by Mike Whitney
July 10, 2010
The EU banking system is in big trouble. Many of the Union's largest banks
are sitting on hundreds of billions of euros in dodgy sovereign bonds and
non performing real estate loans.
But writing down their losses will deplete their
capital and force them to restructure their debt. So the banks are
concealing their losses through accounting sleight-of-hand and by borrowing
money from the European Central Bank.
This has helped to hide the rot at the
heart of the system.
Presently, 170 banks are having difficulty accessing the wholesale markets
where they get their funding. Financial institutions are wary of lending to
each other because they're not sure who is solvent or not. It's a question
ECB chief Jean-Claude Trichet has tried to keep the problems under
wraps, but markets aren't easily fooled. Stress gauges, like
been rising for the last two months. Investors smell a rat. They know the
banks are playing hide-n-seek with downgraded assets and they know that
Trichet is helping them out.
A week ago, stocks rallied on news that EU banks would repay most of the
€442bn one-year emergency loan from the ECB. The news was mainly a publicity
stunt designed to hide what was really going on. Yes, the banks borrowed
significantly less that analysts had predicted (another €132bn), but just
two days later, 78 banks borrowed another €111bn.
The additional loans makes it look like Trichet
cooked up the whole thing to trick investors.
EU banks were engaged in the same high-risk activities as their counterparts
in the US. They were playing fast and loose on speculative trades that were
ramped up with maximum leverage. Bankers raked in hundreds of billions in
salaries and bonuses before the bubble burst. Now the securities and bonds
they purchased have plunged in value, so they've turned to the ECB for a
bailout. Sound familiar?
Trichet is a banking industry rep, much like Geithner and Bernanke.
His job is to maintain the political and economic power of the banks
and to dump the losses onto the public.
Presently, the ECB provides "limitless" loans to
underwater banks so they can maintain the appearance of solvency. Trichet
has lowered rates to 1 percent, provided a safe haven for overnight
deposits, and begun an aggressive bond purchasing program (Quantitative
Easing) which keeps prices of sovereign bonds artificially high. Valuations
on bank assets are supported by a central authority and do not reflect true
The wholesale-funding market (repo) has not shut down.
Banks can still exchange their sovereign bonds
and real estate securities for short-term loans. It merely requires that
they take a haircut on the value of their collateral, which would then have
to be recorded as a loss leaving them capital impaired. This is how markets
work, but the banks are not required to play by the rules.
"European lenders had $2.29 trillion at risk
in Greece, Italy, Portugal and Spain at the end of 2009, including loans
to governments, according to the
Bank for International
Settlements... German banks’ write-downs on loans and securities will
probably reach $314 billion by the end of 2010, with state-owned lenders
and savings banks facing the bulk of the losses, the International
Monetary Fund said in a report in April."
See? The ECB is not buying Greek bonds because
of a "sovereign debt crisis".
They are buying them so the banks won't lose
money. The "sovereign debt crisis" meme is all public relations hype. If it
becomes too expensive to fund government operations, Greece can leave the EU
and return to the drachma which would give it greater flexibility to settle
its debts. That would increase demand for Greek exports and improve tourism.
This is the best solution for Greece.
So, where's the crisis?
If Greece, Portugal and Spain, leave the EU and restructure their debt,
banks in Germany and France will default and bondholders will lose their
shirts. In other words, the investors, who took a risk, will lose
money---which is how the system is supposed to work.
"The region’s banks have written down a
proportionately lower percentage of their assets than their U.S.
counterparts. U.S. banks will have written down 7 percent of their
assets by the end of 2010 and euro-area banks 3 percent, according to
the IMF. European banks still haven’t shown analysts they have completed
So, the banks are underwater, but nothing has
been done to fix the problem. Where are the regulators?
On Tuesday, Euribor hit a 10-month high. The pressure is building despite
Trichet's emergency programs. ECB bank lending is nearly €800bn while
overnight deposits are roughly €240bn. Trichet is willing to drag the EU
through 10 or 15 years of subpar growth and high unemployment (like Japan)
to keep a handful of bankers and bondholders from accepting their losses.
If things get bad enough, Trichet might invoke
the "nuclear option", that is, allow a major bank to implode "Lehman-style"
so he can extort hundreds of billions of euros from the EU member states.
It's been done before; just ask
The "Stress Test"
The bank stress tests in the US were organized by the Treasury as a
They allowed the banks to use their own
internal-models to determine the value of complex securities. The same rule
will apply to EU banks. The Daily Telegraph reports that some of the banks
will actually test themselves. As least that removes any doubt about the
"European stress tests on 91 of the region’s
biggest banks drew criticism from analysts who said regulators are
underestimating probable losses on Greek and Spanish government bonds.
The tests are designed to assess how banks will be able to absorb losses
on loans and government bonds, the Committee of European Banking
Supervisors said yesterday.
Regulators have told lenders the tests may
assume a loss of about 17 percent on Greek government debt, 3 percent on
Spanish bonds and none on German debt, said two people briefed on the
talks who declined to be identified because the details are private.
Credit markets are pricing in losses of about 60 percent on Greek bonds
should the government default, more than three times the level said to
be assumed by CEBS. Derivatives known as recovery swaps are trading at
rates that imply investors would get back about 40 percent in a Greek
default or restructuring."
The tests are a joke.
The banks will continue to use accounting-rule
changes and other gimmickry to obfuscate their losses. Trichet will use the
tests to step up his bond purchasing program (QE) which will transfer the
banks losses onto the member states. Many of the banks are insolvent and
But they are in no real danger, because they
still have a stranglehold on the process.