The problem everyone expects (5/6)
Europe faces a banking crisis that it does not want to admit exists.
The quintessential authority on financial stability, IMF chief Christine Lagarde, made her institution’s opinion on European banking known back in August when she prompted the European Union to engage in an immediate 200 billion bank recapitalization effort.The response was broadbased derision from Europeans at the local, national and EU bureaucracy levels. The vehemence directed at Lagarde was particularly notable as Lagarde is certainly in a position to know what she was talking about: until July 5 her title wasn’t IMF chief, but French Finance Minister.
This casual European confidence was shattered in early October when one of Europe’s larger financial institutions, <Franco-Belgian bank Dexia collapsed, necessistating a state resuce. Europeans are now discussing their banking sector, but even now largely only within the context of the ongoing sovereign debt crisis.
Its fairly easy to understand why. The primary reason why Greece hasn’t defaulted on its nearly 400 billion euro in state debt is becuase the rest of <the eurozone is not forcing Greece to fully implement its agreed-upon austerity measures Withholding bailout funds as pushishment would trigger an immediate default and a cascade of disasterous effects across Europe. Loudly comdemning Greek (lack of) actions which still slipping Athens bailout checks keeps that aspect of Europe’s crisis in a holding pattern. In the European mind Greece is the root of the European debt crisis, and while that crisis may spread to the banks as a consequence, the banks themselves would be fine if only the sovereigns could get their acts together. This is a patently false assumption.
Europe’s banks are if anything as damaged as the governments that regulate them. But one must start somewhere when evaluating a problem of such magnitute, and we might as well begin with the problem as the Europeans see it: that their banks’ biggest problem is rooted in their sovereign debt exposure.
The state-bank contagin problem is fairly straightforward within national borders. As a rule the largest purchaser of the debt of any particular European government will be banks located in the country. For example, fully half of Italy’s 1.9 trillion euro in outstanding state debt is held by Italian banks. If a government goes bankrupt or is forced to partially default on its debt, its failure will trigger the failure of most of its banks.
But that still leaves a lot of debt available for outsiders to own, so when states do crack the damage will not be held internally. The debt of Greece, Ireland, Portugal, Italy and Belgium is half or more in foreign hands, but like everything else in Europe the exposure is not balanced evenly. French banks are more exposed than any other national sector, holding 8.5 percent of France’s GDP in the debt of the most financially distressed states (Greece, Ireland, Portugal, Italy, Belgium and Spain). In relative size Belgium comes in second with an exposure of roughly 5.5 percent of GDP, althouth that number excludes the roughly 45 percent of GDP Belgium’s banks hold in Belgian state debt.
Bank Sector Total Claims Against PIIGS+B Public Sector, 2011 Q1 BIS, Million USDItaly / Spain / Greece / Portugal / Ireland / Belgium / Total
France / 105,045 / 32,581 / 13,401 / 8,611 / 2,855 / 51,529 / 214,022
Germany / 50,982 / 29,389 / 14,080 / 8,799 / 3,191 / 11,278 / 117,719
Japan / 29,772 / 10,352 / 164 / 1,092 / 1,097 / 9,396 / 51,873
United Kingdom / 12,734 / 8,629 / 3,961 / 1,805 / 4,577 / 5,258 / 36,964
United States / 14,380 / 6,060 / 1,936 / 1,269 / 1,741 / 11,400 / 36,786
Belgium / 17,294 / 3,793 / 1,873 / 2,288 / 695 / 25,943
Spain / 10,699 / 502 / 7,250 / 157 / 1,427 / 20,035
Switzerland / 5,201 / 1,485 / 529 / 832 / 111 / 2,057 / 10,215
Italy / 5,798 / 2,442 / 612 / 588 / 413 / 9,853
When the Europeans speak of the need to recapitalize their banks, it is the firebreaking of these cross-border sovereign debt exposures that dominate thier thoughts. This is why the Europeans have so enthusiastically -- if belatedly -- seized upon the 200 billion euro figure. The Europeans are hoping that if they can strike a series of deals that restructure away a percentage of the debt owed by the continent’s most financially strapped states that they will be able to halt the sovereign debt crisis in its tracks.
There are two flaws in this plan. First, 200 billion euro is insufficient even to cover reasonable restructurings. “Simply” the 50 percent haircuts that are being dicussed as part of the third Greek bailout -- which will likely be announced at the tail end of the upcoming Oct. 23 EU summit -- for Greece would absorb over half of that 200 billion euro. A mere eight percent haircut on Italian debt would absorb all of the rest.
Second, Europe’s banking problems stretch far beyond sovereign debt. But before one can understand just how deep those problems go, we must first examine the role that European banks play in European soceity.
where to start: the centrality of European banking(8)
There are several differences between the European and American banking sectors, but by far the most critical difference is that European banks are far more central to the functioning of the European economies than American banks are to the United States. The reason is rooted in the geography of capital.
Maritime transport is cheaper than land transport by at least an order of magnitude once the costs of constructing road and rail infrastructure is factored into the calculus. Therefore, maritime economies will always have a surplus of capital compared to their land-transport-based equivilents. The managing of such excess capital requires banks, and so nearly all of the world’s banking centers form at points on navigable rivers where the capital richness is at its most extreme. Some examples: New York is where the Hudson meets New York Bay, Chicago is at the southernmost extremity of the Great Lakes network. Geneva is near the head of navigation of the Rhone, Vienna is located where the Danube breaks through the Carpathians-Alps gap, and so on.
The United States boasts an interconnected maritime structure. There are six navigable rivers in the Greater Mississippi Basin. The Mississippi empties into the Gulf of Mexico where it bisects the Gulf of Mexico’s barrier island chain, which serves to facilite shipping in a manner very similar to a river. From this point shippers can access the Atlantic barrier island chain and reach all the way to Chesepeke Bay. The ease of transport not only helps make the United States rich, but it greatly eases political unification -- everyone on this expanded maritime network has a vested interest in participating in the same economic structure.
From this the United States banking system has two key characteristics. It is unified (and therefore regulated) at the national level, and Americans have a relatively non-propriatary view of American capital (they are used to capital flowing at extreme velocities across broad swathes of territory). Because of this velocity Americans view banks as simply one source of capital among many. Bank loans account for just 31 percent of total private credit granted in the United States, with bond issuances (18 percent) and stock markets (51 percent) making up the balance.
Not so in Europe. Northern Europe is blessed with a dozen easily navigable rivers, but none of the major rivers interconnect. The Danube, Europe’s longest river, drains in the opposite direction but cuts through mountains twice in doing so. The rivers’ courses -- and so Europe’s wealth -- are not split evenly. Some European states have multiple navigable rivers: France and Germany each have three. Arid and rugged Spain and Greece, in contrast, have none.
The geographic heterogenity generates both financial and ethnic heterogenity as well, resulting in feelings of proprity as regards what capital is generated. Unlike Americans who are rather lackidasical about bank loans v stocks v bonds, Europeans tend to cling to their banks with a nationalistic fervor. Roughly 80 of all private credit in the eurozone comes from banks. The sense of national ownership also has prevented a unity of management or of regulation. Unlike the United States where there is a single central bank, a single bank guarantor, and a fiscal authority, Europe has dozens.
As a starting point, therefore, it must be understood that European banks are both more central to the functioning of the European system than American banks are to the American system, and that any problems that might erupt with in the world of European banks will face a far more complicated restitution effort cluttered with overlapping, conflicting authorities colored by national narcissism.
Demography (9)
The largest piece of consumer spending in any economy is done by people in their 20s and 30s; They are going to college, raising children and buying houses and cars. Yet people in their 20s and 30s are the weakest in terms of earning potential. High consumption plus low earning leads invarably to borrowing. Borrowing is the bread and butter of banks. In the 1990s and 2000s much of Europe enjoyed a bulge in its population structure in precisely this young demographic -- particularly in southern European states -- generating a great deal of economic activity, and from it a great deal of business for Europe’s banks.
But that was then. Europe’s 20-somethings have grown up. Their earning potential has increased, but the big surge of demand is largely over. In Spain and Greece the younger end of population bulge is now 30; in Italy and France its now 35; in Austria, Germany and the Netherlands its 40, and in Belgium its 45. Consumer borrowing in general and mortgage activity have peaked, and the small sizes of the replacement generations indicate that there will not be recoveries within the next few decades (children born today will not hit their consumptive stride for another 20-30 years). With the total value of new consumer loans likely to stagnante (and more likely, declining) moving forward, if anything there needs to be a consolidation of the European banking sector. Any banking problems that Europe experiences are not likely to be ones that they can grow out of. Europe’s banking’s heyday has already come and gone.