"This bear growls on"

In a post at the Telegraph, Ambrose Evans-Pritchard reviews the case for why the credit markets might be on the mend and finds it wanting. While some of his arguments are familiar, the part I found interesting was his belief (contrary to Wolfgang Munchau at the Financial Times’ piece “Pessimism about the eurozone is misplaced”) that neither Europe’s banks nor its economy will fare well: “Far from being the shock absorber, Europe may prove to be the accelerator of this post-bubble denouement.”

Confirming part of Evans-Pritchard’s thesis, a particularly well connected source (he reported that the Fed and Treasury were working on a quasi-nationalization plan for banks back in January) reiterated that the European banks are in at least as bad shape as their US counterparts (this is based on contact with both European regulators and senior bank executives).

From the Telegraph:

No bear wants to be a perma-pessimist, ever waiting for the sky to fall.

So, sunk in a deep armchair with an optimistic bottle of Rioja (Baron De Ley Reserva), I have tried to tot up reasons why the great credit smash-up of 2007-2008 may now be safely over, heralding sunlit uplands once again.

1) Ben Bernanke has carried out the most dramatic rescue since the creation of the US Federal Reserve. His emergency rate cuts – 125 basis points over eight days in January – was a “game changer”, as they say in London’s American Quarter, Canary Wharf.

By cutting rates from 5.25pc to 2.25pc since September, the Fed has averted ‘re-set Armaggedon’ on the Greenspan mortgages – those floating rate ‘teasers’ taken out in 2005 to 2007. Payments will barely jump at all for most subprimers. Big difference.

The cuts are heavenly manna for the banks. These miscreants can now play the “steepening yield curve”, using their monopoly privileges to borrow cheaply from the US Government and lend back expensively to the same US Government on long-dated bonds. This is the time-honoured method for rebuilding balance sheets. It works wonders. Even better (from the banks point of view), few people are aware of this massive bail-out.

2) Bernanke has accepted ‘bus tickets’ as collateral. The broker dealers (Bear Stearns, et al) can take their waste to the Fed’s Discount window, putting a floor under the entire shadow banking and $516 trillion derivatives nexus. Meanwhile, Fannie Mae and Freddie Mac have been armed with nuclear weapons to win the credit war. De facto, if not de jure, the mortgage industry has been nationalized. Big difference.

3) The Bank of England has woken up. Better late than never. As Professor Charles Goodhart (LSE and ex rate-setter) put it: “When you’re in a crisis, you deal with the crisis. Moral hazard comes when times are easier.” Quite.

4) A dodgy one, this: China grew at 10.6pc in the first quarter. The BRICS – Brazil, Russia, India, China – are holding up. (If you ignore their galloping inflation, which you can’t, of course: current inflation merely means a future squeeze.) Actually, scrap point 4. It’s rubbish.

Still 1, 2,and 3, matter a great deal. Yet, I cannot really believe the tale of salvation. The Greenspan credit bubble and Europe’s EMU bubble (Club Med, Ireland, and ERM-fixers in Denmark and Eastern Europe) have together infused so much poison into the Atlantic economy that it will require a brutal purge – like chelating heavy metals from the brain.

America, of course, is already in recession – although the cascade of defaults, business closures, and job losses has barely begun.

Japan is in recession too, according to Goldman Sachs. It is still the world’s second biggest economy by far, lest we forget.

Britain, Ireland, Spain, Italy, and New Zealand, are tipping into housing slumps and demand implosions of varying severity.

Ontario and Quebec have stalled. Canada’s growth is the weakest in fifteen years, hence the half point cut by the Bank of Canada yesterday.

Australia is on borrowed time, whatever the price of coal and iron ore. Household debt is 175pc of disposable income, up in La La Land with England, Ireland, Denmark, and the Dutch. The wholesale funding market for mortgages that underpins this nonsense remains frozen.

Together these countries and regions make up roughly 45pc of the global economy, and over half global demand. My hunch is that this bloc will be sliding towards full-blown deflation within a year as the commodity bubble pops and job losses set off a self-feeding downward spiral.

The alleged parallel with the oil spike of the early 1970s is a snare. Debt leverage has been more reckless this time. It must contract more viciously. Inflation is less sticky (going down) in the Anglo-Saxon world, if not flexless Europe, where stagflation awaits.

If you think that core Europe – Greater Germany, Benelux, and the Scandies (France is faltering) – can somehow tough it out as the rest of the OECD’s industrial family hurtles into a brick wall, read the IMF’s “Regional Economic Outlook: Europe”, published this week.

The Fund has cut its eurozone growth forecast to 1.4pc this year, and 1.2pc next – with perma-slump pencilled in for Italy. This puts it at daggers drawn with the European Central Bank, the fervent apostle of decoupling.

Europe will suffer 40pc of the entire $940bn global losses stemming from the credit crunch. Euro banks alone will lose $123bn (compared to $144bn for the US). “Loss recognition will need to catch up,” said the IMF.

“Liquidity remains seriously impaired. Lenders are tightening credit standards, particularly for loans to enterprises,” it said.

“The deteriorating economic outlook could weaken European and corporate balance sheets appreciably,” it said.

On it goes, more or less dire, if you adjust for the IMF’s softly-softly style.

The report contains a grim chapter on what may happen along the vast arch of over-heating silliness from the Baltics to the Black Sea, funded by Austrian, Swedish, German, Belgian, and Italian banks.

“Europe’s emerging economies are susceptible to financial shocks, which could make the situation dramatically worse,” said Michael Deppler, the Fund’s Europe chief.

Last year, private credit grew 62pc in Bulgaria, 60.4pc in Romania, 55.2pc in Kazakhstan, 45pc across the Baltics. Need one say more?

Current account deficits have reached 22.9pc in Latvia, 21.4pc in Bulgaria, 16.5pc in Serbia, 16pc in Estonia, 14.5pc in Romania and 13.3pc in Lithuania. The gap has been plugged by foreign loans. These are no longer forth-coming. Spreads have ballooned by over 500 basis points.

“Banking systems that are heavily dependent on foreign borrowing to support credit growth could face a sudden shortfall,” said the IMF.

Woe betide the creditors. Loans to the old Soviet bloc account for 23pc of the entire asset base of the Austrian banking system, and 10pc of the Swedish and Belgian systems.

As Europe’s drama slowly unfolds, the ECB is sticking defiantly to its orthodox line. The IMF suggests looking beyond the current food and oil spike (inflation is at a post-EMU high of 3.6pc), and preparing “some easing of the policy stance”.

Axel Weber, the German Bundesbank chief and leader of the Uber-hawks, will have none of it. “I do not share the vision of the IMF,” he said, tartly.

One notes that the Bundesbank was quieter when Germany was in the dumps and needed lower interest rates. It acquiesced in roaring money supply growth as inflation fuelled bubbles in the Latin Bloc – the cause of their current distress. Such is the hypocrisy of EMU. Beware the pious incantations by Mr Weber, a German nationalist in Euro-clothing. (I will return to the theme of Mr Weber in another blog.)

The ECB’s “error” will become clear over the next year as the house price crash across Club Med and Ireland combines in a lethal brew with the East Bloc credit deflation.

Germany will not be immune from the blow-back. It has funded a good chunk of Club Med’s foreign debts: Spain ($362bn), Italy ($275bn), Greece ($129bn), Greece ($98bn), and – honorary Club Med – Ireland ($123bn).

Far from being the shock absorber, Europe may prove to be the accelerator of this post-bubble denouement.

Once you add Europe to the Anglo-Saxon and Japanese sick list, you reach 60pc of world GDP, and two thirds world demand.

This leaves the global boom on tenuously narrow ground. Who is going to buy all those exports from China? Who is going to keep pushing commodity prices into the stratosphere? This bear growls on.

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  1. shtove

    The IMF report intro says this:

    “Strong fundamentals should allow Europe to weather financial turbulence relatively well. Nonetheless, growth is set to ease in 2008 in nearly all countries. Policymakers will need to deal up front with the financial market turmoil, while implementing fiscal consolidation and structural reforms, including in the financial sector, to address vulnerabilities, raise medium-term growth prospects, and deliver on the promise of convergence for emerging Europe. Three analytical chapters discuss reforms to strengthen Europe’s financial systems to allow advanced economies to benefit from innovation without incurring excessive risk and, in emerging economies, to manage rapid financial deepening and develop financial systems further.”

    I like Ambrose’s work, but he’s very picky when it comes to Europe. Best taken with a pinch of salt.

  2. foesskewered

    I know readers from Europe are probably seething but frankly, Pritchard sounds a lot more logical than the “wishful optimism” wafting out of Europe ever so often. Not to be offensive but European banks have been doing an American turn in recent years, adopting much of the hard and fast tactics, seems hard not to think they will suffer similar consequences.

  3. rent_to_own

    Of course all of Europe will suffer in any downturn, the question is which Europe do we mean beyond the overarching geographical term? The Europe of rich non-euro countries like Switzerland or the UK? The Europe of the poor non-euro countries like Serbia or Bulgaria? The Europe of the eurozone housing boom economies like Spain or Ireland? The eurozone exporters like Germany?

    Basically, ‘Europe’ has become a convenient term for whatever one wants to look at, especially for English language commentary. Truly, talking about non-euro countries as if the ECB is responsible for them is one of the less clever tricks.

    The ECB may still be committing major policy errors, and there is no question that ‘European’ banks will be having massive difficulties. But again, what do Swiss of UK banks have to do with the ECB? Apart from more or less sharing the same continent, that is, Swiss or British banks are as relevant as the BOJ to the ECB – and yet, I rarely read about any connections between those two institutions.

    There is a lot of dust being kicked up with the term ‘Europe,’ and I’m quite sure some of it is very much on purpose.

    At least the ECB seems to be fighting the right battle.

  4. Anonymous

    “Euro banks alone will lose $123bn (compared to $144bn for the US)”
    I guess that was a joke from Evans-Pritchard?

    The number for the Euro banks is most likely accurate, but he really believes that US banks are going to take only 15% of the losses in this credit crisis? A recent report on WSJ about the claimed losses so far has shown, that the US banks will be taking 40-50% of the losses, not yet included the agencies, which will lose as well money.

    The truth is simply that Evans-Pritchard is an ideological Europe hater who would never accept that the Euro economies could do better than the anglo-saxon world. If the fundamentals don’t fit with his believes he is twisting numbers.

  5. Anonymous

    Ben Stein Watch? How about The Evans-Pritchard Sentinel? It’s like trying to read Chaucer without a dictionary.

  6. Detlef


    That´s right.
    But look how he wrote it.

    EP is writing about how Europe must be added to the “Anglo-Saxon and Japanese sick list”. So somehow he seems to exclude Anglo-Saxon UK from the European banking problems. While not including UK banking loses to the Anglo-Saxon (IMF US only) account either. :)

    Look how he wrote it:
    “Euro banks alone will lose $123bn (compared to $144bn for the US).”

    It´s not Euro (as in Eurozone) banks, it´s ALL European banks!

    “As of March 2008, expected losses on subprime mortgage-related exposures are estimated at $123
    billion in Europe and $144 billion in the United States (Table 5).”

    But somehow “Europe” changed to “Euro”…

    “The report contains a grim chapter on what may happen along the vast arch of over-heating silliness from the Baltics to the Black Sea, funded by Austrian, Swedish, German, Belgian, and Italian banks.”
    (What about the overheating silliness in the UK?)

    “For Austria, the claims of the reporting banks on emerging Europe
    amount to 23 percent of its banking system assets, though exposures seem well diversified across several countries and small with respect to each individual country. The exposures of banks in Belgium and Sweden to emerging Europe are also significant but remain below 10 percent of banking system assets. For the remaining countries, the exposures are negligible, including those of France, Germany, and Italy with the
    most active banks in central and southeastern Europe.”

    He doesn´t even mention a few quite significant differences between continental Europe and the “Anglo-Saxon” banking system.
    Things that were mentioned in the IMF report.

    I have to agree with anonymous.
    EP reminds me of most “Anglo-Saxon” economics media reporters.

    Their principle:
    If something bad happens in their countries (USA, UK) it´s a necessary market correction which will undoubtedly lead to further growth in the near future.
    If the exact same thing happens in the Eurozone, it´s a sign of doom and gloom for (continental) Europe.

    Mind you, I´m not saying that Europe (which Europe? rent_to_own is right!) can decouple from the US economic problems.

  7. dearieme

    “trying to read Chaucer without a dictionary” – that’s what some of us were schooled on.

  8. Yves Smith


    Thanks for taking the close reading. You make a very good point, that too many journalists follow what turns out to be the Economist’s style maxim, “Simplify, then exaggerate.”

    Despite his flaws, E-P does tend to bring up factoids that aren’t covered widely elsewhere. And he seems to be evenhanded in his downer views. He has bad things to say about just about everybody.

  9. S

    Key point which has been repeated here is the notion that the banks are being bailed out and depositors don’t even realize that they are being pickpocketed. Ignoranc is not bliss this time around. The MSM has done a woeful job of commincating many of these points in plain language Good point on great depression read on some sight which has Rothbard taking taking issue with the notion that the fed did nothing to expand money supply and prime lending. Infact they injected over a billion at the time via treasury purchases and yet banks increased lending by 200M or something close to it. The point being that if the masses. or for that matter Congress, actually knew what was going on there would be dire consequences. It is incumbant on people who understand the system to write their local papers in plain language editorials and explain to people exactly what is going on. Bring back “Common Sense.”

    Also, posited last week that the Fed was tapping the deep pool of 401K annuities to place all this bank capital. It will be interesting to see in the filings who actually bought this lehman, MER, etc paper. As the WSJ recently wrote the whole 401K complex is merely a fee machine. Don’t know if you posted this article but it is worth the read. Yet another myth sold to the blissful public.

    Finally, last week or so you had an article with David Kotak quoted via the FT as having good connections to the Fed. Having been subjected to this guy on CNBC and listened to him comment on the bottom every month since the credit crisis began, his contacts must be the switchboard operator.

  10. Yves Smith

    I hope everyone will bear with me. Blogger has locked my blog. This is really an indictment of what passes for technology at Google; if you look at the characteristics of spam blogs, I don’t see how they could have singled Naked Capitalism out. And they ought to have screened it against my Google ad revenues or my Feedburner traffic, both of which they can readily access. Or better yet, contact me.

    Worse, I am speaking on a first time panel of econbloggers at the Milken Conference next week. This sort of thing never happens at a good time, but this is particularly badly timed.

    If you have any ideas, aside from getting off Blogger and raising hell in Mountain View, they’d be very much appreciated.

    Please keep checking back….

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