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Tuesday, February 10, 2009

Russian Debt And The Euro

Keynes’s genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge.
Martin Wolf, Financial Times

The euro fell again yesterday, by 1.1 percent against the dollar (to $1.2860) and by 1.2 percent against the yen (to 117.52 yen). The change, even if quite large in a short space of time, is hardly dramatic, but what is of more interest is the why. Russian companies announced yesterday that they were thinking of opening negotiations to "restructure" their debt. Bloomberg:

The euro fell after a Russian bank official said the nation’s lenders asked the government to help moderate talks with foreign lenders on $400 billion of loans, adding to speculation financial turmoil in Europe is worsening.

The euro fell versus 13 of the 16 most-active currencies after Anatoly Aksakov, president of the Russian Association of Regional Banks, said in an interview with Bloomberg News that the group has written to the government after talking with foreign banks. He said $135 billion of the loans are due this year and the remainder of the $400 billion within four years.

The “report of rescheduling debt is driving the euro lower because European financial institutions have a bigger exposure to Russia than their counterparts in other countries,” said Takashi Kudo, Tokyo-based director of foreign-exchange sales at NTT SmartTrade Inc., a unit of Nippon Telegraph & Telephone Corp., Japan’s largest fixed-line phone company.

And then there is Kazakhstan to think about:

Kazakhstan’s banks may have their ratings cut as the devaluation of the nation’s currency makes it harder for them to repay foreign debt and “substantially increases” credit risk, Moody’s Investors Service said yesterday.

And Mr Euro, like me, is getting worried:

The widening spreads between the interest rates that different euro-area nations must pay bond investors are “worrying developments,” according to a “speaking note” prepared for Luxembourg Finance Minister Jean-Claude Juncker and obtained by Bloomberg News.

In fact, while there is a growing feeling that the worst phase of the financial-system meltdown may be over in the U.S, unease is mounting that here in Europe the worst may be yet to come. The reason? Europe's commercial banks have more exposure to distressed emerging markets than their U.S. counterparts. By one estimate, European banks provided three-quarters of the $4.7 trillion in cross-border loans to the Baltic countries, Eastern Europe, Latin America and emerging Asia. Thus it is quite likely that the emerging-markets exposure of European banks exceeds even that of U.S. lenders to Alt-A and subprime loans.

“People expect that part of these debts were from the European banking system,” said Sebastien Barbe, a strategist at Calyon in Hong Kong, the investment banking unit of France’s Credit Agricole SA. “You already have a very weak banking system in Europe. If you have these Russian issues, the next step would be questions about whether similar problems will come out of other Eastern European countries.”

Dory Wiley, president of Commerce Street Capital, a money-management firm that invests in banking stocks argues that "most of the big banks in Europe are insolvent........That is what made them great - but unpredictable - shorts. They represent major components in those country funds everyone buys." The big danger now is that European governments, since they are the prime backstops for their commercial banks, will see their debt liabilities balloon and steadily be forced, in a domino like contagion process onto the slippery path towards downgrade, rising yield spreads and default.

Unicredit Saved Again By Libya

I think it should now go without saying that Unicredit is deeply involved in many of the most problematic countries from this point of view - Russia, Ukraine and Kazakhstan to name but three. So while, as reported here yesterday, the Italian bank seems to have scraped its way over the latest hurdle thanks largely to the timely intervention of the Libyan central bank, this hardly seems to be a stable situation (links to the posts which give some background on all of this can be found here).

Libya's central bank will fill half of a 500 million euro ($645.5 million) gap in bank UniCredit SpA's 3 billion euro capital raising measures, newspapers reported on Monday. Shareholders Fondazione Cassa di Risparmio di Torino (CRT) and Carimonte Holding will also take up about 230 million euros of the shortfall, Il Messaggero newspaper said...........La Stampa said Libya's central bank would hold about 7 percent in UniCredit after the capital increase and become the biggest single shareholder.

Making The Punishment Fit The Crime, Or the Crime Fit The Punishment?

Many readers are, unsurprisingly, outraged by the idea that the EU should create bonds to help a distressed Italian (or Austrian, or Irish) banking sector. Typical of many responses is this from an Italian:

I'd favour a liberal approach, but it's only my humble opinion, anyway I think bad banks should have to pay for bad policies, households should have to pay for their reckless borrowing, governments should have to pay for communicating the sunstainability of currency pegs and expantion policies. I'd like to see these kind of attitude, negotiating a volunteer currency convesion and a longer repayment time for forex loans, sharing the losses and extra costs among banks borrowers and government. otherwise the ones who acted properly will not see any advantage in acting the right way.

I think this view is being advanced in a very well meaning way, in the sense that the person voicing it simply wants to see some sort of justice, some sort of sense of responsibility. But as I pointed out in my reply to him, the issues here are systemic ones, and the majority of Germany's citizens are hardly responsible for the bad decisions made by representatives of the Russian subsidiaries of their banks. What I am trying to say is there is no effective mechanism as far as I can see whereby those who took the decisions (many of whom are already bankrupt, and others soon to become so) can be made to pay up and put things right. Meantime innocent parties get trampled on. Being intentionally emotive for a second, think about the one million people who lost their jobs in India in December, and all those millions of other people in poor countries across the globe, what responsibility did they have for the irresponsible lending practices of a limited group of Unicredit managers and employees who caused the financial shock waves they are now receiving?

Take the Latvian case. Looking through the IMF standby loan document, I was amazed to find that as a result of this bailout national debt to GDP will rise from 8% in 2008 to 50% in 2010. The thing is the only "crime" of those Latvian citizens caught up in the Parex problem were those who happened to have their money on deposit there. Now such were the covenants on the syndicated loans contracted by the banks that those who provided them (they certainly knew what they were doing) seem to have first call on any funds the government puts into the bank over and above the needs of the hard pressed depositors. Given the rapid population ageing Latvia now has coming and the serious economic growth problem they face as a result of the boom bust my feeling is that they will be unable to fully recover from the blow and will more than likely have to do some sort of sovereign default at some stage - unless, of course, they are admitted to the eurozone, the debt is "restructured" and some kind of EU institutional support offered. I personally consider the current "sit back and watch" approach to be grossly unfair, especially given that the root of their problem really lies in making it a condition of their EU membership that they join the eurozone, and then withdrawing the possibility when the financial destabilising effects of the original condition send their economy sprialing out of control.

Bad decisions were certainly taken by Latvian politicians, but I have no doubt that the fundamental structural cause of their current problems was the one I have just mentioned. So sending a whole country into bankruptcy because of the decisions and speculation of a few people in a bad bank does not seem to be like using our emotional intelligence, and this is why I think the EU have to help them. We simply cannot continue to perpetuate this kind of injustice in our midst.

I can't help feeling that inflicting significant economic pain on large numbers of innocent people is not a fitting process of retribution. It is more akin to the unfortunate campaign of intensive bombing carried out by the Allied Powers against Dresden, simply to make the German people "pay" for the crimes of Adolf Hitler. It is amazing to me that we are still having the same kinds of argument 60 odd years later.

We live in an imperfect world and the reality principle suggests we accept it as such. When you get hit by a tragedy in your life the best advice, I think, is that you do a bit of psychological counselling, put the issue behind you, and get on with your life. Don't go off on a "fatal attraction" kind of obsessive vendetta to try to make the guilty parties pay. Just do what has to be done, stop Europe's financial system melting down, change the regulations for the future, and let's all go to work and get on with things. A first step in this direction would be - as I argued on Sunday - for the EU Commission to negotiate a substantial EU Bonds issue with the Swedish, Italian and Austrian governments, and stopping the rot on this whole problem before things get further out of hand.


Anonymous said...

Excellent article. You have a insightful and well-written blog, Mr. Hugh.

I too am sick of seeing people think that "they should pay for their sins". While very Christian, it does not make for sound real-world advice. And lest we all forget it was just this sort of laissez-faire approach that caused the deflationary spiral that marked the last depression...

As Keynes is said to have remarked in your outset quote, morals are great for personal behavior but not a useful yardstick for systemic issues. Although many a gold-bug would no doubt disagree. :)

Anonymous said...

"Fool me once, shame on you... Fool me twice, shame on me..."

That is a basic descripter of human intelligence. Those who saw the folly of the irresponsible actions of governments and speculators will not be taken in easily.

Keynes approach works... until it doesn't. Increased government demand will replace personal demand as many individuals will suspend consumption decisions to see how this is going to play out. They will keep their powder dry and wait. The know the economy is in the process of de-leveraging.

Once Keynes approach reaches market saturation, the collectivists will cry that the economy is not sustainable because of all the hoarding going on. The answer to that hoarding is to force individuals' hands through currency devaluation or increased taxation so the government can spend their funds (in a thoughtful manner).

None of this plays out very well.

Sit back, relax, pay down your debts and watch as the market de-leverages. The solution to irresponsible action is not more irresponsible action. That is market morality.