Banks in the Euro zone continue to influence their governments financial problems

Yesterday turned out to be a day dominated by my two main topics. As the day progressed we saw selling pressure in the peripheral euro zone government bond markets which was in the main caused by concern about the banking and property sectors in the relevant countries. There is of course an element of groundhog day about this. However if we return to early May I do not think that this is what Elena Salgado the Spanish Finance Minister meant by “shock and awe” as she announced the 750 billion Euro support package which was combined with the European Central Bank’s commencement of debt purchases in its version of Quantitative Easing or QE which it called the Securities Markets Programme. According to Reuters ten-year government bond yields closed at 6.08% in Ireland,5.89% in Portugal and a whopping 11.89% in Greece. These compare with the equivalent German bund which closed at a yield of 2.27% for those who like to look at relative comparisons. 

If one is looking for the success of the shock and awe programme one might,for example, like to take a look at the equivalent yields after it had settled in for which I have used the closing values for the week in which it was announced. Ireland 4.64%,Portugal 4.93% and Greece 8.28% are the values so they have risen since by 1.44%,0.93% and a whopping 3.61% respectively. One might think that the advance billing has led to a disappointing result particularly if you are a taxpayer in one of these countries facing debt interest payments which look likely to rise (in case you are thinking Greece is fully covered by her individual rescue plan she is in fact still issuing short-term debt). 

Did anybody benefit from shock and awe? 

Actually somebody certainly did as you see German ten-year bund yields were 2.85% at the end of the week whereas as I stated earlier they are now 2.27%. The other core euro nations such as France whose equivalent yields were 3.11% then and are 2.57% now have benefitted too which is not quite what was advertised on the tin was it? Of course other influences have been at play in the meantime as there has been a flood of money going into what are perceived to be safe havens in a worldwide trend and this has benefitted many government bond markets. However for whatever the reason it remains true that as it turns out the biggest beneficiaries are the countries who were supposed to be the ones contributing. Not everything turns out as it seems. 

One caveat I would like to add is that we only know what has happened with the shock and awe plan so it is not possible to say what would have happened without it. 

What about the Securities Markets Programme? 

This was the name for the European Central Bank’s version of QE where it was told by euro zone politicians to purchase debt in the peripheral euro zone countries supposedly because these markets were in disequilibrium. This dissembling was required as otherwise such a plan would be illegal under the ECB’s constitution. Some members of the ECB were always against the plan,for example the head of the Bundesbank Axel Weber has publicly stated that he voted against it. In practice the SMP started with a bank as some 16.5 billion Euros of debt was purchased in the opening week but as time has passed it has purchased smaller and smaller amounts such that it has now bought a total of 61 billion Euros worth. 

I have often mused as to whether the declining purchases reflect declining problems or the fact that some of the ECB were never really in favour of this programme  (even its President Mr.Trichet had in the past described the post-crisis regime at the ECB as being superior to QE,which to those with a memory must now bring a wry smile). Anyway the problems are now longer declining and there have been several rumours recently that the SMP is in operation again. 

One factor that is rarely discussed is that if you look at the purchases and current yield levels the ECB must be losing money on them at this time. I guess officials must be hoping it will have profits from its other operations to offset this problem. On this topic there are quite a few issues for the ECB as it has also accepted securities with a lower credit rating as collateral for liquidity than the other main central banks. Losses and assets with a low credit rating do not make for a strong financial position and I have written before about the ECB’s risky position in this regard. It is not impossible that one day the headlines will be can a central bank go bust? 

An irony,Germany and her banks 

Having highlighted that recent trends have been to Germany’s benefit there is a certain irony to this. Not about her manufacturing or exporting which in spite of weaker numbers yesterday remain strong, the irony is the state of her banking sector. I am reminded of my report on her banking sector yesterday and the fact that they have indulged in risky lending on a large-scale in US mortgages and peripheral euro zone debt but it is also true that under prospective Basel 111 rules they are undercapitalised to make an unhealthy combination. So as we move onto the next stage of the credit crunch which is revolving around Europe’s banks we can see that German banks have as many problems as the Anglo-Saxon ones which does contradict some of the rhetoric that comes from Germany. Further to this Germany in terms of government bond yields is seen as a paragon of stability which no longer looks quite so true. 

The solution as ever is to ask for the can to be kicked down the road. Germany’s banks are happy to accept Basel 111 except the time is not quite right…. 

Portugal and her banks 

Here there is less news but two facts do come to mind. Portugal’s banks continue to have to rely heavily on liquidity provided by the ECB. According to the Bank of Portugal Portuguese bank borrowing from the ECB rose by 0.6 per cent in August from July, to register a fresh record of 49.1bn Euros. Adding to this are the facts that if one looks back at Portugal’s economic history she has struggled to grow over the past twenty years and her level of unemployment has trended upwards. Adding the effects of the credit crunch to this does not make for an inspiring mix. This can be added to by the fact that at a time of supposed austerity Portuguese public expenditure rose by 4% in the year to July. 

Ireland and her banks 

As well as rumoured purchases by the ECB of Irish debt the Irish government stepped in to try to calm bond markets down. The Minister for Finance, Mr Brian Lenihan,  announced that the Government guarantee for short-term bank liabilities, including corporate and interbank deposits as well as debt securities would be extended from its current expiry date of 29 September to 31 December 2010. So more time is bought although in the current atmosphere it is likely to make people wonder as to when Ireland can withdraw state support for her banks. Perhaps the most extreme version of this is that Ireland is in fact a bad bank with a country attached. 

In my view the situation that is hurting Ireland the most is the doubt over the likely property-related losses at Anglo-Irish bank and to a lesser extent the Irish Nationwide building society. This needs to be sorted quickly to stop the drip-feed of bad news from these sources. Tomorrow Ireland has some debt to issue and it will interesting to see how this goes as markets have been successful at time recently in pushing yields up before debt issuance and then lowering it later in moves which are good for those investors but bad for taxpayers. 

Greece and her banks: more cash is needed 

This morning has seen a cash call from the National Bank of Greece which has announced plans for a 2.8 billion Euro fundraising or ”
a comprehensive capital strengthening plan”. Those who relying on official statements might be a little confused by this as we have been told time and time again what good shape Greek banks are in and only one of them failed the euro zone banking stress tests and not this one! Indeed if you read the banks statement about this you might reasonably wonder why it is doing this as it tells you it is in great shape. If we may return to reality this will lead to questions as to why it needs the money and whether other Greek banks will need to raise capital too. 
There has been a fascinating article on Greece by Michael Lewis and some of it realises people’s worst fears. Here is his account of a discussion with a senior IMF official. 

“Our people went in and couldn’t believe what they found,” a senior I.M.F. official told me, not long after he’d returned from the I.M.F.’s first Greek mission. “The way they were keeping track of their finances—they knew how much they had agreed to spend, but no one was keeping track of what he had actually spent.”

“I’m all for reducing the number of public-sector employees,” an I.M.F. investigator had said to me. “But how do you do that if you don’t know how many there are to start with?” 

It is interesting to see what he was told and much of it contradicts the official view of Greece and her attempts to  avoid default or restructuring of her debt. At the end a very  relevant question is posed and I will be interested to see readers thoughts on this.

Even if it is technically possible for these people to repay their debts, live within their means, and return to good standing inside the European Union, do they have the inner resources to do it? 

The Swiss Franc
This continues to rally putting more pressure on Switzerland and her central bank. It is also puts more pressure on those who borrowed in Swiss Franc in Eastern Europe. If you are living in Hungary then a Swiss Franc mortgage is now 1% bigger than when I last discussed this topic and it was only on the 31st of August. I can only imagine how demoralising it must be to see your mortgage debt accelerating away from you must be. Looked at from the other side of the balance sheet it must represent a rising risk for the banks in Europe who made these loans.
Bob Diamond and Barclays 

One would have to be hiding under a stone in the UK to have avoided the news that Mr.Diamond is to take over as Chief Executive of Barclays Bank. However I think that much of the comment on this is misplaced. For a start nearly everyone thought he was in control anyway as his Barclays Capital represents around two-thirds of Barclays profits. 

My problem is that if this means that Barclays will become even more of an investment bank then there is a clear risk for UK taxpayers. Even though Barclays chose not to draw funds from the UK taxpayer it did benefit from the implicit guarantee that in extremis we would bail it out. I can see plenty of reasons to support retail banking and depositors but very few to support investment banking in this way. We are back to the dangers of privatising profits and the salaries and bonuses they produce and socialising potential losses and sadly I have to report that in the two years of the credit crunch period we appear to have learnt nothing at all. This is not Mr.Diamond”s fault he is a symbol albeit a well paid one.


7 thoughts on “Banks in the Euro zone continue to influence their governments financial problems

  1. Good Morning Shaun,

    I want to draw this item on Bloomberg to your attention.

    Quite frankly it beggars belief that the IMF is willing to assist the Greek government, when that same government refuses to relinquish the full details of all its liabilities. I cannot imagine approaching the bank manager for a loan in similar circumstances. We all know what the answer would be.

    To attempt an answer your question above. If the Greeks ever want to repay their debts then surely they must first admit to how much that debt actually is. However from reading your blog and other reports today you really have to wonder if ANYONE at all knows exactly how much that is.

    • Thanks I will take a look. It pretty much backs up the article I quoted from today.

      In terms of Irish news it appears that the ECB is frontrunning itself, at times it is hard to keep up with all the financial alchemy which is going on.

  2. A question I have on the CEBS stress tests on EU banks in July : they constructed sovereign debt shocks and applied potential haircuts to bond holdings of banks owning c.65% of EU banking assets – they deconstructed 10 year bond yields to 5 years for the exercise. The CEBS was scoped by Ecofin. The estimated haircuts were applied to sovereign bond holdings in the trading book and estimated impairment losses were generated to the banking book in terms of household and corporate defaults etc. Conclusions were then drawn about capital adequacy,not liquidity as I undertsand. What I wanted to know is whether haircuts would have been applied in the stress tests to sovereign bonds held by banks as part of their liquidity reserves/capital or were those excluded because they will be kept as long term investments to maturity? Do you know,Shaun.

    • I am not sure that this was ever fully answered. There is a footnote “Since no sovereign defaults are considered in the exercise, there is no impact on holdings of sovereign bonds which are held to maturity in the banking book”. This points towards them being excluded but is not definitive.

      • Although haircuts were not included for 10 year bonds in the stress tests, the CEBS did give examples for comaprison ( Table 7 annex 2) and you might be interested – taking your examples of Ireland, Portugal and Greece –

        Ireland – adverse scenario 2010 = 6.65% yield, 11% haircut
        Portugal – adverse scenario 2010 = 6.96% yield, 19.4% haircut
        Greece – adverse scenario 2010 = 11.84% yield, 33.3% haircut

        According to your Reuters figure Greece is running ahead of these adverse scenarios and the other two are getting close.

  3. The Eurozone countries need an haircut, a good point to start would be with the head.

    You have one country that takes most of the EU budget and the rest just take whats left.

    No- one knows how much dept there is and no-one cares while the contributors keep paying money into this hole full of corrupt Rats.

    How long will the good times last for the rats, its ended the ship is foundering and will sink before the end of winter why.

    Because everyone wants everything, but are not willing to pay any longer, a run on the banks will follow, as soon as the good news turns sour.

    AIG was the start, following the US bailout of ZFS the owner, now its AIB- follow this reasoning and soon a,b,c,etc has gone and Z remains ZURICH FINANCIAL SERVICES was just the beginning with its AIG unit.

    Will the Euro keeps its inflated false value, not a hope in hell joe public dont want overpriced inferior goods, from European countries.

  4. The earlier Irish bank failures and Irelands debts suggest the Euro will silently devalue; it has no options acceptable to member states. It is extremely overvalued, and its problems are compounded by an overpriced uncompetitive shamble of EU mismatched dept laden countries. First it was the eastern block countries then Greece, now it’s Ireland, Portugal will follow then Spain. Whose close trading relationship between Portugal and Spain will mean Spain is next, followed by Italy, then France, again close dependent trading partners. Making matters much worse is fraud, which has become endemic. The root source being AIGFP a Zurich Financial Services owned subsidiary company that caused the failure of the financial system and the banks, destroying the last lingering hope of a European stable Currency.

    There are closely related transactions many fraudulent related to Ireland’s banking failures. Some of these go back several year and have again connections with Zurich Financial Services its Banks and its AIG and AIGFP subsidiaries.

    The 2008 Bailout of Parent Company Zurich Financial Services by the American government effectively restricted some contagion spreading to Europe. The EU failed experiment with a single Euro currency fits all, including dead duck participants like Greece, Ireland, Spain, Portugal, Italy, and Ireland.

    Appears so similar to the American experience that questions must be asked about the Mortgage and Bonds debts held by Banks with interconnections between ZFS its holding companies and subsidiary banks.

    Further investigations related to its insurance empire should reveal that it is over-exposed and a threat to the stability of the European Union, and the rest of the World.

    The EU trillion+ Euro war chest will not go very far compared to the American bailout experience. This just delayed the hit on Europe and the Euro.

    Ireland is just the start, paying an unsustainable rolling dept will not help. Austria has baulked payment, Germany may follow, then France, who will argue “why assist, the dept laden beneficiary’s, the benefits are dept.

    Now we have the problems accumulating Portugal is expected to require funding within weeks. The Euro weakness and ECB intervention again will not work, the Euro is overvalued– the yen, dollar, and pound are clear indicators.

    As of August 2010 funding by the ECB was

    Greece 96 Billion Euro, + Bank deposits 26% = 40% of GDP.
    Ireland 95 + 14% = 60%
    Portugal 50 + 15% = 30%
    Spain 15 + 5% = 11%

    The new addition of dept laden Eastern block member countries, being further anchors round the more affluent competitive EU countries necks. And doom from the Spanish housing market indicate clearly Spain will need funding regardless of bullish comments from Ministers and ECB member Banks” but.

    It is now time for the ECB to act and devalue the Euro or face a wave of countries opting out of the Euro. The UK is in a primary position and prognosis indicates it will be the currency to hold, with Gold being long term.

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