More Collateral Damage From Negative Interest Rates (Updated and Corrected)

Yves here. This post, focusing on the Spanish economy and banks, gives some examples of the dislocations causes by negative interest rate policies.

By Don Quijones, Spain & Mexico, editor at Wolf Street. Originally published at Wolf Street

Bankers in the Eurozone’s core nations, in particular Germany, are fast losing patience with the European Central Bank’s rampant forays into the markets and with its ambitions to drive interest rates deeper into the negative. That now includes Germany’s two largest banks, Deutsche Bank and Commerzbank, that are in a coordinated manner and apparently with the backing of the government counterattacking the ECB for its destructive policies.

But it’s one thing for bankers and politicians in one of Europe’s most financially conservative nations to express dismay; it’s quite another when the supposed biggest beneficiaries of ECB policy begin complaining. This is precisely what is happening in the Eurozone’s fourth largest economy, Spain.

The first shot across the bow came from Francisco González, the president of Spain’s second biggest bank, BBVA, who moaned a couple of weeks ago that the ECB’s negative interest rate policy “is killing banks.” Now, a new complaint has emerged, this time from someone who actually has a seat on the ECB’s board: the governor of the Bank of Spain, Luis María Linde.

A Dangerous Dependence

In the latest edition of the Bank of Spain’s Economic Bulletin, Linde cautioned about one of the primary effects of the ECB’s monetary medicine on Spanish households: the growing dependence of Spanish household wealth on the performance of Spain’s stock market. While Linde describes this trend as a “side-effect” of ECB policy, the reality is that pushing savers into riskier investments — in particular, into stocks — was always one of the overarching goals of central banks’ financial repression.

With interest rates in the Eurozone at their lowest point in history and yields of even some corporate bonds below zero, yield-seeking savers feel they have little choice but to invest their money in riskier assets. An investigation by the Bank of Spain confirms the gathering loss of weight of low-risk, low (or even zero) return assets in investment portfolios as investors are lured into variable income assets. Six years ago, guaranteed and fixed-income assets accounted for 82% of investments on the market; today they represent 62%.

Spanish households currently own 26% of all listed shares, according to data from the Spanish stock exchange, or BME. It is the highest level in 12 years and double the EU average. In other words, ECB policy is working a treat in Spain.

The problem is that the Madrid Stock Exchange General Index (MADX) is not exactly firing on all cylinders, despite all the increased demand among retail investors. In fact, it’s down 14% so far this year and according to the Bank of Spain’s forecasts, is likely to lose a further 6% over the remainder of the year. If the forecast rings true, it will be only the third year on record that the MADX has suffered a contraction of more than 20%, following a 23% slide in 2002 and a 40% collapse in 2008.

That will not be good news for Spanish households, whose late entry into the markets will allow large institutional investors, banks and hedge funds a timely opportunity to dump equities before things get really bad.

The Real Fear

The Bank of Spain has even bigger reasons to be concerned about the direction of ECB policy. Most importantly, its primary constituency — Spain’s big banks — are beginning to feel the brunt of Draghi’s negative interest rates, as shrinking margins take a heavy toll, and their already deeply compromised balance sheets don’t give them much leeway.

Spain’s sixth largest financial institution, Banco Popular, is urgently seeking to raise new capital in a desperate bid to shore up its finances. The bank is allegedly offering loans to its customers on the scandalous condition that they subscribe to the rights issue.

One of the reasons why Popular is in such dire straits is that it’s no longer able to benefit from the huge margins it was able to earn through the so-called floor clauses that it, like most Spanish banks, introduced into its variable-rate mortgage contracts in 2009. These clauses set a minimum interest rate — typically of between 3% and 4.5% — for variable-rate mortgages, even if the Euribor dropped far below that figure.

In April this year a Spanish judge ruled that these clauses are abusive (but not illegal) and lack transparency. Following the latest ruling, the banks named in the suit must reimburse clients all the money they’ve surreptitiously overcharged them since May 2013, when Spain’s supreme court changed the law, effectively banning the current use of floor clauses.

That alone is expected to set the banks back €5.26 billion, but if next month the European Court of Justice (ECJ) rules that the refunds should extend all the way back to the first mortgage payments, the rationale being that if a clause is declared void, “it is so from its origin,” the banks could end up owing many more billions. And that doesn’t include the billions of euros of profits the banks can no longer generate each year from applying the floor clauses.

In an ominous sign of what could lie in store, the ECB has instructed all six of Spain’s biggest banks — Santander, BBVA, CaixaBank, Bankia, Sabadell and Popular — to include the potential impact such a ruling would have on its balance sheets for their next round of stress tests. The results are unlikely to be pretty given that a) profits in Spain’s banking sector are already shrinking at a blistering pace; and b) the total cost to the banking sector of the floor clause fallout is estimated to be anywhere between €11 billion and €15 billion over the next three years.

Real-World Stress

Granted, failing an ECB stress test these days is a practical impossibility. As we reported in February, the European Banking Authority decided that for this year not a single bank will be allowed to pass or fail the test because, in the EBA’s own words, European banks are in a “steady state” and are expected to remain that way.

But in the real world, bank problems can quickly escalate out of control. It was the fear of banking failure that drove Spain’s Supreme Court to rule in May 2013 that reimbursements to floor-clause victims should only apply to payments from that date. In four weeks’ time the ECJ could overturn that decision. If it does, the banks will be made fully liable for every centimo they have cost their customers.

The resulting fallout could end up crippling the banks’ finances, as the Supreme Court feared, just at a time when even Europe’s biggest financial institutions are struggling to cope with the debilitating side effects of the ECB’s NIRP medicine. By Don Quijones, Raging Bull-Shit

And in Germany, there’s now an apparently government-backed Revolt against NIRP-Obsessed Draghi. Read…  ECB Gets Clocked by the Two Biggest German Banks

Update: From Don Quijones via e-mail:

Dear Naked Capitalism readers (with a special mention to Neq Neq),

I would like to apologize for getting a rather important aspect of the last article, on the NIRP effect in Spain, very badly — indeed embarrassingly — wrong: the chronology.

Let me explain.

When I began researching for this article, the first thing I came across was an article on the Spanish financial website El Confidencial about how the Bank of Spain was worried about the potential for further deterioration in the Spanish stock market. On its own, it was nothing out of the ordinary. It was barely worth writing home about, never mind a 1,000-word article.

But then in the byline I saw a link to another article that was a whole lot juicier. Turns out that Spain’s most senior central bankers had also expressed concerns about the effect that the ECB’s financial repression was having on Spanish households’ investment decisions. In effect, NIRP was driving savers away from low-risk assets to much more dangerous ones, in particular stocks. And those stocks are now crumbling in value.

Now that’s a story.

The problem is that story was from December 2015, not June 2016. I had committed one of the worst rookie errors a blogger can possibly commit: to not consult the date of publication of an article or other source you’re citing. Worst of all, I made it the main thrust of the article.

In my defense (if such as thing is possible), I was:

a) Writing my second article of that day (Thursday).
b) Trying to finish my tax decalaration for Friday.
c) Getting ready for Saturday’s wedding (a close friend’s big bash affair in the middle of nowhere in Northern Catalonia). And we had no way of getting there, given that I had somehow, somewhere, mislaid my credit card (which I only use to rent cars). Hence this time no rental car. And no buses or trains come even close to reaching the village La Doña and I were supposed to be staying in.
Last but not least, my wife and I were also preparing for the arrival this week of my beloved mother-in-law from Mexico. She’s a fantastic woman — in fact, she’s the person who insisted that I start my own blog — but getting everything in place for one of her periodic visits is always a logistical nightmare.
For a normal person (especially of the male gender), trying to balance all those things at the same time without f**king at least one of them up would be a major challenge. For me, it was impossible.

It wasn’t until today that I found out where and just how badly I had messed things up. In response to Nek Nek’s insistent digging and questioning of the numbers, I went back to the original El Confidencial article and the first thing I saw was the date: 23/12/2015. Just before Christmas last year. Almost 180 days ago. Not exactly what you’d call the latest news.

My first reaction was to pinch myself. When that didn’t work I began cursing myself in three different languages (English, Spanish and French). That lasted about five minutes before I finally began writing this email.

Before I finish, I’d like to thank Neq Neq for questioning some of the article’s assertions. Naked Capitalism’s community of commenters and their dogged focus on the facts and determination to probe below the surface and challenge received wisdom is one of the site’s biggest assets. It’s also one of the reasons why I’m always so pleased (and just a tad nervous) each time I see that one of my Wolf Street articles has been featured on the site. The comments are often informative, sometimes very funny and always worth a read.

[Finally, Neq Neq, apologies for my initial knee-jerk response. if you’re still interested, here’s the link to the Bank of Spain’s Economic Bulletin, from December (in Spanish). The relevant section is the one titled “Desarrollos recientes de la industria de la inversión colectiva en España.” As for the citation about the BME, it was taken directly from EL Confidencial (link here, also in Spanish), which means any problems you have with the data, you’ll have to take up with them.

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  1. Alex morfesis

    Anti trust collusion continues…savers are getting hurt because the golf tee crowd is refusing to compete…historically, iirc, margins of 150 basis points were considered quite acceptable…and this was before massive computerization of banking…today, the margins seem to be at 250 to 750 basis points, depending on the credit score of the victim…oh sorry…mark…ok ok…consumer…

    Computer screen capitalism is a disease we must eliminate in our lifetime…

    Faulty Basel has made a mess of our systems by imagining that one can “trade” away the historical risks of short term deposits and longer term loans…nahganahhapyn…

    european corporate justification ??

    Considering those clauses probably exist in other european countries (they certainly do in america) ecj will be ex-parte communicated to make the “right” decision…

  2. Steve H.

    – Linde cautioned about one of the primary effects of the ECB’s monetary medicine on Spanish households: the growing dependence of Spanish household wealth on the performance of Spain’s stock market. While Linde describes this trend as a “side-effect” of ECB policy, the reality is that pushing savers into riskier investments — in particular, into stocks — was always one of the overarching goals of central banks’ financial repression.

    ! The woolen eye-cover is starting to fray…

    1. cnchal

      . . .the reality is that pushing savers into riskier investments — in particular, into stocks . . .

      It’s easier to shear the sheeple when they are all in one place.

      At this point, when deflation is likely to rage, in home vaults and mattresses where one squirrel away cash seems prudent.

  3. Jim Haygood

    On a flight from Malaga to New York in 2002, a Russian guy was standing in the aisle, loudly boasting to a seatmate about his “nothing down” Spanish property empire.

    That was the first clue that got me wondering, “What is wrong with this picture … when some loud-mouthed dimwit thinks he’s Soros or something?”

    During the 1990s, the convergence of risky bond yields in formerly inflationary, devaluation-prone Spain, Italy and Greece to the hard-money reference standard of Germany provided the rocket fuel for an epic generational bubble.

    With Europe’s great convergence bond bubble now in the rearview mirror, monetary policy serves the same purpose as casts, traction and painkillers after a bad bicycle wreck: it’s a palliative to allow healing to start, but it’s no overnight cure, because there isn’t one.

    Who lost Europe?

  4. Paul Greenwood

    Europe is unravelling. It is not Brexit. It is the hoodlum violence at the EM Soccer tournament which reveals the street level stresses. Everything else is a safety valve which is being taped shut by the elites in a pre-revolutionary situation. Little news gets through about the turmoil in France because it is a creeping revolution as always in France “on the street”. I do wonder if the car torching has taken off……

  5. NeqNeq

    I went looking for the BME shareholder data cited in the article and could only find the 2014 values (from the 2015 report). I assume he is citing those values.

    I dont want to link directly to the pdf, because I dislike that practice (download driveby). For those interested here is a link to the relevant portion of the BME site:

    Filter by studies.

    The most recent study/report is titled Propiedad de acciones cotizadas: record de extranjeros y suben las familias It is in spanish, but you are looking for the chart on page 5 of the report.

    If I remember correctly 2015 was the first full year of the ECB negative rates, so I am not sure why the reported demographics count as evidence for the claim “In other words, ECB policy is working a treat in Spain”. Remember that Don’s argument is that neg rates push households into risky stock markets. You can’t use those values because effects cannot precede causes.

    The biggest change is actually the % of shareholders who are classified as “Foreign” investors which went from 40% in 2013 to 46% in 2014. By comparison “household” (Familias in the report) went from 26.1% in 2013 to 26.2% in 2014.

    Finally, I can’t quite make out Don’s real fear. He seems to be suggesting that because margins for banks are lower (no mention on total profit though), that lawsuits which stem from wrongdoing threaten to make life difficult for the banks. I fail to see why that should be a consideration when discussing the ECB policy.

    1. Don Quijones

      No, NeqNeq, as I mention in the article, the information comes from a report published by the Banco de España, which was covered in some detail by the financial publication El Confidencial. As such, the trend appears to be more recent than you suggest.

      As for my concerns about Spanish banks, they are quite clear: margins are getting squeezed tighter than ever, partly because the banks can no longer get away with gouging their customers with mortgage interest rates substantially higher than the benchmark rates (in some cases as high as 3.5%) and partly because it’s hard to earn robust margins with interest rates around or below zero.

      You mention profits but they’re down across the board. BBVA, Spain’s second bank, announced first-quarter profits over 50% lower than the same quarter last year. Santender’s profits were considerably better but were still down on last year’s. Banco Popular, in classic Bankia fashion, declared bumper first quarter-profits just two months before announcing an urgent need for more capital.

      If we’ve learnt anything in the last few years, it is that accounting in the banking sector can be highly elastic. Or as Francisco González, BBVA’s CEO, put it during testimony in the Bankia case, it is like “chewing gum.”

      As for the lawsuits, it’s only natural that when times are hard, margins are tight and profits are dwindling, a sudden major expense can end up hitting balance sheets pretty hard. That isn’t just my opinion; it’s the opinion of a majority of Spain’s supreme court judges and the Bank of Spain itself, which recently warned that new bailouts may be needed if the banks are made to refund all the money they amassed through the floor clauses.

      1. NeqNeq

        Don, thanks for the update. I guess there was a typo or mis-citation in the piece here:

        Spanish households currently own 26% of all listed shares, according to data from the Spanish stock exchange, or BME. It is the highest level in 12 years and double the EU average. In other words, ECB policy is working a treat in Spain.

        I have not read the Banco de España piece you meant to cite. Can you link?

        In terms profits: I was not saying, or implying, that profits were up. I merely said that overall profits were not mentioned. I have no idea what they were, but margins can go down but total profit go up. If I recall correctly, profit squeeze by the neg rates has been offset by increased volume at general EU level. Spain may not follow that trend, but its reasonable to think there should be evidence before believing that (or, rather, believing any proposition re Spanish Banks). It sounds like its kind of a mixed bag, and because banks can manipulate any particular quarter (fun with accounting!) typical year over year comparison is methodologically…well we should assign large error bars.

        Re the real fear: The fear of bailouts, while a concern, is not really something that should be placed at the feet of neg rates. At least in my opinion. At the end of the day, the banks engaged in behavior which has been deemed illegitimate (though not illegal?). The penalty for that behavior may (we will see) set banks on a path to failure. That does not count as a counter argument for ECB policy in my book. My guess is that you will disagree, and thats fine.

    2. tegnost

      I’ll admit to remaining largely confused about what impact negative rates have, it seems the dons point is that households are currently finding fewer places to put their money in 2016 forward. The effect as I see it here in the states, which is still just low interest, bond holding families I know are more than happy to take from bonds and buy properties, and of course stocks have performed pretty well for quite awhile. I think the fear is that banks will bail at the top leaving mom and pops holding the bag, which would of course improve the banks at their expense, right? Naturally in that case as in the u.s. the banks profit margins look healthy, indeed, but the lived economy suffers. It’s a consideration then because the ECB, like the fed before it, is choosing winners (the banks they regulate) over the lived economy of in this instance spain, no?

      1. tegnost

        also, to some of your interesting data points you provided, I’m curious if the increase from 40% up to 46% of foreign investment are from investment banks and hedge funds front running the flight of mom and pops into the market as they belatedly try to find refuge in stocks from negative rates, as in my opinion they did here as well. You know, bernanks famous “we’re going to recapitalize the banks”, and geithners “foam the runway”

        1. NeqNeq

          Front Running is possible. I will wait until the 2015 information comes out before forming a belief either way.

          1. tegnost

            Thanks, I appreciate the questioning viewpoint as it expands the discussion and helps the novices among us such as myself gain a better understanding.

          2. NeqNeq

            Yikes! Please don’t think I am anything but ignorant or have a better understanding than you! I don’t know how negative rates will pan out. It is entirely possible that what Don is pushing is exactly right when all is said and done.

            I only challenged the BME numbers (26% share) as counting as evidence that neg rates are causing a rush of households into stocks since the numbers were there prior to the neg rate announcement.

            Anyone could do that if they looked at the dates. I just happened to have the time to do so today.

  6. steelhead23

    Fractional-reserve banking is beginning to look more like fantasy-reserve banking. At what point does bank emission of capital become fraud if the regulators insist that the banks are sound, when they clearly aren’t.

    1. James Levy

      Problem is, the very people who will certify the banks as “sound” are the ones who define what fraud is. They are not going to define their own actions as aiding and abetting fraud, so legally it will not be fraud.

  7. John

    One of the most important goals of the European Union was to create a currency that would rival the dollar as the global reserve currency. It would need to have appreciating tendencies and be more valuable than the dollar in order to be appealing enough to replace it. Moreover, the capitalist class wanted their assets denominating in a currency with those qualities. The Germans were fine with having such a strong currency because the periphery nations were allowed very generous exchange rates when they adopted the Euro, and combined with the bubble this meant they could provide a very strong market for German manufacturing.

    The powers that be have completely given up on this goal because at this point, they’re focused on simply preventing the collapse of the euro. Thus, the ECB has no problem with negative interest rates and the depreciation of the euro (capital is willing to accept their euro-denominated assets losing value because they’re petrified of the whole thing collapsing)–they view this as the only way to keep capital flowing through the financial sector and to keep yields low on the PIIGS’s government debt. The Fed, of course, has done the same and made every effort possible to pump liquidity into the American financial sector and reflate the pre-2008 bubble. Asset values have soared (the US stock market, in particular) and another property bubble is being blown. Of course China has a massive property bubble on the verge of popping and is extremely reliant on foreign demand for its (shrinking) growth rate.

    At some point, a ceiling will be reached and we’ll have another financial crisis. I don’t know where it will be triggered, but when it does, the global financial sector, being so interconnected, will collapse. What more tools do central bankers have at their disposal? If they use their ‘bazookas’ again, will they be able to reflate the bubbles and keep the party going? And then what happens when the next one arrives? For how much longer can we keep doing this?

    Reading this article makes me think that maybe Europe will be the first domino.

  8. different clue

    I assume there is still some employment in Spain, with some people still living in houses which they are said to “own”. Hopefully more people are than are not . . . in Spain. Do people with jobs and houses and mortgages in Spain believe they own or will own the houses they live in? Is the actual physical proof of ownership of houses in Spain as confused as it has become in America thanks to MERS and all the games played with separating “home ownership” into levels and layers with slices of levels and layers owned or claimed by many different entities? Or is it possible for a Spanishman who thinks he owns his house to prove that he actually does own it?

    Because if exclusive ownership of one’s own house can actually be PROVED and ACCEPTED in Spain, then perhaps people who live in houses and have mortgages . . . and still have jobs which permit the steady paying off of those mortgages . . . . should prepay the principal on the mortgage as fanatically fast as is humanly possible as a way of turning “money” into “ownership of personal subsistence survival wealth” and detaching and air-gapping that part of one’s economic existence from the bank-financial-money system and what might happen to any “money” within reach of it and at its mercy.

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