Well it must come as something of a relief for any Italian readers I have to learn that UniCredit SpA, Italy's biggest bank by assets, has definitely NOT incurred losses on the Russian interbank market. Although perhaps I should rephrase that by adding just one extra word: yet. UniCredit has definitely NOT YET incurred (significant) losses on the Russian interbank market. This important piece of information is what we can glean from today's statement from Unicredit spokesman Marcello Berni to the effect that "We have no losses on the interbank market....The rumors come from a misinterpretation of news that came out today"
The "misinterpretation" - that lead to a 15 cents, or 7.3 percent, drop to 1.85 euros of Unicredit shares in trading today in Milan - was the result of a report from Moscow-based Interfax to the effect that UniCredit was about to sign an agreement with Russia's central bank to get compensation for losses on interbank operations. The source for the Interfax story was UniCredit Russia Chief Executive Officer Mikhail Alekseyev. But as Marcello Berni points out Alekseyev was referring to possible support the Russian central bank has offered to financial institutions in case of losses on the interbank market, and it should not be read as meaning that such losses had already been incurred, only that Unicredit have hat-tipped the central bank to be readying the money up just in case they do.
The real roots of this problem are to be found in the fact that Unicredit has very substantial exposure to losses in a number of key Central and East European countries, and the Italian government, which already has a debt to GDP ratio of over 100%, is in no position - especially with an economy which looks set to shrink all the way through from here to 2011 - to offer much in the way of cash to support the bank. As I point out in this post, Austria (which is a much smaller country than Italy, but which has similar East European exposure) has already lined up an initial 100 billion euros to support its banks, while the Italian government has remained hesitant to be specific about anything, but seems to be talking about support which only amounts to something like 20 billion euros. So we are left with the rather undignifying spectacle of the leaders of the eurozone's third largest economy having to rely on Muammar Abu Minyar al-Gaddafi and Vladimir Putin for vital support to keep one of Italy's leading banks alive.
Unicredit used to also be Italy's leading bank by market value, but since their stock has now declined by 59 percent in the last six months, and the company's market value stands at 24.7 billion euros ($31.3 billion), it now lies behind Italian rival Intesa Sanpaolo SpA. I repeat, as far as I can see Unicredit currently constitutes the greatest systemic risk to the eurozone banking system, and people somewhere ought to be thinking very carefully about just what the plan 'B' is going to be if all this goes horribly wrong.
Monday, November 17, 2008
Saturday, November 15, 2008
The Spanish Crisis In A Nutshell
This will be a relatively short post, since I think the facts here speak for themselves. Basically the roots of the Spanish "problem" are undoubtedly many and complex, but there is one underlying ingredient in the present dynamic which more or less governs everything else: the dependence on external financing due to the ongoing current account deficit, and the difficulties the banks have had raising this external financing since the outbreak of the "financial turmoil" (aka as the US sub prime crisis) in August 2007. Following the difficulties which arose in the global wholesale money markets in the wake of the "August troubles" two countries - Spain and Kazakhstan - found themselves in a virtually unique (and unenviable) situation: the doors of the global money markets were slammed tight shut in their faces. Since September 2007 both of these countries have, each in its own particular way, struggled to handle the aftermath of what effectively amounted to "financial armageddon".
Astonishingly, after mountains of words have been written, and hours and hours of radio and TV talk shows and "turtullias" have been held, this simple detail about the Spanish situation remains obscure to the the majority of the Spanish people (and indeed, equally incredibly, the majority of Spaniards still don't have the faintest idea what cédulas hipotecarias actually are).
So at the heart of the current problem in Spain lies, not the fact that 12 month euribor interest rates went up somewhat, which they did, and which was (of course) an aggravating factor, no, the real reason that Spain now has around one million empty properties waiting to be sold (apart from the fact that there seems to be no switch here to "shut off" the construction industry when it produces products for which there is no market) is that the Spanish banks have been unable to raise sufficient money to provide the mortgages that are needed to enable people to buy them (or better said they are unable to raise the money at prices which make the mortgage business a profitable one for them).
And what better example of this than what happened in August 2008.
Sudden Stop In Bank Lending In August
According to the latest (provisional) data from the Bank of Spain, Spanish banks lent 33 million euros LESS to Spanish households in August than they did in July. After years when the banks were lending between 8,000 and 10,000 million euros a month, this situation, I think, counts as what people in the technical jargon of the trade call a "sudden stop". The whole Spanish financial system seems to have seized up in August. Even lending to non-financial corporates - which had been increasing during the boom at the same rate as to households - virtually dried up, with only 523 million in additional lending.
Of course, such lending has been slowing steadily since August 2007 (see charts below).
This is not the first time bank lending to households has ground to a halt during the current crisis, back in December 2007 new lending was only 561 million (see chart below), but this time the situation looks much more serious, and even definitive, since in the intervening period the economy has simply deteriorated and deteriorated.
Spain's Current Account Deficit Reducing Slightly
The principal reason why Spanish banks are so short of money to lend is the size of Spain's external current account deficit. Running at around 10% per annum, the deficit means that Spain needs to find roughly 7,000 - 8,000 million euros (7 to 8 billion) a month to settle the account. Unless external lenders step in and provide funding (by buying cedulas, or Spanish government debt, for example), the Spanish banking system keeps gasping for air, it suffers from a chronic lack oxygen in the bloodstream (and each month things simply get worse) in the form of new money to lend to oil the transactions flow. This is what having a "financial crisis" means when you come down to the nitty gritty of things. Actually the size of the deficit has come down since the early months of this year, when the monthly deficit was more like 11,000 million euros, but this "improvement" has been due more to a reduction in the value of imports (due to collapsing internal demand and lower oil prices) than to an increase in exports (both goods and services exports were effectively stationary in August year on year, and as the global economy enters recession this is hardly likely to improve).
Another factor which it is very important to bear in mind is that the deficit on the income item in the monthly current account (basically the difference between what Spanish residents receive from money lent abroad and what Spanish residents pay to external lenders) has been rising notably of late, as both the volume of debt and the cost of serving it, ie interest rates, have risen.
The financial account has also deteriorated recently, with the "other investment" heading (basically the balance between loans people outside Spain make to Spain as compared with loans people in Spain make to the rest of the world) turning strongly negative in July and August after very robust performances in February and March. So, effectively, the whole system is now folding in on itself, and the consequences are not hard to see. GDP slows and then contracts, more than likely in a pretty violent fashion in the not too distant future.
Well, I said this would be a relatively brief post (although I hope there is a lot of meat here to chew on). I think this is the core of the Spanish crisis in a nutshell. To better understand how it all works out in practice across the real economy you will need to dig around in my earlier posts, and to understand the implications of what all this will mean as we now move forward, well, naturally that will form the substance of the posts which are now to come.
Astonishingly, after mountains of words have been written, and hours and hours of radio and TV talk shows and "turtullias" have been held, this simple detail about the Spanish situation remains obscure to the the majority of the Spanish people (and indeed, equally incredibly, the majority of Spaniards still don't have the faintest idea what cédulas hipotecarias actually are).
So at the heart of the current problem in Spain lies, not the fact that 12 month euribor interest rates went up somewhat, which they did, and which was (of course) an aggravating factor, no, the real reason that Spain now has around one million empty properties waiting to be sold (apart from the fact that there seems to be no switch here to "shut off" the construction industry when it produces products for which there is no market) is that the Spanish banks have been unable to raise sufficient money to provide the mortgages that are needed to enable people to buy them (or better said they are unable to raise the money at prices which make the mortgage business a profitable one for them).
And what better example of this than what happened in August 2008.
Sudden Stop In Bank Lending In August
According to the latest (provisional) data from the Bank of Spain, Spanish banks lent 33 million euros LESS to Spanish households in August than they did in July. After years when the banks were lending between 8,000 and 10,000 million euros a month, this situation, I think, counts as what people in the technical jargon of the trade call a "sudden stop". The whole Spanish financial system seems to have seized up in August. Even lending to non-financial corporates - which had been increasing during the boom at the same rate as to households - virtually dried up, with only 523 million in additional lending.
Of course, such lending has been slowing steadily since August 2007 (see charts below).
This is not the first time bank lending to households has ground to a halt during the current crisis, back in December 2007 new lending was only 561 million (see chart below), but this time the situation looks much more serious, and even definitive, since in the intervening period the economy has simply deteriorated and deteriorated.
Spain's Current Account Deficit Reducing Slightly
The principal reason why Spanish banks are so short of money to lend is the size of Spain's external current account deficit. Running at around 10% per annum, the deficit means that Spain needs to find roughly 7,000 - 8,000 million euros (7 to 8 billion) a month to settle the account. Unless external lenders step in and provide funding (by buying cedulas, or Spanish government debt, for example), the Spanish banking system keeps gasping for air, it suffers from a chronic lack oxygen in the bloodstream (and each month things simply get worse) in the form of new money to lend to oil the transactions flow. This is what having a "financial crisis" means when you come down to the nitty gritty of things. Actually the size of the deficit has come down since the early months of this year, when the monthly deficit was more like 11,000 million euros, but this "improvement" has been due more to a reduction in the value of imports (due to collapsing internal demand and lower oil prices) than to an increase in exports (both goods and services exports were effectively stationary in August year on year, and as the global economy enters recession this is hardly likely to improve).
Another factor which it is very important to bear in mind is that the deficit on the income item in the monthly current account (basically the difference between what Spanish residents receive from money lent abroad and what Spanish residents pay to external lenders) has been rising notably of late, as both the volume of debt and the cost of serving it, ie interest rates, have risen.
The financial account has also deteriorated recently, with the "other investment" heading (basically the balance between loans people outside Spain make to Spain as compared with loans people in Spain make to the rest of the world) turning strongly negative in July and August after very robust performances in February and March. So, effectively, the whole system is now folding in on itself, and the consequences are not hard to see. GDP slows and then contracts, more than likely in a pretty violent fashion in the not too distant future.
Well, I said this would be a relatively brief post (although I hope there is a lot of meat here to chew on). I think this is the core of the Spanish crisis in a nutshell. To better understand how it all works out in practice across the real economy you will need to dig around in my earlier posts, and to understand the implications of what all this will mean as we now move forward, well, naturally that will form the substance of the posts which are now to come.
Friday, November 14, 2008
As Italy Enters It's Fourth Recession Since 2000, Who Will Bail-Out Unicredit?
Italy, which is still the eurozone's third biggest economy, slipped into a recession in the third quarter. The Italian economy fell into what is now its fourth recession in less than a decade as gross domestic product shrank 0.5 percent from its level in the second quarter, when it contracted a revised 0.4 percent, the national statistics office said today. This is already Italy's worst recession since 1992, and there is evidently more and worse to come.
Italy effectively followed Germany, Europe's largest economy, in posting two consecutive quarters of contraction -- the technical definition of a recession. Spain contracted on the quarter, while France narrowly avoided recession by posting a slender 0.1% expansion after contracting in the second quarter.
From the third quarter of 2007 the economy contracted 0.9 percent, and this was the sharpest year on year quarterly decline in more than 15 years. ISTAT will provide a detailed breakdown of the GDP figures when it releases its final report on Dec. 12.
The IMF recently forecast that the Italian economy will shrink 0.1 percent this year and 0.2 percent next year, while Italy's employers organisation Confindustria are forecasting a 0.2 percent contraction this year. Making a rough, back of the envelope, calculation, if the economy once more contracts by 0.5 percent in the last quarter, we could be looking at a 0.4 percent contraction this year over 2007, and a year on year drop of around 0.9% again in the last quarter.
The real problem being raised here is not so much the recession itself, but the long term trend growth of the Italian economy in the light of the need to sustain a sovereign debt in the region of 104% of GDP and financing a rapidly ageing population. As can be seen in the long term growth chart below, Italy's growth rate has been steadily dwindling for some time now, and it is clear that this tendency is not going to be reversed any time in the near future.
Very Slender Bank Support Programme
Just how delicate all of this now is is highlighted by Italy's programme to help the banking system cope with the consequences of the global financial crisis, and deal with the impact of the economic unwinding which is currently taking place in Eastern Europe, which was finally approved by the European Commission earlier today (Friday).
The Commission said in a statement that the plan to offer guarantees for new banking debt and other aid was needed to remedy serious disturbances in the Italian economy.
The Italian government says its conservative banking system has been hit less hard than others by the crisis, but even so the government has offered to swap up to 10 billion euros ($12.5 billion) in government bonds in temporary exchange for other forms of debt held by banks, and in any event it is by no means clear that the Italian banks will not be hit hard by what is now to come in the East of Europe.
This sum the Italian government has set aside compares with the Austrian government's 100 billion euro ($129 billion) banking package. Despite being a small country, Austria has a fairly large exposure to the East European banking system (equivalent on some estimates to 100% of Austrian GDP), but the exposure of Italian banks (and in particular Unicredit) is hardly negligible.
In reality, most of the capital that is being "readied up" in Austria is destined for use in underpining lending in CEE countries including Romania, Hungary, Bulgaria, Poland and the Baltics. As the Eastern Euopean euro-pegs break or the currencies slide, domestic households will have to be "eased of" CHF and euro denominated loans, and the subsidiaries of Austrian, Belgian, Swedish and Italian banks look set to have to eat large loses as a consequence.
By tapping their home governments, those banks who have significant CEE exposure effectively lean on taxpayers in their home countries for refinancing countries with large current account imbalances, and large forex household debts. In other words Italian taxpayers are going to have to fund the losses Unicredit and other Italian banks will accumulate on their CEE lending just as the US Treasury is having to fund United States sub-prime loses. The difficulty is, however, that Italian taxpayers are already "in hock" up to their eyeballs, and if people aren't careful Italians could end up paying for some of the CEE loses with part of their future pension entitlements.
This is why this is no simple and ordinary "technical recession" and why the issue of where the money is going to come from to refloat Unicredit should the worst come to the worst, is the NUMBER ONE question facing the European bank bail out at this point in my humble opinion.
Italy effectively followed Germany, Europe's largest economy, in posting two consecutive quarters of contraction -- the technical definition of a recession. Spain contracted on the quarter, while France narrowly avoided recession by posting a slender 0.1% expansion after contracting in the second quarter.
From the third quarter of 2007 the economy contracted 0.9 percent, and this was the sharpest year on year quarterly decline in more than 15 years. ISTAT will provide a detailed breakdown of the GDP figures when it releases its final report on Dec. 12.
The IMF recently forecast that the Italian economy will shrink 0.1 percent this year and 0.2 percent next year, while Italy's employers organisation Confindustria are forecasting a 0.2 percent contraction this year. Making a rough, back of the envelope, calculation, if the economy once more contracts by 0.5 percent in the last quarter, we could be looking at a 0.4 percent contraction this year over 2007, and a year on year drop of around 0.9% again in the last quarter.
The real problem being raised here is not so much the recession itself, but the long term trend growth of the Italian economy in the light of the need to sustain a sovereign debt in the region of 104% of GDP and financing a rapidly ageing population. As can be seen in the long term growth chart below, Italy's growth rate has been steadily dwindling for some time now, and it is clear that this tendency is not going to be reversed any time in the near future.
Very Slender Bank Support Programme
Just how delicate all of this now is is highlighted by Italy's programme to help the banking system cope with the consequences of the global financial crisis, and deal with the impact of the economic unwinding which is currently taking place in Eastern Europe, which was finally approved by the European Commission earlier today (Friday).
The Commission said in a statement that the plan to offer guarantees for new banking debt and other aid was needed to remedy serious disturbances in the Italian economy.
"The Italian guarantee and swap scheme is an effective instrument for boosting market confidence and the commitments we have secured from the Italian authorities ensure that distortions of competition are kept to a minimum," EU Competition Commissioner Neelie Kroes said in a statement.
The Italian government says its conservative banking system has been hit less hard than others by the crisis, but even so the government has offered to swap up to 10 billion euros ($12.5 billion) in government bonds in temporary exchange for other forms of debt held by banks, and in any event it is by no means clear that the Italian banks will not be hit hard by what is now to come in the East of Europe.
This sum the Italian government has set aside compares with the Austrian government's 100 billion euro ($129 billion) banking package. Despite being a small country, Austria has a fairly large exposure to the East European banking system (equivalent on some estimates to 100% of Austrian GDP), but the exposure of Italian banks (and in particular Unicredit) is hardly negligible.
In reality, most of the capital that is being "readied up" in Austria is destined for use in underpining lending in CEE countries including Romania, Hungary, Bulgaria, Poland and the Baltics. As the Eastern Euopean euro-pegs break or the currencies slide, domestic households will have to be "eased of" CHF and euro denominated loans, and the subsidiaries of Austrian, Belgian, Swedish and Italian banks look set to have to eat large loses as a consequence.
"That this is about providing credit to Austrian companies is just a pretense," said Matthias Siller, who manages emerging market funds at Baring Asset Management. "This move is a clear commitment to eastern Europe......But this has nothing to do with charity. Those (Austrian) banks are system-relevant banks in central and Eastern Europe, and if they had to withdraw capital from there, this would set off a landslide," he said.
By tapping their home governments, those banks who have significant CEE exposure effectively lean on taxpayers in their home countries for refinancing countries with large current account imbalances, and large forex household debts. In other words Italian taxpayers are going to have to fund the losses Unicredit and other Italian banks will accumulate on their CEE lending just as the US Treasury is having to fund United States sub-prime loses. The difficulty is, however, that Italian taxpayers are already "in hock" up to their eyeballs, and if people aren't careful Italians could end up paying for some of the CEE loses with part of their future pension entitlements.
This is why this is no simple and ordinary "technical recession" and why the issue of where the money is going to come from to refloat Unicredit should the worst come to the worst, is the NUMBER ONE question facing the European bank bail out at this point in my humble opinion.
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