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Alarm Bells Ringing: Behind The Smoke And Mirrors Of The European Banking System

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http://www.zerohedge.com/news/2014-08-02/alarm-bells-ringing-behind-smoke-and-mirrors-european-banking-system

Alarm Bells Ringing - Behind the Smoke and Mirrors of the European Banking System

Alarm bells in the European banking system have been ringing for quite a while but nobody seems to be listening. The roaring capital markets are just too loud.

But we have been keeping track of a few things.

Private sector lending is dropping sharply in the Eurozone. The latest figures have just been released and the picture is not at all encouraging. Total private sector credit by Eurozone monetary financial institutions has accentuated its negative trajectory last June, with lending to households seeing the largest monthly decline since the height of the great financial crisis in late 2008. Uh-oh.

Periphery back in play? Very recently the second largest private bank in Portugal was caught in the bankruptcy of the Espirito Santo conglomerate, reporting the largest ever corporate loss in the country’s history just last Wednesday, and raising the specter that all might not be well in the Eurozone’s periphery. Now the Portuguese government may be forced to intervene, possibly using a very large chunk of the financial sector stabilization funds set aside during the country’s recent bailout.

BIS issues a(nother) warning. This should not be a surprise. In its 2014 annual report, released at the end of June, the Bank of International Settlements (“BIS”) warned that “banks that have failed to adjust post-crisis face lingering balance sheet weaknesses from direct exposure to overindebted borrowers and the drag of debt overhang on economic recovery”, with this situation being the most acute in Europe. It also stated that increases in government debt ratios in several cases appear to be on an unsustainable path. It appears that debt levels matter for (some) economists after all.

Bad loans rising. Before we had Fitch, the ratings agency, stating last May that in a sample of 124 Eurozone banks which participated in the latest stress test impaired loans increased by an average of 8% in 2013, with no less than 30 banks seeing an increase of 20%. This could have certainly contributed to the massive contraction in private sector credit that we are now seeing on its own. But there’s more.

Emerging dangers. Trillions more in fact. In February Reuters reported that European banks have loaned in excess of $3 trillion to emerging markets..

..

Where’s the capital? Another eye-opener came over a year ago. In April 2013, Jakob Vestergaard and María Retana at the Danish Institute for International Studies published "Smoke and Mirrors: On the Alleged Recapitalization of European Banks", a report partially funded by the World Bank. The title says it all. According to the authors, by using broad capital measures based on risk-weighted assets European banking regulators have overstated the banks’ soundness and resilience in their stress assessments.

..

Sovereign debt jumps. But alarm bells should have been ringing even before that. In the third quarter of 2012, the overall government debt-to-GDP in the Eurozone surpassed 90% for the first time ever, as shown in the graph above. Why is this number important? In “Growth in a Time of Debt”, after analyzing 3,700 annual country data points going back centuries under the most varied macroeconomic conditions (and the occasional spreadsheet error ;), Carmen Reinhart and Kenneth Rogoff found that in countries which are above that 90% threshold GDP growth is generally weak. In other words, from that point on the odds are firmly stacked against us seeing the growth rates necessary to smoothly reduce debt loads that even the BIS agrees are problematic. And several Eurozone countries are way past that level now.

And who were the buyers of bonds in some of the most indebted periphery countries? In April 2012 Bloomberg reported that Spanish, Italian and Portuguese banks increased their holdings of domestic sovereign debt by very significant double digits, mostly financed by the ECB. Much to the chagrin of bond vigilantes, the ensuing decline in the bond yields of these countries virtually up until today might not be a sign of strength and stability – but rather an impressive feat of financial engineering.

That Minsky moment. Over two decades ago, Hyman Minsky described in his “Financial Instability Hypothesis” the interplay between the financial markets and the wider economy, which according to him is at the heart of the business cycle in a capitalist economy with a sophisticated financial system. During the good times increases in asset values often lead to investment and speculative excesses financed through debt. At some point the resulting cash flows can no longer cover those debts, impairing loans and prompting banks to tighten credit availability, even to companies with good credit ratings. This in turn leads to a contraction in asset values and economic activity in general.

And where are we now in the Eurozone? We have already seen the general increase in asset values, so check. And now we can also check bad debts rising and private sector credit contracting. If Minsky was right, what follows is not pretty.

..

Still I'm sure it's all under control....

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£14bn for Ireland?

Meh...... Mario will be full on QEing soon enough.

I think I'd be more concerned about the impact of a collapsing Russia on countries like Austria and lending to the Eastern periphery.

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Wooh - really big numbers and who knows what is really going on?

EDIT: The Irish numbers truly are scary though. With the rates they charge and outcome of an 0.5% write off rate is bad.

Under Yank rules, US banks have to move to a 100% provision at 90 days plus if my memory serves me correct.

I would also add that if up-to-date accounts are being paid off but accounts in arrears grow with non payment, the value of accouts in arrears quickly mushrooms to overwhelm the bank.

I wish I understood this but at 2AM on Sunday morning after numerous ciders I haven't a chance. I'll take your word for this. Is this bad? Is Eire going to go bust again? Are we going to bail it out again. Should we have all bought a house in Cork? Anyone know a Limmerick? OK, that was cr*p.

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£14bn for Ireland?

Meh...... Mario will be full on QEing soon enough.

I think I'd be more concerned about the impact of a collapsing Russia on countries like Austria and lending to the Eastern periphery.

How soon is now?

Lefties/VI have been holding out for imminent ECB QE for a long time now, to protect the value of their hyperinflated homes going forwards, whilst now getting worried about a few behind the scene comments from the main players (including Yellen) about inequality/opporunity for young people.

Concerned about the threat they will allow an attack on VI's insane house prices/land values/boom jobs reliant on warped boom/low rate money in the future. You've had the window to sell up into, for a silly high price.

Dr. Draghi Prescribes a Dose of Deflation for Spain as his latest Quack Cure

Posted on April 1, 2014

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.. Here are the two extraordinary aspects of Draghi's praise for deflation as the solution to Spain's Great Depression level of unemployment. One, Draghi's pro-deflation policy contradicts the ECB's anti-deflation policy. That explains the strangest puzzle economists have had about the troika.

The troika's practices are insane under their own written policies. Under their stated policies they should have -- over a year ago -- adopted maximum monetary stimulus. Instead, they have been claiming that they are waiting to intervene until the eurozone is minutes from sinking into deflation. The troika has also been claiming that if this intervention comes a minute too late the results will be disastrous because the intervention will likely fail.

"Mr. Draghi has said low inflation is concentrated in crisis countries where falling prices are welcome and necessary to regain competitiveness on world export markets."

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How soon is now?

Draghi's last ECB meeting:

http://www.ecb.europa.eu/press/pressconf/2014/html/is140703.en.html

As a

follow-up to the decisions taken in early June, the Governing Council today also decided on specific modalities for the targeted longer-term refinancing operations (TLTROs). The aim of the TLTROs is to enhance the functioning of the monetary policy transmission mechanism by supporting lending to the real economy. A press release on the modalities for the TLTROs will be published today at 3.30 p.m. As announced last month, we have also started to intensify preparatory work related to outright purchases in the ABS market to enhance the functioning of the monetary policy transmission mechanism.

Question: Mr Draghi, you also reminded us that you intensified your work on the ABS programme or the potential programme. Has that effort yielded any results, and could you update us on those?

snip......

On the first point, on the first question, first of all, what's the purpose of this programme? The purpose of this programme is to address the impairment in the bank lending channel, to address fragmentation, which translates itself into different funding access conditions and different risk premiums across the euro areas, countries, members.

There are many aspects of the work that are currently being addressed. They are analysis, legal, accounting and operational. There are several bodies that have been involved, in fact, already for quite some time in this work, which is in fact the revisitation of the overall segment, market segment, of securitisations. And they are the FSB and then the Basel Committee and IOSCO and then the European Commission.

Incidentally, the Basel Committee and IOSCO have produced an announcement today about a broad study on this issue. What sort of ABS is the ECB interested, I would say, in promoting?

I think I've said that last time -- they should be real ABS -- namely, we are interested in ABS, as I said, to heal the impairment of the bank lending channel. And we are interested because we want to channel lending to the real economy, and more specifically, to the SMEs. So it should be real ABS. As I said, no CDO squared or financial derivatives or things like that in this concept.

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If they are targeting sme's that is a pretty limited programme in terms of size of monetary effect.

If it is to be material in any monetary sense, it would have to be linked to property.

!. TLTROs is up to E1trillion

2. Here's what Draghi said (it's in the link I posted if you care to read it) abut ABS purchases

There is one thing that I read often and it is the following – why are you confident that you actually can give some significant size to this market when there is no market for ABS?

Now, that's not true. As you've seen probably from the paper that we published together with the Bank of England, the outstanding amount of securitisations in the European Union at the end of 2013 was about €1.4 trillion, which is one-fifth of what's in the US. But in the US -- and it's mostly in the US, the market is guaranteed by the government, because you have the securitisation related to real estate and housing mortgages.

In this case, there would be also the interest in promoting securitisation that could actually help, as I said before, lending to the real economy and to the SMEs. So to some extent, the size of the market is endogenous, and it depends very much on certain conditions, one of which is regulation. The regulation after the crises treated, I would say, good ABSs and complex or bad ABSs the same way, and they treated the ABS more severely or differently with respect to assets that are very, very similar, both from a capital viewpoint, capital charges viewpoint, and from the liquidity charges viewpoint.

So this is quite an interesting and potentially important development.

As the FED program comes to an end and they start to tighten, ECB is starting to ramp up asset purchases. It's going to be fascinating to see whether the FED can do this whilst the ECB pushes the other way.

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To be honest TMT, I wish I could pretend to be knowledgable but as time progresses I find out I know nothing.

It is not a 'what will happen' question? It is 'what will the response be' and to that I can only say they will try and hold things together and the people at the bottom and middle of society will become another bit worse off.

I suppose it is all a question of how much they QE again to save all this and when they do it - do they wait for what has happened in Portugal - banks looking very wobbly - to spread and we have another kind of collapse or whether they get in first and QE.

I imagine they would like to QE first but politically the politicians may prefer an excuse to justify doing it? Then again, how many of the Public in the EU take any notice of QE at all. They could announce it on the news and most would not even notice.

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This is an interesting statement. We know they choose their words carefully:

He refers to outstanding abs in the European Union - not the Eurozone. And he also refers to working alongside the BoE? What does this mean?

Is the sme programme going to be implemented across the uk too - we know our banks haven't been lending to them for years now.

EDIT: I guess London is currently a major player in terms of European structured credit. For the Europeans it would be difficult to allow them to continue such a processing role if they were outside the programme. I would guess there would be pressure from London to ensure they are in there picking up their slices. In that way, the UK is steadily co-opted in another European project.

I suspect given the dominance of London and the cross border flows it's sensible to consider the EU market in the round. Though all he's saying is they worked on the paper together (yes, I noticed it too and thought it was interesting)

I suspect the ECB was also keen to utilise BoE knowledge/experience in these markets rather than rely on what they're told by French and German banks who let's face it are up to their ears.

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