Yesterday saw America closed for the Labor Day bank holiday and there has been little movement in equity markets. Indeed yesterdays rises in European ones are being lost this morning as I type. After the recent rises it will be interesting to see the next move. Currency markets are still somewhat on edge particularly the ones surrounding the Swiss Franc and the Japanese Yen. For a time issues here were calmed down by a rise in the value of the Euro, however the Euro rise has stopped for now and has reversed to 1.28 versus the US $. So we again see the US $ at 83.87 versus the Japanese Yen or back pretty much to 15 year highs, the upwards move of the Euro means that the rate here of 107.33 versus the Yen is not quite as high,for now anyway. So there will be wailing and gnashing of teeth by Japanese exporters. In some ways the move overnight is a surprise as I doubt that anybody really expected the Bank of Japan to do anything at its meeting.The currency twin that I wrote about on the is also strong again and the Swiss Franc has risen to 1.2914 versus the Euro.
So the perceived improvement in the US economy actually led to a strengthening of the Euro in currency markets at the end of last week but now we are back to the more usual recent beat of rallying Swiss Franc and Japanese exchange rates. Each time this happens I am reminded of the money the Swiss National Bank is currently losing from its failed currency intervention of earlier this year. Last time this was calculated it was 7.5 billion Euros and as rates have moved adversely since it will be higher now. In theoretical economics such currency intervention from a position of strength should always succeed as you can create your own currency and sell it, if I had my way I would pin those losses on the wall of those who believe that rule always applies in the real world.
Europe and her banks: worries return
Part of the reason for the fall in the Euro which has taken place overnight has been a return to the subject of the stress tests for Europe’s banks by the Wall Street Journal. This concentrates on two main points.
“some banks didn’t provide as comprehensive a picture of their government-debt holdings as regulators claimed.”
“banks excluded certain bonds, and many reduced the sums to account for ‘short’ positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July,”
Regular readers may well recall that I wrote at the time that the treatment of government bond holdings in the euro zone bank stress tests was near to a farce (26th July and 23rd July 2010).You see you could keep your holdings out of the test by claiming that you were going to hold such bonds to maturity,who was going to check this actually happened was left undefined. So to my mind there was a clear temptation to put the worst performers on your book in the long-term hold section and as if by magic they in effect disappeared. One of the effects of the credit crunch has been to show us that the banking sector’s view on temptation is similar to Oscar Wilde when he wrote “I can resist anything but temptation”.
The manipulation of the data has been illustrated for the French banking sector. This matters because French banks are holders of quite high amounts of other countries debt and in particular they have high holdings of peripheral euro zone debt. If we take data from the Bank of International Settlements from March 31 it indicates that French banks were holding about 20 billion Euros of Greek sovereign debt and 35 billion Euros of Spanish sovereign debt. In the stress tests which took place on the same day, four French banks, which represent nearly 80% of the assets in France’s banking system, reported holding a total of 11.6 billion Euros of Greek government debt and 6.6 billion Euros of Spanish debt. Rather curiously they appear to be more concerned with misrepresenting their holdings of Spanish debt,perhaps they felt that their Greek holdings were too well-known.
The problems with cross-holdings
These cross-holdings go right to the heart of the European banking problem. Any issue with a particular sovereign would affect the other countries banks as they hold so much sovereign, banking and property-related debt in these countries. Back in May Bloomberg estimated that European financial institutions held some 134 billion Euros of Portuguese,Greek and Spanish government debt. Remember problems would also hit banking and property related debt.
Here is a situation where you might think you would be most likely to find some stability and “Germanic” conservatism. However this is not true. For example Germany’s banks were involved in the American mortgage market and estimates of their exposure there go as high as 850 billion Euros.In addition it looks as though the new Basel 111 banking regulations will require German banks as a whole to hold some 105 billion more Euros of capital.
The current problem is Anglo-Irish bank on which subject I wrote on the 1st September . The concern around this is reaching such levels that it is starting to look as if the problems are so bad they call into question Ireland’s solvency. Ireland’s Finance Minister is currently in Brussels trying to organise a deal for Anglo-Irish but it looks as though somewhere around another ten billion Euros of support will be required. In terms of funding Irish banks need to find nearly 30 billion Euros this month as state support schemes are ending.
Greece and her banks
It is still baffling to me that anybody believed a result which had only one Greek bank failing a stress test. Let me put this into numbers. On the 11th March 2010 Greece issued a new ten-year government bond at a price of 98.742 and a yield of 6.35%. Last night this same bond closed at 68.77 and a yield of 11.75%. If we look at shorter-dated government bonds her three-year maturity yields 11.81%, this bond with lass than 3 years to go has a price of 84.10 and its yield has risen by 9.36% over the past year. Now consider that Greek banks were large holders of their own governments debt and imagine the losses caused by these yield rises and price falls. Each time a bond matures there must be a sigh of relief from Greece’s banks as the bond is redeemed at par.
These losses are before we get to the impact of the economic slowdown in Greece or any losses on holding abroad. There has been some new information on Greek banks which shows that according to her central bank has just issued numbers which show that in July household and business deposits declined from €216.5 billion to €212.3 billion. Now this probably will not have the impact reported elsewhere as presumably the Greek banks will get replacement funds from the European Central Bank but it does make them ever more dependent on the ECB for funding which is by no means healthy and to my mind was a driver of the recent extension of some of the ECB’s policies into 2011. Frankly unless something changes these policies will continue to be extended.
Here there is a modicum of good news and a partial reason for the improvement in her credit status on a sovereign basis. For a while Spanish banks were unable to borrow in inter-bank markets. Now it would appear that the healthier half can. Recently the main five banks and the biggest Caja La Caixa have been able to return to bond markets albeit at highish interest rates. As an example La Caixa has just issued a billion Euros of covered bonds for a 3 year term.
The bad part of this is that it increases the squeeze on the approximately 50% of the Spanish banking sector that is perceived to be too weak to benefit from inter-bank markets. In essence this is the savings banks or cajas and as time passes I expect to have to return to this subject more and more. Overall this partially improved position for some of Spain’s banks has meant that her government bond yields have stabilised at lower levels and for now some of the pressure has been released. The ten-year yield is now 4.09%.
The banking system overall
It is quite plain to see that there are considerable strains throughout the euro zone banking system examples of which I have highlighted today. If we look at it another way and look for international comparisons we find the following from the International Monetary Fund. The IMF estimated in April that Europe’s banks are also still carrying much of the troubled assets they had during the 2008 problems. Euro-zone lenders will have written down about 3 percent of their assets from the peak of the credit crisis by the end of 2010, compared with 7 percent for U.S. banks. For this to be reasonable you would have to believe that their behaviour running up to the credit crunch was less than half as risky as the US banking sector. This to my mind is an example of something which has become very familiar the idea of kicking the can down the road hoping that tomorrow will be better able to deal with it. This of course relies on economic improvement which as I highlighted in my article on the United States does not look that clear-cut anymore and frankly such a plan was always something of a gamble in my view.
Impact on sovereign nations
So far those in the “core” nations have found that their government debt has not been impacted by the continuance of issues in the banking sector as they have seen their government bond yields fall accompanying those of Germany’s. To give an example of this I quoted a date for the issuance of a Greek government bond above and that night ten-year bund yields closed at 3.17%. Last night they closed at 2.34%. So these nations have a duofold benefit for now of cheaper interest payments when they issue new stock and any banks holding their debt will be likely to be making a profit.
However for some of the peripheral nations the situation has deteriorated. I have discussed Greece already but the comparative government bond yields for Ireland are 4.33% then and 5.83% now,and for Portugal they were 4.22% and are now 5.72%. So we have seen outright rises at a time of general falls. Moving forward September is not only a month of refinancing of bank debt for Ireland it is also a month where sovereign nations have plenty of debt to issue too with the Financial Times estimating that some 80 billion Euros worth will be required.
The problem for some of these countries is that their government bonds have performed badly in what has been a favourable environment which poses the question what are the implications for them if the situation changes? Because of the inter-connections in the euro zone such a move would rapidly became a problem for all of them.
Returning to my currency discussion reminds me of a subject that may yet return to haunt Europe’s banks. Many central European banks were involved in lending money to individuals and companies in Eastern Europe in Swiss Francs and the exchange rate moves of this year have highlighted the risks and dangers inherent in this. Any further rallies in the Swiss Franc have to have implications for the banks who loaned this money.