Business

Europe’s Debt Crisis: Why it’s Taking so Long to Solve [Analysis]

 

 

When are the Europeans going to get their act together?

Well the answer is: They are getting there! Inexorably and slowly – above all slowly.

Is it a secret conspiracy?

Most certainly! Some would call it:

Organisation and cooperation on an interdepartmental and cross-border level while fully respecting the national sovereignty of the historical traditions of all members and associates of the European Union in order to in due course coordinate the national instruments and relevant institutions for the furtherance of economic prosperity and enhance financial stability throughout the sphere of influence of the members of the original Rome treaty and later integrated identities and applicants.

You wanted the short version didn’t you? Translated into American English:

Let’s gang up on the banks and be really mean to them!

How do they keep it a secret? Well they hide it in plain view – under a truckload of paper! First of all they translate everything into 22 different languages – excuse me: 22 truckloads of paper – and formulate themselves as above – and elaborate on that.

The Russian spies are handed the copy in Latvian – no need to encode, as no sane Latvian speaker would ever dream of living in Russia given an alternative. The Americans won’t understand as long as there is no word under three syllables on the first page (two pages for good measure) and the Chinese are not remotely interested.

Will the banks not get whiff of it? Very unlikely! They have their focus the wrong place: On manipulating the politicians – and two thirds of the politicians are either old communists or they just hate Muslims, Jew and Christians and want to ruthlessly defend their version of apple pie. Of the remaining third – two thirds are simply too thick to get it and the remaining tenth was the one that started the civil servants in the first place. Furthermore: Could you imagine a bank employing a qualified academic civil servant? Not one banker would get through f.i. the French. Frankly I’ve wondered listening to bank “economists” how they got their degree – and I’m Ecole Superieur nowhere near the sharpest tool in the kit.

No the secret is more than safe – actually it wasn’t before late 2010 I got the vaguest hunch something was up and the commissions press release is dated September 23rd 2009:

Titled: Commission adopts legislative proposals to strengthen financial supervision in Europe

(as I said: The banks are in for it!) Even headline formulation is certain to make any journalist fall asleep instantaneously.

They set up two committees (certain to make every business man cringe) which are actually mergers of several other older committees that obviously – in the light of the Lehman Brothers meltdown – didn’t work. That’s the way to kill a committee – set up another!

Quote:

  •  a European Systemic Risk Board (ESRB) to monitor and assess risks to the stability of the financial system as a whole (“macro-prudential supervision”). The ESRB will provide early warning of systemic risks that may be building up and, where necessary, recommendations for action to deal with these risks.
  • a European System of Financial Supervisors (ESFS) for the supervision of individual financial institutions (“micro-prudential supervision”), consisting of a network of national financial supervisors working in tandem with new European Supervisory Authorities, created by the transformation of existing Committees for the banking securities and insurance and occupational pensions sectors. There will be a European Banking Authority (EBA), a European Insurance and Occupational Pensions Authority (EIOPA), and a European Securities and Markets Authority (ESMA).

Huh????

Sorry that needs clarification!

The ESRB is responsible for the oversight of the financial system to prevent systemic risks to financial stability –and prevent failures of the financial systems spreading into the real economy. In layman’s terms: How to prevent bank credit squeezes from killing off sound businesses and evicting people from their homes on a large scale.  The macro-economic side of things.

The ESFS is actually the coordinating organ for the national bank inspections – whatever weird shape or form that might have (it a constant interdepartmental struggle if the bank inspection should defer to the independent CB’s or agencies under government ministries). They deal with inspection and sets standards for:

a)      Banks: European Banking Authority (EBA)

b)      Insurance: European Insurance and Occupational Pensions Authority (EIOPA)

c)       Pension funds and schemes: European Insurance and Occupational Pensions Authority (EIOPA)

d)      Securities and Markets: European Securities Authority (ESA)

The microeconomic side.

The ESRB is really the European club for CB CEO’s. The ESFS has a steering committee – whose members I’ve not been able to track down.

Is this structure working?

Most certainly: It is up and running plus hitting on all cylinders.

Let me give you some examples you may or may not have heard of:

1)      There has been a lot of talk about a Tobin-tax on financial transactions – something the banks have done their utmost to block and hinder. So far they have succeeded; but it is indeed a hollow victory!

Everybody has overlooked the principal aim of the proposal: To control and curb the rampant speculation of the banks – in so far as the tax had worked according to intention there would not have been any revenue worth mentioning.

You most clearly saw it in the Greek debacle where there were great fights over what a “credit event” was with respect to the different Credit Default Swaps – and the under which national legislation the underlying sovereign bonds were issued.

The gross CDS position was about 70 bio. EUR; but the net was just 3-4 bio. EUR. All the rest were covers within covers within covers.

If ever there was a systemic risk that was one.

As the direct ESRB approach with a general Tobin-tax failed with all the usual sick arguments that the EU should not interfere with national taxation, and EU is just mean to banks, and the British will not accept whipped cream on their apple pie.

David Cameron actually stormed out from the meeting leaving Merkel and Sarkozy discussing how to deal with that.

What they came up with was clearly twofold:

a)      The British will have to split up their banks – at least separating the detail banking sections into thoroughly independent units – I’ve already reported on that:

With appropriate links to the government White Paper.

b)      To drive home the point home the British banks have been hit with the LIBOR scandal, which was no great surprise to any of my regular readers as I already back in 2011 had noticed that the Danish CB would not touch the corresponding CIBOR rate with a barge pole. A typical move for the ESFS – ESA subordinate organ.

Where do you think the intelligence came from? The British banks?

2)      Back in late 2010 it became obvious that something within the pension community was afoot: The Danish bank inspection issued a demographic survival rate list to all pension funds in accordance with how Danes actually die, not how the pension funds thought they died twenty years ago.

A typical ESFS – EIOPA initiative.

Now most of the pension funds was seen to be unable to meet their obligations as people weren’t as kind to die timely as the pension funds had supposed – even the mighty ATP had to dig into their reserve funds to make both ends meet. This caused the ATP CEO Lars Rohde to remark that the future focus would be on not losing money instead of getting the best profit – the leeway his huge reserves had given him were suddenly reserved to meet obligations.

The immediate result was a revision of the discount factor (in some cases to 5%). The effect of raising the discount factor is to reduce the present value of especially the remoter obligations. As there is no interest rate to speak of at the moment (10 year sovereign bonds with an interest rate of 7% – as is the case with Spain – is tantamount to a denial of credit to a country) this clearly indicates that the pension funds are not able to meet their obligations.

The advantage is that confusion, incompetence and obfuscation of the pension funds is boiled down to one central and descriptive figure from which the national bank inspection can work with the individual pension funds – or rather tell the pension funds that they have to tell their savers that they won’t get the pension they were promised.

The pension funds WILL have to adjust their payment plans.

3)      Late 2011 agricultural banks in Denmark kept on folding as new standards for evaluating acreage value were instituted (an ESFS – EBA ploy if I’m not wrong). This showed quite a few banks to have made inadequate impairments on their agricultural loans.

4)      At the same time the banks and mortgage banks loans to real estate developers were re-evaluated because their book values have to be adjusted with impairments according to a realistic sales value. The jury is still very much out on this one:

a)      A fire sale would mean plummeting real estate prices that would smash the banks and their mortgage banks instantaneously.

b)      It will eat into the banks earnings as cancer, because you will have to make reservations for any interest earned on these loans in obvious distress – furthermore any further extension of credit will have to be impaired the moment it is granted.

The problem waiting a solution is the increased solidity demands in the Basel III. As it is the banks are hanging on to an illusion of life where one phone call from the bank inspection can close any bank down as being bankrupt – simply the application of those standards would mean any vestige of equity will disappear with the same speed the telephone receiver drops from the banks CEO’s dead cold hand – I’m not joking: In 2010 the CEO of Amagerbanken suffered a fatal heart attack the same day the bank inspection called.

On the other hand the chance of raising new capital on the market is very little indeed. The usual trick of Bank A and Bank B swapping newly issued shares without any money really changing hands is unlikely to sit well with the bank inspection (ESFS-EBA and the ESRB). It remains a mystery to my how these banks manage to escape being stricken from quoting on the stock-exchanges; but that is a small matter for the ESFS-ESA.

Speaking of the ESFS-ESA: During the last year or so Danish banks have been slapped with (small) fines for not reporting stock deals – the most notable to date has been Nykredit; but the latest is Jyske Bank. One wonders why neither Danske Bank nor Nordea have been reprimanded. Apparently they are hiding under the umbrella of being “systematically important” – on the other hand both Nykredit and Jyske Bank have claimed they are so too. Perhaps the matter for the two larger banks is so serious that it can’t be downgraded to a fine. Bank inspections generally don’t move unless they have an ironclad case – and they move at the time of their choosing.

5)      Finally to move outside the parochial sphere of the Shire: The intelligent observer would have noticed that the Spanish bank Bankia reported a need for a capital transfusion of 3-4 bio. EUR at the beginning of the month of June – not a week later the money gap was 23 bio. EUR – for Bankia alone. After the IMF had been over the books a fortnight later the sum was “not in excess of” 62 bio. EUR for all the Spanish banks – excepting the three largest banks (according to some Santander is the world’s 15th largest bank).

Now auditors don’t simply misplace 20 bio. EUR. There are two possible explanations for the sudden reversal of fortune from concern to distress:

a)      The new standards for evaluating “brick-assets” have been invoked suddenly.

b)      And/or elimination of cross-holding was done.

The reasons for excluding the three largest remains obscure. One possible explanation is that the large Spanish banks are quite exposed to South America where large loans might still be on the books without having been serviced for decades (since the South American melt down some 25-30 odd years ago).

In conclusion:

Europe is doing rather much to get their act together but especially the formation of European Systemic Risk Board points to a genuine concern that the banks will drag the economies with them into the abyss – at the same time things can’t be left painted over like in Japan and Argentina, as the continued crisis leave those countries in a more than exposed position.

Furthermore neither Spain nor Italy are capable of recapitalising their banks so the European Union must step in one way or the other – what remains unclear is how Spain is going to guarantee this recapitalisation: The reports – even to parliamentary committees – have been deliberately vague on that point; but to assume that some EU countries (mainly Germany) are just going to donate money is very naive – the Finns have been specific as far as that.

Germany and the others are not just going to let Spain and Italy get off the hook as long as there are taxable fortunes in those countries – and they are certainly going to help repatriate some of the money that has fled those countries. But that is for the long haul.

One thing remains reasonably certain: Banking in Europe is going to change forever in so far as the “happy days” are never going to come back. For starters: There is no way “the market” can recapitalise the banking system. Few investors have any desire to pour money into the bottomless pit of European banking. That leaves just nationalisation of the banks, because sovereign states are the only entities that have the ability to tax the evaded fortunes and privileged pension funds. The different legislation in the European countries will have to conform to a common standard (banks are experts in legal arbitrage), but the order in which these standards are brought in line is a matter of priority – different for each individual country.

It is far from being a question of currency as the non-EUR currencies have little to no leeway: The British might devalue the pound, but then they will be hammered – and Britain is especially vulnerable as a third of the British GDP is banking and a third of Europe’s banking is British. The new standard is not the currency of the country; but the creditworthiness of the country.

Any devaluation of a currency is going to make the interest rate of the country’s 10 year sovereign bonds go through the roof, as investors will rightly assume that the trick is to be repeated – and that risk will be priced in. It is thus only countries running a balance of payment surplus that is in a position to adjust their currency – but only upwards. This is something these countries have absolutely no desire to do as that will kill not so much their trade balance; but their employment! As the now cheaper imports would replace domestic production and exports would be hamstrung.

Any opting out of Europe would entomb a secessionist in an economy dependent on a very narrow range of exports –as Russia is. Norway can do it, as their oil wealth is so disproportionate to their size; but that illusion shattered about 20 years ago when oil prices plunged in a matter of weeks.