Of banks and euro zone default taboo
If ever you doubted that the euro zone bailout was in fact a bailout of banks, French and German banks in particular, look no further than the latest report from the Bank for International Settlements.
The trillion-dollar package of loans, backstops and emergency measures announced by the European Union, International Monetary Fund and European Central Bank in May was advertised on the basis that it would create breathing room for ailing southern European nations to impose fiscal discipline and establish a credible path to stability.
In the case of Greece, it is hard to see how it could dig its way out of its hole courtesy of a policy of austerity which was going to kick off a swingeing and long-lasting recession.
Why European authorities would contemplate doing this without at the same time making lenders bear part of the pain via a default or debt rescheduling made even less sense.
At least it did until you start to look at the data of who is exposed to Portugal, to Ireland, to Greece and to Spain.
French and German banks together had more than $950 billion in exposure to the four at the end of 2009, according to the BIS quarterly review of banking and financial markets:
What’s more, their exposure to those countries’ public sector debt equaled 12.1 percent of Tier 1 equity for German banks and 8.3 percent for French lenders.
Collectively European banks had $1.58 trillion of exposure to the four, $254 billion of which was direct government risk. It is sensible to view exposure to the troubled parts of the euro zone collectively not just because the countries share suspect fundamentals, though Greece is by far in the worst position, but because market contagion was lumping them together and could easily have upended one and all.
The taboo against default — the cleanest, surest way to a sustainable base, and one which could have been combined with forcing the countries involved to behave responsibly — is because default would have opened the far bigger can of worms that is the European banking system, which is critically undercapitalized and which has made far less progress than its U.S. peers in writing down debts.
Much of the money lent to Greece and other suspect euro zone borrowers was supplied by banks which are too big to fail, too interconnected to contemplate and which are reliant on massive short-term funding in currencies in which they are not blessed with a strong deposit base.
Meanwhile, funding costs for banks have risen, a sign of poor confidence, Moody’s has downgraded Greece’s credit rating to junk and the price of insuring PIGS debt against default is higher than in the immediate aftermath of the bailout in May.
MAYBE NOT A RUN BUT PERHAPS A BANK TROT
Even though Greece itself has been given a couple of years’ grace, there can be no assurance that counterparties or depositors in Greek banks keep faith.
We are only now seeing statistics from April, before the worst of the storm hit Greece, but even then the situation of its banks was looking extremely dangerous. Depositors removed 8.5 billion euros from Greek banks in April, according to Greek data, capping a 7.5 percent decline since April 2009. In banking terms, these are really sobering numbers. If not a bank run, depositors to Greek banks are certainly breaking into a trot.
While there has been very little growth in lending at home, other than in loans to the government, Greek banks have had a noticeable uptick in foreign lending. Jamie Dannhauser, an analyst at Lombard Street Research in London, thinks this is a sign that Greek banks are having to support their foreign subsidiaries, which doubtless themselves are having difficulties raising funds and retaining deposits. Principal support is coming from the Bank of Greece, funding from which now accounts for almost 20 percent of non-equity liabilities. Bank of Greece lending to Greek banks was 90 billion euros at the end of April, with 123 billion pledged as collateral.
“Shut out of the interbank markets and unable to issue medium- and long-term debt at reasonable cost, one can only describe the funding position of the Greek banking system as precarious,” Dannhauser wrote in a note to clients.
Predictably, Greek banks are being forced to raise the rate of interest they pay in an attempt to stem the outgoing flood of deposits. This will only make them less profitable and less able to withstand the coming wave of writedowns as Greek domestic and commercial borrowers default due to the recession the austerity measure will bring.
It may turn out to be difficult to keep the default genie in his bottle, taboo or not.
(Editing by James Dalgleish)
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)