European Banks Face Devastating Exposure to Emerging Markets

This view from the City of London is interesting, given the devastation that permeates their own surrounding landscape. The Anglo-Americans seem to be throwing down the gauntlet. What now, Monsieur Trichet?

The European banking system is certainly a mess, and if there was a case to be made for pursuing the 'Swedish option' of nationalizing the banks in a crisis of their own making this is it.

One sentence in this was especially eye-catching.

"We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights."

Problem -> Reaction -> Solution.

There always seem to be some arcane powers at the ready to solve the unexpected crisis.


UK Telegraph
Failure to save East Europe will lead to worldwide meltdown
By Ambrose Evans-Pritchard
11:17PM GMT 14 Feb 2009

If mishandled by the world policy establishment, this debacle is big enough to shatter the fragile banking systems of Western Europe and set off round two of our financial Götterdämmerung.

Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East.

Mr Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that.

Stephen Jen, currency chief at Morgan Stanley, said Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut.

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble.

"This is the largest run on a currency in history," said Mr Jen.

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not.

Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus.

Under a "Taylor Rule" analysis, the European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

But I digress. It is East Europe that is blowing up right now. Erik Berglof, EBRD's chief economist, told me the region may need €400bn in help to cover loans and prop up the credit system.

Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve.

We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights.

Its $16bn rescue of Ukraine has unravelled. The country – facing a 12pc contraction in GDP after the collapse of steel prices – is hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch. Pakistan wants another $7.6bn. Latvia's central bank governor has declared his economy "clinically dead" after it shrank 10.5pc in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

"This is much worse than the East Asia crisis in the 1990s," said Lars Christensen, at Danske Bank.

"There are accidents waiting to happen across the region, but the EU institutions don't have any framework for dealing with this. The day they decide not to save one of these one countries will be the trigger for a massive crisis with contagion spreading into the EU."

Europe is already in deeper trouble than the ECB or EU leaders ever expected. Germany contracted at an annual rate of 8.4pc in the fourth quarter.

If Deutsche Bank is correct, the economy will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt.

The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

So we watch and wait as the lethal brush fires move closer.

If one spark jumps across the eurozone line, we will have global systemic crisis within days. Are the firemen ready?

Why Is There No Reform?

First the reform of the financial system, and then the stimulus can find a footing. The existing level of debt obligations are too large and unproductive of cash flows to service.

The debt must be written down and the currency devalued to increase the wages of debt payers relative to them. This is an unacceptable alternative at the moment because politically the debt holders and the big money center banks are running the system. The parallels to Japan are remarkable, where the inability to realize their losses caused an entire country to lose its way for a decade.

Until we break up the big money center banks into their parts, and write off their debt obligations, we are pouring money into a Wall Street sinkhole of corruption. This will involve the reinstatement of Glass-Steagalls.

"The United States should emerge from the economic crisis with a two-part financial system that places tighter restrictions on banks, says former Federal Reserve chairman Paul Volcker.

To prevent another banking crisis from undermining the economy, the U.S. financial system must turn back the clock to a time when commercial banks were the core of the credit system, said Mr. Volcker...

The system that Mr. Volcker envisions "looks more like the Canadian system than it does like the American system," he told a Toronto audience last night..."

And there will be no recovery, only increasing pain, until we break the pattern.

“The Government should allow every distressed bank to go bankrupt and set up a fresh banking system under temporary state control rather than cripple the country by propping up a corrupt edifice…

…amounts to swapping taxpayers’ ‘cash for trash,’ Stiglitz said yesterday in a panel discussion at the World Economic Forum in Davos, Switzerland. ‘You shouldn't chase good money after bad. We’re talking about a national debt that’s very hard to manage.'" Joseph Stiglitz

What is the reason then that we are following a path that will fail? Are those who know what is happening afraid to admit it, to tell the truth? Is it simple looting until the harsh medicine is taken? Is it the cowardice of the Democrats? Is it the obstructionism of old line thinkers like Larry Summers and Tim Geithner?

It is most probable that there are still just too many of those who say, "Why can't things just go on as they have done before?" The awareness that the game has changed will penetrate the public consciousness slowly.

It's over. We cannot keep trying to rebuild the unsustainable, because eventually the great forces of probability will crush us and destroy us, all that we have.

But until the people are ready for change, to accept that reforms are necessary, the Administration must tread lightly. As de Tocqueville said, "The most dangerous moment for bad government is when it begins to reform."

Only time will tell. Until then you know what to do.

P.S. An early responder said, "I presume that you mean buying gold" about 'you know what to do.' And then they laid out the reasons and ways in which the government would confiscate it.

Sorry to have been cryptic, and its my fault. Let me give you the more straightforward answer that I gave to them.

"Actually it's "need little, want less, and love more" which is at the bottom of he blog.

But if it does become the kind of government that blatantly confiscates wealth through whatever means, where will you hide? First they came for gold...

Ok don't buy gold. What you will buy? Whatever wealth you do have will be taken eventually. There are no bystanders if a government turns to lawlessness.

Better to get your head screwed on straight now and realize it is not about gold, it is not about the right investments, it is about freedom."

How Cheap Is the PE Ratio When Earnings Are Negative?

Market Watch
S&P heads to first quarter ever of negative earnings
By Kate Gibson
4:29 p.m. EST Feb. 13, 2009

NEW YORK (MarketWatch) -- As Wall Street tracks Washington's moves to help the beleaguered banking sector and push through a massive economic stimulus, nearly 400 of the S&P's 500 companies have weighed in and reported a collective loss, even excluding the financials.

"This is the worst; after the sixth quarter of negative growth, it will be the first quarter ever of negative earnings," said Howard Silverblatt, senior index analyst, at Standard & Poor's.

A sixth quarter of negative growth ties the prior record set when Harry Truman was president, running from the first quarter of 1951 to the second quarter of 1952.

"Next quarter, we're expecting a new record of seven quarters of negative growth," Silverblatt added.

As of the close of business Thursday, Silverblatt calculates S&P earnings per share, on a reported basis, at a loss of $10.44 for the quarter. If financials were taken out of the equation, that deficit would drop to $2.35 a share.

"The majority of it is financials, but the biggest issue to hit as reported -- the worst charge -- was ConocoPhillips (COP) , which accounted for $3.66," said Silverblatt.

Income from continuing operations at the companies in the S&P 500 that already have reported earnings fell $90.8 billion, with financials contributing $70.4 billion of the decline. Conoco accounted for $31.9 billion of the shortfall, said Silverblatt...

The Dow is now "too heavily weighted in financials to accurately reflect the current business mix of this country," said Marc Pado, U.S. market strategist, Cantor Fitzgerald.

With 84.8% of the market value and 390 issues reported, operating earnings, which includes income from products or services and excludes financing and other costs, are down 62% from the fourth quarter of 2007, Silverblatt said...

Balance Sheet Recessions and Japan Redux

Here are a few excerpts from an essay by Axel Leijonhufvud at VoxEU which was brought to my attention by xyphius from Japan.

The essay in particular was quite good, but the introductory comments in the email from xyphius were also quite to the point that we've been making here for some time.

"I've been wondering about the consequences of what Japan did in the lost decade and whether there are any lessons to be learnt from it. I remember asking a (Japanese) friend in the early part of this decade (before Chinese Viagra revived the moribund economy) why after so many years with so little to show from policy there was little pressure for change - his reply: "We aren't hurting enough to want to change."

I take my cue from that answer: Deficit spending was a palliative that bought off demands for political reform, and propping up the banks and by extension their insolvent clients prevented a liquidation in which a meaningful transfer of assets could have occurred. In short, the political, bureaucratic and business oligopoly maintained the status quo ante.

What might become of the cocoon years? A horrible festering mess?!"

It could be something beautiful if Japan embraces reform and becomes a more vibrant, open democracy and breaks up the keiretsu economy and the tyranny by bureaucracy. It is as likely if not moreso that Japan would choose a return to national fascism. But having expended the flower of its youth in the last great War, and with zero population growth, Japan would likely need a more youthful ally. War is an old man's game, but younger men provide the fuel.

The object lesson here for us of course is that the US is going down the same path, with a military-financial complex that resists change, and may subject the country to enough of a economic scourging to set the stage for rescue by a 'great man' as national saviour. Fascism was a rather popular choice the last time the world went through a deflationary depression.

To make it pointedly clear, the US must reform its financial system which requires breaking up the big Wall Street money center banks. Once broken up they may more easily be reintegrated into an organic economy, and stimulus may take root in a real economy.

The point is not to save the banks. The point is to save the depositors, the pension funds, and the good regional banks that are banks, and not vehicles of financial engineering.

The dollar must relinquish its role as the reserve currency of the world, because our hobbits, dwarves, and men have shown themselves incapable of wielding that power gracefully. It is too great a temptation and its misuse will result in our own destruction. But we must also reform the international trade system and prevent the blatant market manipulation of the Asian tigers, China and Japan.

There are those who say, "Why can't things just go on as they have done?" The awareness that things have changed will penetrate the public consciousness slowly. It's over. It's done. Things must go forward, and we can never go back. You cannot keep trying to rebuild the unsustainable, because eventually the great forces of probability will crush you.

Our fate should we fail to reform our system is to change into something more horrible than we can possibly imagine.

And here are the excerpts from the VoxEU essay by Axel Leijonhufvud.

Richard Koo (2003) coined the term “balance sheet recession” to characterise the endless travail of Japan following the collapse of its real estate and stock market bubbles in 1990. The Japanese government did not act to repair the balance sheets of the private sector following the crash. Instead, it chose a policy of keeping bank rate near zero so as to reduce deposit rates and let the banks earn their way back into solvency. At the same time it supported the real sector by repeated large doses of Keynesian deficit spending. It took a decade and a half for these policies to bring the Japanese economy back to reasonable health.

The Swedish policy following the 1992 crisis has been often referred to in recent months. Sweden acted quickly and decisively to close insolvent banks, and to quarantine their bad assets into a special fund. Eventually, all the assets, good and bad, ended up in the private banking sector again. The stockholders in the failed banks lost all their equity while the loss to taxpayers of the bad assets was minimal in the end. The operation was necessary to the recovery but what actually got the economy out of a very sharp and deep recession was the 25-30% devaluation of the krona which produced a long period of strong export-led growth. Needless to say, the US is in no position to emulate this aspect of the Swedish success story.

Why not?

The lesson to be drawn from these two cases is that deficit spending will be absorbed into the financial sinkholes in private sector balance sheets and will not become effective until those holes have been filled. During the years that national income fails to respond, tax receipts will be lower so that the national debt is likely to end up larger than if the banking sector’s losses had been “nationalised” at the outset.

No Ordinary Recession by Axel Leijonhufvud