Edward Harrison here with an article I posted last evening at Credit Writedowns. Since I posted this, the markets have sold off in Asia and Europe. The U.S. will open way down. Clearly, contagion has spread. The areas where I could see contagion spreading beyond Spain should be Ireland because of their banks and Eastern Europe because of their public finances and integration with Western Europe. Because all of Europe is undergoing fiscal austerity right now, these pressures will likely increase.
Last spring and summer I wrote a series of articles on the bleak situation in Spain, centred on the Spanish Cajas (savings banks), the imploded housing market and the high level of unemployment. The gist of these posts was that Spain faced an uphill battle since the jobs market was in a world of hurt and Spain’s Cajas were hiding billions in real estate losses via forbearance.
The problems with the Cajas, who have been frequent users of ECB liquidity, became urgent during the depths of the recession in March 2009 when Caja Castilla La Mancha was rescued. By April, reports that Spain’s savings banks may have 40 billion in writedowns were widespread. For me, it was revelations last July about GMAC and Hypo-Real-Estate’s speculations in the Spanish mortgage market that made it clear how deep the forbearance problem was. GMAC was selling Spanish mortgage assets for 14.5 cents on the dollar while Spanish house prices had only fallen 13%. I asked "What does that tell you about likely losses in the Spanish banking system going forward?"
Well, with the nationalization of CajaSur, the planned forced merger of two Cajas and the forced merger of yet four other Cajas this week, we have the answer. Now, the Spanish are moving forcefully to clean this mess up. But clearly, their are a lot of dud assets on Spanish banks’ books – just as there are on the books of banks in the US or Germany or Ireland to name a few conspicuous countries. As I have been saying for a while, all of these problems didn’t magically disappear, they have been lurking, waiting for economic weakness to re-assert themselves.
The question for me, with Spanish austerity and all, is how is Spain going to prevent this from spiralling out of control? I mean, now that a lower growth path is all but assured, this has to drive unemployment, foreclosures, and non-performing loans higher. From where I sit, this looks like a situation which will get worse, not better. Can someone explain to me what I am missing here?
“Edward Harrison here with an article I posted last evening at Credit Writedowns. Since I posted this, the markets have sold off in Asia and Europe.”
Correlation is not causation, Ed. Har-har. Lucky for you; people will be calling for heads on sticks if this downdraft plays out…
Fear not, the plunge protection team will provide whatever liquidity is required. Investor risk has been eliminated; this time it’s different.
Hey, this is good. not sure if it’s been posted prior. h/t Boing/Boing
I think people are too pessimistic about Eastern Europe’s prospects. Significant portions of the economy are not accounted for over there, making the system much more resilient that the official figures would suggest. A good portion of the capital flows, including foreign investments, is in the gray and black areas and as such is unaccounted for.
Their governments are not overly indebted and they have ample room to return to high growth rates, 5% or higher, unlike countries like Ireland or Spain. Personal debt levels in these countries are also lower than in the rest of Europe. Even though most of personal debt is euro-denominated, the capitalization levels were higher than elsewhere, so the bank has more room to ride out the storm. Most Eastern European countries have already undergone currency devaluations over the last year (the ones that needed to devalue, like Romania).
I think that East European governments do play a role in creating this sentiment. Political and economic establishments there are much more intertwined. Many of Eastern European businessmen have overextended themselves before the crisis and have trouble rolling over their debts. Although a minor part of the economy percentage-wise they have disproportional political clout. So it’s in their interest to paint a bleak picture and create a bit of panic.
The new chairman whose primary job is that of a priest started his chairmanship by reading a prayer while his bank reported $750 million in losses.If it was not such a serious matter it would been very funny
I read your post and also this: http://blogs.ft.com/brusselsblog/2010/05/world-is-dangerously-exposed-to-european-default-report-says/
There is not much to cheer about, unless the euro “achieves” parity with the dollar, which would make any inefficient business look like a winner. People on the other side of the pond might see things differently, though.
Unless there is a coherent and comprehensive political response at EU level, as discussed in the FT today (see Yves’ links) that would at least create an impression that the current disorder could be replaced by something less chaotic, the European economy will gradually slide into a sort of bastard Chapter 11 mode. That is a disorderly hair cuts situation where the creditors, in the broadest possible sense will be ; different classes, categories, jurisdicitons, etc., would be competing for a shrinking cake with nobody calling the shots.
I have been slowly developing an idea for progressive (income graduated) bond haircuts. In this model, the tax system or some mechanism within the writedown precess would partially compensate some parties for losses. I am thinking of conventional political economy in which the lower and middle income levels would get this compensation.
So I am advocating a writedown, but with some compensation to some parties. The writedown itself is the key; without it the whole shooting match goes down. That’s where we are going now, in a MegaJapanese extravaganza of corruption, greed and (maybe) fear. Mostly corruption and greed though.
Writedowns are not, of course, all or nothing affairs. I was figuring 80% or so haircut with a small proportion of holders, say 25%, being eligible for say 50% compensation on their loss. Then overall you have roughly 1-(0.2 + (0.25*(0.5*0.8))) = 70% writedown in a politically saleable package.
If you think this might work I hope you, Yves and others might pick it up and run with it. I think we have taken the wrong road starting with the 100% payoff to AIG. Nothing will stop this shell game of ‘hide the toxic debt’ until the system dies or the writedowns come. I think our people and our leaders have to come to a reckoning on the debt. And I think those more fortunate to have lived in high style will need to take the hit–proportionately in some sense.
Your thoughts are most welcome…also yours Edward, and Yves and anyone else. We are out of time and this might work.
You’re right, I wrote about these problems a year ago. Now it is unfolding.
Spain might blow-up the Euro and the whole of EU with it!
‘GMAC was selling Spanish mortgage assets for 14.5 cents on the dollar while Spanish house prices had only fallen 13%. I asked “What does that tell you about likely losses in the Spanish banking system going forward?”‘
Well, it certainly says something about the banks’ problems, but it says a whole lot more about how the buying and selling of Spanish real estate involves lots and lots of cash. Which it does. The stated price was often in the ballpark of 50% of what the buyer was expected to pay – and since the stated price was convenient for everyone but the tax collector, I am in no way surprised that the stated price has not gone down much.
“Can someone explain to me what I am missing here? ”
Since you’re asking for it : Spain population is yet low and always welcomed strangers.
rental knows what he’s talking about here: Spain’s “black money” economy is quite a bit larger than many foreigners expect. Self employed professionals and businessmen have been dodging taxes for decades, and one of the ways they use this money is in home purchasing. This is so major that 50/50 splits among real prices vs stated prices happened every so often, even if 30/70 was more common. This was so attractive to sellers that pretty much everyone was supposed to follow such an arrangement, even if they had no hidden money to pass around: It is known that banks were willing to set up two loans: a regular mortgage for the amount to be paid in front of the tax man, and a second loan, apparently not associated with the sale, which happened to be placed just to pay the rest of the home under the table.
This is not just a reason prices won’t go down as fast as expected, but a reason people are unwilling to sell for the real prices: Many home owners in Spain doesn’t really own one home, they own quite a few, that they use either as an investment mechanism, a summer home, or something to give their children when they want to move out. People are just unwilling to take a bath on a home owned for those reasons, so they would rather sit there with a lot of unused property. They won’t even rent it to someone they don’t know, because the law is very friendly to the renter.
This also creates a big distortion when it comes to the rental market: There are very different prices quoted if you don’t know the owner of the property or if you are part of their social network: If someone vouches for you, a rental agreement end up being for half of what it would otherwise, due to the perceived change in risk.
“CajaSur nationalization shows weakness of Spain’s banks”
The Spanish RE market stuff is really fascinating. How much of this fiddling goes on in Italy? We can already guess that Greece has much the same situation.
Classing Spain and Greece in the first world was always a stretch.
Jack, the situation in Italy is either similar and different. We are conservative guys, who buy an home for living in it and not for speculating on a price increase. Doing the deal with an under-the-table part of cash is quite common and directly tied to the fiscal laws and the income tax deduction regime. But, aside from some marginal buyers who have been buying on hopes that the economic situation would have been rosy for many years to come, the only troubled loans are those granted to some big developers (say Zunino, Coppola, Statuto and others), where the banks are taking possession of the open projects. And all in all, the amount of the troubled home loans is very low compared to the total outstanding loans. Also because, being conservative, we do not like to extend ourselves too much taking on large amounts of debt. In fact, we have one of the least indebted private sector of the western world.
Do not forget that, contrary to Italy (a manufacturing country), Spain is in disarray because constructions was their main act, both for selling retirement and vacation homes to north europeans and for selling new and comfortable homes to the local market, since traditionally Spanish tend to take less care of their homes than others, thus increasing the demand for new homes. Although 750.000 available units on the market is a tough scenario.
“CajaSur nationalization shows weakness of Spain’s banks”
Another excellent ‘canary in the coal mine’ fallacy, excuse me, argument.
Glad to see anglofinancescum mobilizing all the market’s rather significant powers of unreason to further talk down the euro towards, who knows, even even Greek competitiveness. Great howling again, Yves cs. Keep ’em coming!
Btw, traveled through the US last month. Ghosttowns and trailer parks surrounding gated pockets of wealthy egomaniacs. People scared, angry, utterly confused by f*ked up media. Over their deafened ears into debt. Reversed remittance streams. Third world atmosphere. It’s bad.
Life’s still soo much better over here on the ‘crisis hit’ Continent. I guess that goes some way to explain the unanimously inhumane, abject, depraved American reactions to southern Europe’s troubles.
But it’s no excuse. You people are seriously f*ked up.
Uw opmerkingen hebben uberhaupt niets te maken met Spanje of de banken daar. U zou moeten opmerken dat ik ook de Amerikaanse banken langs de Ierse en Duitse banken noemde. Yves is een voortdurende criticus van wat er gebeurt in de Verenigde Staten (en in Groot-Brittannië). Eerlijk gezegd, ik weet niet wat je over praat. En ja, we zijn een f*ed up land. 100%. Onze dag komt. Morgen, lul.
Your comments have absolutely nothing to do with Spain or the banks there. You should notice that I also mentioned the American banks alongside the Irish and German banks. Yves has been a continual critic of what is happening in the United States (and in Britain). Frankly, I don’t know what you are talking about. And yes, we are a f*ed up country. 100%. Our day is coming.
The last, untranslated words of Mr. Harrison’s rather hapless attempt to write Dutch read: Tomorrow asshole. QED, I would say.
And as Mr. Harrison’s proved himself too much of a coward to translate this uncivilized slur, I will not dignify any of his responses with an answer.
Still, it’s a chilling thought that a man like this has any credibility whatsoever.
Let’s start over. I WAS trying to be civil despite your obvious sarcasm and reference to Anglofinancescum. I do think you and I got off on the wrong track here. You’re right about the last untranslated bit. But contextually, it is a phrase my friends (and all of Holland) used to use to mean “Cheers” when leaving bars early in the AM – hearkening back to when they would meet people at the port in Rotterdam arriving at work or the like. So I apologize if you took offense. I was really saying “cheers, you’re right, our day is coming too.”
In any event, as I indicated, you didn’t address the substance of the Cajas problem, which, despite your protests, is real – otherwise they wouldn’t have nationalized CajaSur or Castilla La Mancha. And the problem in the PRIVATE sector in Spain is much deeper than that. The government has had pretty good finances. Spain really never should have joined the Euro:
If I were the Spanish, I would be pretty pissed off because people are using this crisis as an excuse to foist American-style capitalism on them. In this we agree. All of the nonsense about firing people more easily is a canard for the crony capitalists. If firing people so easily solved structural labor problems, then why does the US have 17% underemployment. The Spanish should resist this at all costs. I imagine you feel the same way.
As for what is wrong in America, you make a good point and I DID say I agreed.
Fair enough Edward. Writing in second – or third, or fourth – languages can be tricky as it is, even without the use of sarcasm.
One advice: don’t use the word ‘lul’ anymore when leaving Dutch bars. It’s dangerous.
The Spanish ‘cajas’ system of community banks backed by local governments and heavily exposed to local real estate was always one Europe’s many tradition-induced anomalies waiting to be arbitraged to the stone age by haute finance.
Point is, Spain already announced all the spending cuts it can sustain, and more. The economy started growing again, even if at a pathetic rate.
Maybe people have become desentisized by financial reporting about failing banks. But a country’s not a bank. And people are no bankers. What good can come from these alarmist stories, except more room for speculation?
I’ll tell you the same thing I told Dan Duncan, and that is that you need to take it to a bar.
You interject a lot of your own personal baggage into these discussion threads, too much.
Granted, there’s some element of truth in what you say. But it is so laden with anger and emotion that the thing you offer up is the mirror image of the thing you despise—-sheer chauvinism and chest thumping.
To paraphrase Robert Hughes, on either side of the divide between Euro and Anglo, you stand ready with tar-brush and gold leaf, and instead of the wicked old stereotypes we have a whole new outfit of equally misleading new ones.
Sorry sir, but I don’t see what ‘personal baggage’ I carry around, apart from having cloesely followed (I’m a financial journalist) the disasters American-style capitalism has wrought at its home and abroad.
I appreciate free markets. I greatly admire US democracy. In fact, I’m personally rather partial to Americans, at least the many I’ve met.
But the European debt crisis is a hoax pumped to reality by media, finance and politics working in unison.
Awesome as it is, I find this relentless machinery pretty scary, too.
‘Personal baggage’, I guess.
I think it’s words like scum and slur, “utterly f*cked up” and “don’t use those dangerous words in a Dutch bar” that adds a noisy charge to your message. Few would disagree that America is utterly confused and f*cked up—we’re pitiful and pitiable, but this is not a tribal contest here. Discuss the content; don’t attack the messenger.
BTW, go easy on the Heineken while blogging or take it outside if you can’t debate important ideas with civility.
Bas, your anger against this blog and the article is misdirected. If you think that Caja del Sur is not a coal mine canary, and that the European debt crisis is a hoax, then perhaps you believe that Spain does not suffer from a real estate bubble, and that German banks are not leveraged at multiples among the highest in the world. Perhaps you believe that European monetary policy is rock-solid. And that Europe’s only problem is English-speaking bond traders.
You need to re-examine your anger (yes, baggage) and your assumptions.
That Bas guy sure is fired up… I hope he’s right and it is all just hoax.
If that proves not to be the case, it appears the ECB has decided to finally run a double blind experiment on monetary theory.
Maybe the neoclassicists are right and US fiscal support will lead to hyper inflation, or not. No data to support the proposition yet in North America in the last two years, nor any in Japan in twenty.
Maybe the MMT guys are wrong and austerity will not create a debt deflation, a demand collapse and unemployment that all combine starve the EU’s national treasuries of revenue driving them further into debt even as they shrink their budgets, or maybe Bas is right and Europe is just fine (that would make a pretty good argument for capital controls if the data bear Bas’ theory out). It is possible that all those who are about to be unemployed have plenty of savings, but if so, it is unclear where they have stashed the money.
In either case I think we can all agree that Ben and Jean-Claude are both blind or we would not be having this discussion.
John, the MMT guys are right austerity will create a debt deflation. M3 has already turned south in the US and the leading indicators are rolling over. That’s why the ten year is at 3.10%. This is not a drill.
What can the Spanish do? Tied into the Euro, not a whole lot except endure depression-like circumstances. But I anticipate, this is going to unravel at some point unless we see some demand from somewhere or the Euro depreciates spectacularly – not that the Americans want this.
Were I Spanish, I would probably have to go the inflationary route and unilaterally separate from the Eurozone i.e. take a sabbatical. The Peseta would plummet and the real problem would be the private debt hangover – much of which is in foreign hands I might add.
The German banks and others were speculating recklessly in Spanish mortgages and they will have to pay the piper. That’s what my GMAC/HRE post was about. This is why I don’t think the German really understand the interconnectedness. Their banks have exposure everywhere. Spanish property, Greek sovereign debt, US subprime, US commercial property. This is where the contagion will come from – via the interlocking global financial arrangements.
Honestly, this does look like an impenetrable mess of financial claims. I don’t know how we all are going to get out of this without a seriously painful relapse.
Edward: “Were I Spanish, I would … unilaterally separate from the Eurozone. The Peseta would plummet …”
leaving the euro, reintroducing the pesata, devalue the peseta… for foreign debt holders this would be the same as accepting a haircut.
Why not, as mentioned by Jim above, force/negotiate a haircut for bond holders?
Spain’s problem is more the private sector debt. That means separate individual negotiations for every debtor. That’s not going to happen. Nor is my scenario (at least not yet). What is more likely to happen is that Spain will undergo austerity and people and businesses will default. This will turn non-performing loans into credit writedowns and impair bank capital, reducing credit. When the pain becomes too much, you might get a currency move.
Unfortunately, it is increasingly clear that neo-classicism has such a deep hold ideologically that so long as “the establishment” remains, and by that I mean the established political parties in affected countries, we are likely to be subjected to the procrustean demands of neo-classical monetary theory.
At least in the US you can’t play the political game unless you have access to capital and as a consequence our politics has lost sight of what citizenship has historically meant. The Euro problem is the perfect diagram of what you get when money matters more than people. I wish it were not so.
“This is why I don’t think the German really understand the interconnectedness. Their banks have exposure everywhere. ”
Exactly…I suppose the German press has not chosen to explain exactly how enormous the haircuts will turn out to be for German depositors/investors. German capital was one of the largest sources of funds for all of the speculative investments that were made in the last decade.
Seeing how the financial “innovations” have morphed credits into equity (at least for speculative purposes) why not suddenly “freeze” credit trading one day at 2:30pm EU time, hopefully at the day’s lows, and turn the worst into equity.
Gottcha is allowed right?
“The question for me, with Spanish austerity and all, is how is Spain going to prevent this from spiralling out of control?”
Good question. Spanish Banks and Cajas are waiting for a miracle that didn’t came soon enough to save CajaSur, owned by catholic church clercks. They recall that in the early nineties crisis, a fast, housing-led recovery, solved an enormous finantial problem. Now they pray for a similar outcome. But with the highest inventory of unsold houses ever in history, and the international finantial unrest, it is more than unlikely that there is a housing-led recovery this time.
So, expect more and bigger domino pieces falling to the ground. For instance, watch out Cajamadrid, the second largest caja of Spain.
The merging of the Cajas could backfire by bringing down the stronger banks just like the merger of Merill Lynch almost brought Bank of America to the brink of bankruptcy.Just like the Fed,Spain’s central bank will have to act as lender of last resort.