November 27, 2014
S&P Downgrades and Banks: Threats to Global Stability
Posted on Jan 19, 2012
By Nomi Prins
According to a recent Business Week article, Spanish banks hold 30 billion euros ($41 billion) of “unsellable” real estate loans. Just like in the U.S., where smaller banks got hit hardest, small and mid-size Spanish banks did too. In addition, about 308 billion euros worth of Spanish loans are “troubled.” Home prices in Spain are off 28 percent from their April 2007 peak, with land values in the outskirts of urban areas down by as much as 75 percent.
In economic desperation, voters elected conservative party leader Mariano Rajoy as prime minister at the end of 2011. He promised to lead Spain to economic recovery by invoking austerity measures in return for backing to help the biggest Spanish banks.
Meanwhile, the top six Spanish banks sit on $33 billion of foreclosed assets, having set aside $105 billion in write-downs against bad loans since 2008, with an additional $60 billion to come. The backdrop is a 23 percent unemployment rate, triple its 7.9 percent level in May 2009. Property transactions continue to decline. Foreclosures keep ramping up. The gap between what banks want to sell foreclosed or troubled property for, and what investors are wiling to pay, continues to widen, forcing more small and mid-size banks to buckle under larger than anticipated losses, which in turn squeezes liquidity out of local usage.
Square, Site wide
According to a 2010 SEC report from the National Bank of Greece (NBG), loans to businesses and households were expected to remain low [due to] “downward pressure on household disposable incomes and firms’ profitability from the austerity measures.” It wasn’t kidding. In order for the NBG (or any bank) to reduce its dependency on ECB funding, it has to reduce loans to its own economy.
The ECB agreed to accept worse collateral (with junk ratings), including bank-issued bonds with Greek government guarantees (under a May 2010 rule change for all member countries). The ECB bought Greek (and other) government bonds in the secondary markets to support their value and, thus, their value as loan collateral. As with the Fed’s quantitative easing measures, euro-style, this only perpetuates a fantasy of demand.
After four rounds of austerity measures, nationwide protests, 110 billion euros in IMF and ECB bailouts to keep bondholders (and banks) happy, escalating interest rates driving borrowing costs higher, a downgrade to junk, and a prime minister swap, Greece remains in tatters with more pain to come.
Portugal and Italy
Last summer, S&P warned that it would downgrade Portugal if it didn’t play ball with the IMF and EU over a 78 billion euro bailout. So Portugal towed the austerity line. Its economy deteriorated. S&P downgraded it to junk status.
The IMF and EU declared that Italy also needed “structural reform,” meaning public austerity and privatization. National assets went up for fire sale, as they did in Spain and Portugal, to the highest international bidder. Now, the high borrowing costs the government faces as a result of bolstering the banking system, paying bondholders and selling infrastructure has resulted in more downgrades and dim prospects.
According to the Italian Central Bank, 500 Italian cities are facing losses on derivatives contracts. JPMorgan Chase and Banca IMI are accepting Italian government bonds as collateral, rather than less-risky U.S. Treasuries or cash, certain that the ECB will step in to buy, and thus prop up, Italian bonds if needed, as it did in August 2011.
As Greece showed, using high-cost sovereign debt as collateral leads to more bailouts to ensure big lenders get their money back. JPMorgan Chase, having weathered the U.S. subprime crisis with support from the Fed, isn’t about to lose on that bet. Meanwhile, several Italian towns, the city of Milan and the Tuscany region are suing the big American, German, Swiss and French banks over derivative losses and misleading asset purchases, but those institutions will likely get bailout money anyway.
Bailout Economics Doesn’t Work
ECB bailout money didn’t (and won’t) go toward helping any European country’s local economy, any more than it went to aiding the mainstream U.S. economy. The ECB and IMF, at the Fed, U.S. Treasury and U.S. administration’s urging, camouflaged the insolvency of European banks, perpetuating losses with bailouts and forcing cowardly governments to support them, while turning a blind eye to boosting core economies.
Meanwhile, banks with access to the ECB’s “window” are taking the money and immediately putting it back into the ECB as reserves. Overnight deposits at the ECB continue to break records, currently hovering at about 500 billion euros ($640 billion). As in the U.S., European banks are not using that liquidity to help fix local economies, but hoarding it to preserve themselves. The total amount on reserve is 98 percent of the amount made available in emergency three-year loans in late December at 1 percent interest; banks get 0.25 percent, so are paying 0.75 percent interest for the loans, far less than the market would charge.
There’s an ugly pattern here. Central entities such as the Fed, ECB and IMF perpetuate strategies that further undermine economies through emergency loan facilities and bond and derivatives bailouts, with a chorus of rating agency downgrades to spur them on. Governments get stuck trying to raise money at harsher terms plus repay the bailouts that caused those terms to be higher. Banks run more scared and hoard cheap money that doesn’t go into helping populations, exacerbating the damaging economic effects. It doesn’t take a genius to see where this is going: more bailouts, more fears of bank losses, assuaging pushy bondholders, more downgrades, more austerity. Rinse, repeat.
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