yet another child of the failed interventions of the past one and a half years: optimistic and indecisive. If this “progeny of the troubled asset relief programme” fails, Mr Obama’s credibility will be ruined. Now is the time for action that seems close to certain to resolve the problem; this, however, does not seem to be it.

All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency.

Under the first view, the prices of a defined set of “toxic assets” have been driven below their long-run value and in some cases have become impossible to sell. The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses. This was the rationale for the original Tarp and the “super-SIV (special investment vehicle)” proposed by Henry (Hank) Paulson, the previous Treasury secretary, in 2007.

Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities. The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad – on sovereign, housing and corporate debt – will surely fall on US institutions, with dire effects.

Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. This choice is surely a “no brainer”.

The new plan seems to make sense if and only if the principal problem is illiquidity. Offering guarantees and buying some portion of the toxic assets, while limiting new capital injections to less than the $350bn left in the Tarp, cannot deal with the insolvency problem identified by informed observers. Indeed, any toxic asset purchase or guarantee programme must be an ineffective, inefficient and inequitable way to rescue inadequately capitalised financial institutions: ineffective, because the government must buy vast amounts of doubtful assets at excessive prices or provide over-generous guarantees, to render insolvent banks solvent; inefficient, because big capital injections or conversion of debt into equity are better ways to recapitalise banks; and inequitable, because big subsidies would go to failed institutions and private buyers of bad assets.

Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress. Yet why does a new administration, confronting a huge crisis, not try to change the terms of debate? This timidity is depressing. Trying to make up for this mistake by imposing pettifogging conditions on assisted institutions is more likely to compound the error than to reduce it.

Assume that the problem is insolvency and the modest market value of US commercial banks (about $400bn) derives from government support (see charts). Assume, too, that it is impossible to raise large amounts of private capital today. Then there has to be recapitalisation in one of the two ways indicated above. Both have disadvantages: government recapitalisation is a bail-out of creditors and involves temporary state administration; debt-for-equity swaps would damage bond markets, insurance companies and pension funds. But the choice is inescapable.

If Mr Geithner or Lawrence Summers, head of the national economic council, were advising the US as a foreign country, they would point this out, brutally. Dominique Strauss-Kahn, IMF managing director, said the same thing, very gently, in Malaysia last Saturday.

The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once. It is an important, but secondary, question whether the right answer is to create new “good banks”, leaving old bad banks to perish, as my colleague, Willem Buiter, recommends, or new “bad banks”, leaving cleansed old banks to survive. I also am inclined to the former, because the culture of the old banks seems so toxic.

By asking the wrong question, Mr Obama is taking a huge gamble. He should have resolved to cleanse these Augean banking stables. He needs to rethink, if it is not already too late.

Anonymous said...


"If they can leverage the thing wide enough to break te eurozone apart, then there are riches more than the heart can dream of to be made in a very short period of time for those who would play the currency swings on a eurozone break up. This would have to be the quickest way to get rich in town at present, which is why we must make sure it doesn't happen"

Who is "they"?? Who is betting? I thought big banks are (near) insolvent, investors wiped out, countries leveraging fast... are we talling here about an elite of investors/organizations?


Edward Hugh said...

Hi again,

Who is "they"??

You and me, if you have savings, or a pension fund.

"Who is betting?"

Japanese housewives, everyone with a home trading platform.

"investors wiped out,"

You've been reading too many popular newspaper headlines. Everyone is in treasuries at the moment, but they are dying to come out. Didn't you notice the commodities rally last week when everyone thought the China stimulus plan would work, there is "loooaaaaaaaaaads" of money out there, but no credit :)

For everyone who bought an overpriced house, someone pocketed the money from selling it. The problem isn't that there isn't money, the problem is that noone wants to lend to high risk people like the Spanish. Maybe they will start lending in India, in Brazil, once risk aversion subsides, but meanwhile if you can place short term bets that the Greek spread will rise, then why not.

The irony here is that "the specualator" might even be a Greek citizen who has his money in a fund looking for yield, who is looking for protection against the looming bankruptcy of his country's pension system, but is inadvertently provoking it.

As I say, the best solution would be to return creditworthiness to Spain as soon as possible, but to do this you need a credible correction programme.

Edward Hugh said...

"Who is "they"?? "

In other words "they" is "us", but in the Spanish case it is simply the rest of the world, despite Miguel Sebastian we now need them more than ever, and we need them to be able to believe in us.

(Crickey, I can't believe I just said that, I am not even Spanish :), Catalan at best :) ). Still, this is now my country, right or wrong.

Edward Hugh said...


If you want a better idea of what is going on, stop (completely) reading the Spanish press, read Bloomberg, and FT Alphaville blog. ie, the exact opposite of what Sebastian recommends. I'm sure he doesn't deliberately want to keep people ignorant, but this is the result he would get.

On Bloomberg you'll soon get an idea of what "investors" are up to, and remember, investors are not economists, they do not (in general), eg, understand what is going on in China.

rytu said...

Hi Edward,
very interesting comments to this post.
I also se my opinion is not so lonely, as I feel to agree with the FT article too, expecially regarding solvency issues and the total amount of losses to face, or the strategy on how to rescue financial institution and/or creditors, or the approach to new/old bad/good banks...

What I want to underline is that all has been done till today and waht is planned to do are simply not working. Everytime we see a very big amount of money put in the hole, being said that now the system has been stabilized, and after some weeks we see a much more huge amount of money poured in, listening that this is the masterplan to solve the whole problem. I fear we will see this scene again and again.
So let's understand someone, maybe a lot, will have to face losses and all of us have to suffer and work harder for a whyle. but it's very important that the people/institution that will suffer losses should be the right ones.

I don't want to be semplicistic, a GDP contraction is not just step back to 2007 or 2005 level, I assume a -3% means large unemployment and bankroupts, not to mention a -5% or a -10%. But what I see here is not a choise between a bailout plan paid by the state or the EU (whole tax payers) and a 5 years deep crisis with a rebound. What I really fear is that all these plans will simply not work, so we will have an enormous burden of debts on the shoulder of govenrments and any other institution involved and the same a meltdown outplaced for only a couple of years.

more or less it's like when you say that the deflation strategy will not work in Latvia, so we will see anyway all the bad thigs we want to avoid and at the end they will be forced to devalue, buying some months at the price of 7.5 billions € and the distruction of production system.

rytu said...

I want to share also an insane idea.
Assuming that we are not in a shortage of capital, as almost all agree there are a loads of money waiting to be invested, and that the credit crunch is largely due to the lack of trust in the financial system and among it's members, we have the bigger issue represented by the solvency of the systemic banks.

So, as I said in my previous posts, 1- removing the executives who proved they failed or simply they are not good for all seasons; 2- expliciting the real value of the losses and toxic assets (meaning the bank's share will finally reach the bottom and private investors will start again to buy), in order to restore a sufficient level of trust; 3- rethink some basic rules. Tremonti said we need more rules and not more capital. I agree with these words but not with the sense Tremonti wants to give to them, I don't want an hyper ruled system and I think it's even impossible to create it and make it works. But there are many thing that proved to be completely wrong, like the algorithm to create or to evaluate many financial products, that asserted the risk was virtually abolished. I mean, I see positively that a bank issues loans also to subprime or ninja clients, and that it can create and distribute risks packing financial products backed by those loans, but it's impossible all of them have a AAA rating. Avoiding this the whole system slow down lowering the risks. Yes we don't have the so called "turbo capitalism", but it's more sane that the capitalism lays a little more on real economy.

Well, once coped with all of that, that seems really impossible to me as thing are turning around now, let's come to the insane idea. One professor of mine used to say, as a joke, that no company ends its activities due to losses, but only for lack of liquidity.
I'd allow banks and some other financial institution to waiv from orthodox insolvency rules. I mean once they take out their losses and bad assets (surely they will overcome the liabilities) they will find themself in technical insolvency, and I'd allow them to carry on the business, providing the liquidity to go on by central banks intervention. FED and ECB showed they can afford this strategy, other CB have to be backed by their governments or by international institution.

I think this will stabilize the system, dividing the good banks that will grow up fast, from the bad and the worst, that will be absorbed or forced to cope with their losses and size down, but with no systemic shock and with a mid-term time to do it.

Thanks a lot for the patience of all the readers of my free toughts

Anonymous said...

Reading the last news from Ireland (deflation, combined with a massive bank bailout, combined with a collapse of the housing market, combined with severe debt collection restrictions), I would suggest that you move Ireland way closer to the top of your list of potential failures, maybe right behind Hungary. Why on Earth does Hungary not have a triple A rating? What a farce.

Edward Hugh said...


"Why on Earth does Hungary not have a triple A rating? What a farce."

Because Hynek, Hungary is raelly indanger of default over the next 3 years. I have been following this economy since 2006. It has simply deteriorated and deteriorated, and now is near to the point of no return, if the EU doesn't really take it under its wings. Check the posts in the top right hand sidebar on my Hungary blog. It is a clear case of the love male life expectancy, ageing population, population decline trap which now awaits so meany CEE economies.

This is no way detracts from what you say about Ireland. Ireland and Spain are more or less in the same boat.

All the wires are alive with a huge EU bailout which is being prepared, to dwarf all the USA ones. The Telegraph is talking about 17 billion pounds in debts that need sorting out.

My impression is that all this is being kept totally under wraps at the moment to avoid panic. A big chunk of this will be UK debt, andother big chunk will be German.

The numbers are totally daunting. My feeling is that the sudden disappearance of Michael Glos as German economy minister last weekend may have been to do with his unwillingness to sign onto what is coming.

Tremonti also makes more sense in this context. All will be known at the end of February apparently. Or at least, not all, but more.

Anonymous said...

That was obviously a rather politically incorrect joke. I have read most of your Hungary blog posts and, visiting Hungary at least there times a year, I completely agree with nearly all you say about that unfortunate country.

I meant that if Ireland deserves an AAA, then Hungary does too, because ratings-wise I can not see a big difference between the two (well, Ireland with fall from a bit higher level).

On the other hand, I can not really see how a mega EU bailout would - institutionally - work, especially with regard to the non-eurozone countries. I can easily imagine the ECB bailing out Ireland (by means of buying out their bonds), or maybe helping Spain. But, apart from that, well, it seems to me just a conspiracy theory.

By the way, I do believe that the ECB (aka Germany) will need to and will have to bailout Ireland sometime soon, otherwise it would be Ireland going broke fast and furious.

Edward Hugh said...


"That was obviously a rather politically incorrect joke."

Yeah, I can see that now, and I was obviously reading far too quickly and far too literally. It has been a hectic day. I am trying to work out whether China is about to swing upwards or continue on down.

Incidentally, can you mail me, you will find the mail in the sidebar.



Anonymous said...

EU Bonds , this is like giving an alcoholic “Bara libre” the only thing EU bonds will accomplish is to hand over the last vestiges of independence € zone countries have, while saddling Germany with responsibility for paying the EU debts, it is far more likely that by making Germany the ultimate Guarantor for EU debt you will drag down Germany & its economy.

It’s time to face the music, Portugal, Spain Italy Greece have diligently used the € to paper over their economies fault lines, pouring more € (guaranteed by Germany) will cover up the fault lines for a short while, eventually these countries will have to face the music & take the medicine, now is as good a time as any.

Edward Hugh said...

Hi Anonymous,

"while saddling Germany with responsibility for paying the EU debts"

Well, I think we need to be careful here, since looking what is happening to German banks at the moment (and the very rapid contraction in its economy) a case could be made that we might need to saddle the rest of the EU with German debt. And indeed with UK debt.

It is interesting how Micheal Glos suddenly disappeared from the scene last weekend, to spend more time with his family, I suppose.

Basically, it looks like the whole EU banks problem is going to turn out to be enormous, in all likelihood much bigger than the US one - the only difference being that since the lending in places like Russia, Spain and Eastern Europe didn't have the same kind of meltdown ratios the subprime's did, the defaults need a year or two longer to arrive. But they will as the real economies contract sharply.

Basically, I think at this point we need to be prudent, and wait till we get some "official" numbers from the EU at the end of the month before we jump to too many conclusions, but the whole EU banking system may not be far short of insolvency. They may need to nationalise the whole lot.

So my argument is, rather than breaking up the eurozone, and watching ourselves flounder one by one, why not try and swim together, and survive all this. As I keep saying, maybe Alambama isn't the most exemplary state in the USA, but most Americans accept its presence, and don't take any pleasure in its misfortunes.

Why is Germany so badly affected, after years of hard work and thrift? Rising median ages are the core problem. Basically years of ultra low fertility coupled with relatively unfriendly immigration attitudes means that the median age of the Japanese and German population (at 43) is now the highest on the planet. Previously it was assumed that we wouldn't see much in the way of economic consequences from all this till much later in the century, but now, to me at least, it is obvious those consequences are already here.

Basically they reveal themselves in very weak domestic consumption growth, which means that economic growth (which is needed to pay all those pensions and health care costs) is totally dependent on exports, and hence the economic well-being of others.

Thus, while both Germany and Japan had no housing bubble, or excessive consumer borrowing (in fact they were huge net savers, running large current account surpluses) their economies have folded much more quickly and much more dramatically than the rest. In addition their banks (and in particularly Germany's) have lost large chunks of those savings financing others housing booms (the US, Spain, Ireland, Eastern Europe etc).

This is now the second time this has happened, since we saw a much weaker version of the same phenomenon after the internet bust in 2001. But each cycle this gets worse as the median age steadily rises, and I can't imagine it is exactly pleasant for the Germans and the Japanese who haver to live through it.

So before these tow countries finally fall off there perches altogether I suggest it is time to do something, in the short term via encouraging immigration, and in the longer term by fomenting much more child friendly policies, making it much more attractive for those women who want to do so to have children, even if this comes at the cost of the welfare and pensions funding of the elderly. At this stage in the game their societies have precious little choice, and if they do nothing the long term future of these societies is obviously in jeopardy.