Risk appetite suffered a sharp deterioration on Monday as fresh uncertainty about the global economy prompted investors to shift from equities, commodities and emerging market assets into the perceived safety of government bonds and the dollar. Markets were further unnerved by warnings on the economic outlook from the head of the IMF and an ECB report saying eurozone banks face another $283bn in writedowns on bad loans and securities this year and next.
As Izabella Kaminska notes, it is Southern Europe that is now getting all the attention.
This time it’s the turn of 25 Spanish banks, all of whose senior ratings were on Friday downgraded by Moody’s. Banco Santander, of “we’re so strong we’re actually going to expand through the crisis” fame, meanwhile, remains under review for possible downgrade.......
Also, this one in Bloomberg:
A Spanish fund planned to aid lenders will be set up with 9 billion euros ($12.6 billion) and will have the capacity to raise an additional 90 billion euros in debt, Finance Minister Elena Salgado said. The government is still working on the details of the plan, which will need the approval of parliament, Salgado told a news conference in Madrid today after a weekly Cabinet meeting. The government would raise the initial 9 billion euros with a debt issue, she said, adding that there was “no hurry” as “there is not one entity in difficulty.”
As unemployment and bankruptcies surge, bad loans at Spain’s banks rose 4.27 percent of total credit in March, the highest since 1996, compared with 1.2 percent a year earlier.
But as Isabella detailed: "Moody’s also noted that a significant government capital injection - which apparently has been discussed for some time now by the Spanish government and the banking sector — could prompt subsequent upgrades of some BFSRs. "
And guess what else it might prompt, more downgrades in Spanish sovereign debt, that's what it might prompt. Economy Minister Elena Salgado was widely quoted in the press last week, giving an estimate of 9.5% total fiscal deficit for 2009 (not bad my guess of 9% back in February, I think). But they are still hoping for a contraction this year of only minus three percent, and this seems very optimistic, so the outcome will surely be a deficit in double figures.
This, in my view, is the last year that the financial markets will pardon such a deficit from Spain, and we will now be under fiscal pressure as well as relative price pressure. Essentially, I agree with Krugman (or should that be, given the NYT links, Krugman agrees with me) and what we need in Spain is an "internal devaluation" of about 20% to jumpstart the economy - and this is 20% vis a vis Germany, where they are also having deflation, so the size of the correction is very large. And at this point - August will mark the second anniversary of the commencement of what looks like becoming Spain's "lost decade" - we haven't even started.
And Greece is also moving towards centre stage, as the FTs Kerin Hope details in this article:
After a decade of explosive loan growth triggered by Greece’s entry to the eurozone, the country’s banks are experiencing the downside of a financial cycle for the first time as the economy stutters in the global downturn.
Exports are declining, the tourist season has got off to a poor start and the Greek economy is projected to shrink by about 1 per cent this year, according to the International Monetary Fund. Years of excessive spending have pushed up the public debt to almost 98 per cent of gross domestic product.So far the banks have shown some resilience, assisted by a €28bn government support package that included a €5bn capital injection in preferred shares, and there have not been any government bail-outs of individual banks.........
However, the situation may be about to worsen with analysts forecasting bad loans will rise this year from 3.8 per cent to about 6 per cent before peaking in the first half of 2010. Meanwhile, Fitch, the ratings agency, last week warned the banks’ performance for the rest of the year would likely be hit by higher loan impairment charges.
So the world seems to work like this. Latvia gets battoned down for a few months via a few billion in loans from the IMF and the EU Commission. As a result, the Baltics now become yesterday's story - till they aren't again, of course. And we move on, as I more or less feared, and its time to begin to focus on Southern Europe again (while Eastern Europe deteriorates sufficiently to make it back into the headlines). I think people can only keep so many things in their head at any one time.
Basically the whole EU system seems to be in denial on what is happening at the moment. The markets have been focused on the East, but they are now starting to wake up to the fact that the South is still here, and when this "matures" we will have a full blown financial crisis, that is for sure. At that poiunt the Spanish and Greek governments will effectively lose control of the situation, just as they have done in Latvia and Hungary.
This is one of the reasons I am following Latvia closely. Basically what is happening in the East is a sort of "dry run" for what is going to have to have to happen in the South. The whole package, from "fiscal austerity" as a tool to attack recessions, to "internal devaluation" via price and wage deflation is about to be applied in the South as a path towards restoring export competitiveness and economic growth.
There has been a lot of talk, of late, about the contagion danger from Latvia, but few seem to consider the possibility that - given the way the EU itself is putting its credibility on the line in the Latvian case - if finally Latvia folds (and devalues, as I feel it must), then the contagion problem could leap straight to the South from the East. Obviously Romania is looking very vulnerable to anything that happens virtually anywhere, but Spain looks a lot more vulnerable to me at this point than either Poland or the Czech Republic, due to the massive external financing requirement.
Basically investors have now started to remember that Greece and Spain still exist. I suppose we will now see the crisis zigger-zagger across from the South to the East and back again, with the German real economy receiving body blows on both counts in the middle.
Meantime in Berlin and Frankfurt they seem to be mainly worried about the US fiscal deficit at this point. Stange what makes people tick.
In view of the movements we currently have on the Forex, a significant rally on the Forint and the pound for example, I do not expect anything else but massive crashes. And bankruptcies. Nobody does like it. Nasty Austrians no more than supposedly gentle Krugman-ites.
What can we expect when the normal course of currencies does not operate, when debt-ladden countries are using their IMF funds to stand by their currency whilst others with massive surpluses firmly peg their currency.
Banks and countries that made inconsiderable loans have to take their toll and lose their shirt. The earlier the better. Any alternative is more painful in the end, anyway. With bigger deficits and heavier debts.
I agree with you that the Spanish situation is really more of a trap as there is no monetary way-out.
But let us be clear. Whatever happens, people should and will stay in their homes. The ownership will not migrate to those who lost their shirt funding the mortgages. Spain has no obligation to run the bankruptcy process à l'américaine, does it?
The financial system will just default and stop financing assets of all kinds at the current level pricing. Do the current prices make sense? In view of revenues?
Funding the economic activity at it current level asset-pricing is yet an other money-loosing proposition. Do we need them at the current time?
The situation is not really that easy elsewhere in Europe. This is getting extremely tough here in France as well for example. The only difference: "There is still a decent level of savings - yes the old-style one - at all levels, including the middle class". But unemployment is moving up, slowly but unstoppable. And anxiety is pretty substantial.
I'm sure that you are aware that the 80s, 9Os were quite difficult here especially in industrial areas. And that the idea of sharing the pain with owners of 200 or 300 K-Euros pisos will not be welcome here by anyone, whatever their political circle.
People here feel that that we ran into serious deflation in the past. Salaries have not moved up for quite a while except for the happy few in real estate, banking and multinational operations of multinational corporations. That's ain't a lot.
Most people here feel that those that enjoyed their massive ultra-liberal development, Ireland, UK and Spain, may have to stand by their financial choices. Our tax levels are quite high by most standards. Where would you take the money? In middle-class monthly accrued savings? In corporate circles? Ask Sarkozy.
Anyone expecting to force Stuttgart to print that money or force taxes onto the EC is not on earth. And you certainly are.
So, from the point of view of a german ¿what is the solution?
The obvious reason is that the "phantom" exchange rate of the southern countries is overvalued (plus a housing bubble that went bust).
Change in labour markets legislation and decentralization of wage bargaining are necesarry reforms, to say the least.
Sending them (us) more money (in the form of euro bonds) will do nuts to solve the problem. Au contraire, the thinking that "germany wont allow us to go bust" will preclude any significant reform.
As Edward described quite clearly in a series of recent posts, Germany will have quite a few things to do as well.
Which implies, I guess, the obvious question: if Germany does not pay for Spain et Greece et cetera, who else will?
And, in my opinion, the answer just can not be "no-one", because that may as well mean a quick breakup of the eurozone.
Well, I'm inclined to go along with Hynek here. Look it is the very scale of the situation which is the problem.
Ireland is manageable, but Spain is ten times bigger.
And if you don't send the bonds, really you give Spain a prisoners dilemma kind of situation - especially for the politicians - where it becomes (as we are about to see in Latvia) much more attractive to engineer a large default and a big devaluation than face all the pain.
This is fine, but it then leaves a large crater in Kaisrestrasse where the ECB used to be, since I doubt the system would stand the shock.
Then the worry is what happens in New York and Tokyo, since compared to this Lehman Bros was Chicken feed. So I guess, one way or another, the money will be coming. It did, after all, go to Bank of America.
What I am really scratching my head about is this latest 80 Billion Salgado is offering to finance. It is too small to do any real good, and there are no effective plans to turn the economy round.
So what do the "poderes facticos" do. Draw it all out of the company account in cash and take it to Germany for safe keeping? Before putting the company in receivership, of course.
In other words, if clear exit strategies from this mess are not offered to people, it will be "sauve qui peut", with all that that implies.
No way that this crisis can be circumvented. Massive pre-emptive QE at Euro-level will not happen. One can build plans. But IMHO this is politically impossible.
That's why making it softer for people is essential. The current aggressive handling of foreclosures must be avoided. This is a key political issue. Anyone that has personally been through such a process - for business for instance - will tell that there are proposals that can be transformed into effective laws. Will not make the banks poorer anyway. And this is in the hands of a Eurozone parliament.
Fresh from "naked capitalism". That may give some ideas to Zapaterro. Social ideas by the way. May we hope that people in the Eurozone do not get the US handling. Or worse the old - pay until death, litteray in ancient French "mort-gage" - that used to be the norm here in France.
"Congress can pass legislation granting current homeowners the right to stay in their homes as long as they like, simply by paying the fair-market rent. In other words, no one gets tossed out on the street, as long as they can pay the rental value of their house. The fair rent would be determined by an independent appraiser — exactly the same way that a lender is supposed to determine the size of a mortgage that can be issued on a home."
Hi Marin Belge.
I do agree with you that the ECB (aka the Bundesbank) will not opt for "massive QE".
I am even beginning to think that it is mainly because the Germans lived through the terrible times of the Weimar Republic hyperinflation, and that their enormous prosperity of the 1980s was associated with a very strong D-Mark. Certain things in history cast very long shadows.
Although I am personally inclined to believe that QE does not help much in the long run, it may help prevent the deep recession to turn into a deep depression, Latvian style.
So much for the QE.
Yet, your second key point, namely that "no one gets tossed out on the street, as long as they can pay the rental value of their house" would, if applied in real life, require exactly the impossible - that is, massive state aid to banks, EU bonds, and, obviously, QE, probably in the form of massive EU bond purchase program.
It is because if you agree with a mortgage holder that he would, from now till eternity, be required to pay only the market rent (interest), you would effectively require the banks to write off the principal.
In some bubble locations (City of Prague springs to my mind instantly) the current market rents are very often actually lower than the interest payments (assuming that the r/e were financed with a mortgage).
And, it is the mortgage principal that matters.
For example, a top five Czech bank has a balance sheet of some EUR 20 billion and a capital of maybe EUR 2 billion. Out of its assets, some EUR 7 billion are mortgages. Now, if just one half of those mortgages were turned into the "permanent rent instrument", the bank would have to write off EUR 3.5 billlion, that is nearly double its capital.
Now, the Czech state would be hard pressed to get the 3 or so billion and would have to call for outside help.
And that, unfortunately, would be just one small, very reasonably capitalised bank in a small country. The position of any large Spanish bank would be twenty times worse.
Where does it leave us? Surely, between the rock and a hard place. The only solution I can think of at the moment is a state guarantee of all or part of mortgages originated by its banks. A guarantee would limit loss of capital, and the eventual losses could be spread over time.
It has actually been discussed in Prague since last week, and it seems that the government takes this option very seriously. However, what may be possible here, where the number of mortgages is surprisingly low, may not be possible in Spain or Ireland, or at least may not be possible without the ECB backstopping (re-insuring?) the respective governments.
So, accounting-wise, there may be a way, but with certain unnamed governments in denial (can not agree more with Edward on this point), we have not yet started to look for a decent map, let alone for a way out of the mire.
Hi Filip and Hugh,
Thank you for your patience on such a sensitive issue and your active contribution.
For example, a top five Czech bank has a balance sheet of some EUR 20 billion and a capital of maybe EUR 2 billion. Out of its assets, some EUR 7 billion are mortgages. Now, if just one half of those mortgages were turned into the "permanent rent instrument", the bank would have to write off EUR 3.5 billions, that is nearly double its capital.
I have very limited information on the scope of the bubbles in Eastern Europe. What you say about Prague is certainly not reassuring. Should we understand that the situation is even worse in, say, Poland?
I believe that faced with such a dilemma, a country like Germany or France would choose the Swedish solution. They just expect Spain to handle it in very the very same way. I cannot imagine North-of-Europe politicians to stand by an ECB-supported "recapitalization" of, say BBVA or Santander before nationalization.
Let it be clear that we are not talking hair-cuts à la Wall Street here. And unbearable doses of moral hazard. With massive political support.
Are you so concerned that you believe that Spain can not even stand properly by its cajas?
You just can't reduce the banks' cash flow like that-- with no unintended consequences and no moral hazard ;)
This is not Argentina (yet) and a much smaller cash flow would annihilate the banks and decimate the debtholders/depositors. I don't think Zapatero is as dumb as to pull something like this, because the creditors would cut off Spain and RUN FOR THE EXITS -- and I would be the first to do it
Hello Marin Belge.
I could not respond to your comment yesterday, I was fairly swamped with my other work (which, by the way, involves quite a lot of debt collection).
So I must apologise for causing a bit of mild panic. In fact, I meant the section that you quoted as a sort of model, a "what-might-happen-if" description of future events following the lines of your proposal.
In real life, the situation in our part of CEE is not at all bad. There are no forex denominated mortgages and the total amount of outstanding CZK mortgages is fairly small, just about EUR 25 billion.
My best estimate is that out of this amount, some 20 per cent (EUR 5 billion) are risky and some 5-10 per cent will actually default.
Obviously, default does not mean loss. Assuming a very pessimistic 50% loss rate, the banks may have to cope with a total cash loss of up to EUR 1.5 billion, spread over the next few years. Which is, in fact, fairly bearable.
just an ignoramus question for you all, how do you enforce a devaluation of an economy? is it just prices and wages, or how do you go about it?
"how do you enforce a devaluation of an economy? is it just prices and wages, or how do you go about it?"
This is just the point. No one has the faintest idea.
Well, OK, I'll correct that, you deflate the economy. What does that mean? You cut internal demand by cutting wages - and since you don't control the private sector this means public sector wages. Then you squeeze fiscal spending like we are seeing them doing in Latvia now, to try and accelerate the contraction. This creates massive overcapacity, and then prices and wages in the private sector follow suit - normally by the creation of massive unemployment - woudl that be 30% in Spain???
It is a bit like primitive medicine, using leeches and blood letting to cure the patient. Horrific, isn't it. This is why people when I was a child used to say, "no return to the 1930s".
Basically, I don't think anyone ever seriously thought that what just happened in Spain would ever happen, they convinced themselves it wouldn't by talking about "convergence". But it has, and something needs to be done.
In the early 1980s Spain resolved this problem with a 20% devaluation. This time it can't. What happens next. No one knows. All I can say, is watch this space, since whatever it is that does happen it will be very exciting.
Also, don't take your eyes of Latvia, since in 12 or 18 months we will be following them into the hole.
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