European Crisis Not Contagious – Banks Are

The International Monetary Fund (IMF) have released a stack of reports and papers over the last couple of days, including the one stating that the Greek bailout operation has been more or less – a fiasco, so far. But there’s more: New research indicates that the international banking  is continuously increasing their risk taking and that more any more trouble with the European banks may have severe spillover effects on  financial institutions outside Europe,

“Both German and French banks mostly transmit/receive shocks to other European banks, especially in the UK. French and U. banks pre-crisis also appear to have strong spillover to Russia. Outside of Europe, spillover are largely confined to the US.”

Hélène Poirson/Jochen Schmittmann

The average sensitivity to European risk, specifically, has been steadily rising since 2008. Banks that are reliant on wholesale funding, have weaker capital levels and low valuations, and higher exposures to crisis countries are found to be the most vulnerable to shocks. The analysis of bank-to-bank linkages suggests that any globalization of the euro area crisis is likely to be channelled through UK. and US banks, the research paper says.

The report “Risk Exposures and Financial spillover in Tranquil and Crisis Times: Bank-Level Evidence” provided by Hélène Poirson and Jochen Schmittmann was released yesterday in the shadow of IMF’s Greek audit report.

(Transcript of IMF press briefing on Greece here.).

This report is not necessary reflecting the official IMF view, but provides some interesting details on who will influence who if more trouble occur.

The researchers have discovered a clear pattern of interconnectedness between European banks.

“French and German banks co-move strongly only with selected US financial institutions, while UK banks are connected strongly with both Asia (pre-crisis only) and the US (in both periods).”

“This last finding suggests that the estimated spillover effects capture pure risk transmission across banks (contagion) rather than shared sensitivities to macro-financial variables.”

“This last finding suggests that the estimated spillover effects capture pure risk transmission across banks (contagion) rather than shared sensitivities to macro-financial variables.”

Moreover, the researchers have mapped the connections between the individual institutions.

“The estimation framework allows us to highlight the presence of “clusters” of interconnected banks that tend to co-move together more strongly than with other banks, either due to inter-bank linkages (counterparty relationships, interbank-lending) or the exposure to common vulnerabilities.”

A few examples

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• Large German banks appear to co-move strongly either with other German banks or with other European banks.
• Spillover from German banks to other European banks are most pronounced in the case of French and U.K. banks and, to a lesser extent, in the case of Dutch, Belgian, and Swiss banks.
• During the subprime crisis and in the post-crisis period, a Franco-German cluster can be detected comprising Deutsche Bank and BNP Paribas and a UK-German cluster comprising Commerzbank, Barclays, and RBS.
• None of the banks from peripheral crisis European countries (GIIPS) are found to co-move in a significant way with the largest German banks.
• Spillover from German banks to other regions appear limited to the US: prior to the subprime crisis, two of the large German banks seem to co-move significantly with banks in the U.S. (namely, Deutsche Bank with Lehman Brothers and Hypo Real Estate with Goldman Sachs)25; during and following the subprime crisis, Freddie Mac and Fannie Mae have synchronized returns with the largest German financial institutions (Deutsche Bank, Commerzbank, and Allianz), which in turn can be traced back to the latter’s sizeable holdings of subprime portfolios and related exposures to US real estate.

Conclusions

“Similar to German banks, the spillover of French banks to other regions are largely limited to U.S. financial institutions and can only be detected since the onset of the subprime crisis.”

“The financial spillover of U.K. banks, by contrast, reach beyond Europe in both periods. Pre-crisis, there is empirical evidence of strong co-movement of US, Indian and Chinese banks with U.K. banks; during the subprime crisis and post-crisis, spillover to U.S. banks are dominant and the analysis does not detect any co-movement with banks in other regions.”

“In summary, we can tentatively conclude from the analysis of bank-level spillover that direct financial spillover from the EA banking and sovereign debt crisis transmitted through the equity markets outside of Europe are likely to be confined to US banks and financial institutions. Indirectly, however, given the role of the US as a global financial hub, such spillover – if they were to intensify – could potentially transmit more widely to systemic banks in other regions (Asia, Latin America, and Middle East).”

“The analysis in this study leaves unspecified the channels of transmission of financial spillover both within countries and across borders. While this undertaking is beyond the scope of this paper, it would be an important avenue for further research.”

Definitively!

(Download the full report here.)

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More fun stuff:

• Please, Don’t Mention “Contagion”!
• IMF Director Christine Lagarde Sees “Crisis of Confidence”
• The Worlds Most Contagious Countries – Here’s The List
• Europe In Debt (Part 1): Creating a Monster
• Europe In Debt (Part 2): Poisonous PIIGS With Toxic Lipstick
• Europe In Debt (Part 3): Exit On Main Street
• In The Bright Minds Of IMF

Other possible related articles:

• IMF admits mistakes on Greek bailout (bbc.co.uk)
• Brussels fights back in Greek crisis blame game (guardian.co.uk)
• ‘Masters of Austerity’ Targeted as Blockupy Activists Shut Down European Central Bank (commondreams.org)
• German banks can´t withold Dibabank (yournovelty.wordpress.com)
• Brussels fights back in Greek crisis blame game (guardian.co.uk)

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The European Community Is Disintegrating

Professor George Irvin makes another attempt to explain why the European leaders mishandling of the financial crisis will only make things worse: In Brussels there seem to be a total lack of understanding of the diversified emotions amongst the euro zone’s  citizens – mixed with an ignorant perception that a “one-size-fits-all” policy is the way to fix the problems. However,  at the moment any sense of community spirit we Europeans might have is eroding.

“Think of what would have happened to Louisiana after Katrina had it been dependent on selling its own dollar bonds to the international market to raise money!”

George Irvin

The European Community Spirit?

“Another EU debt crisis and another inadequate bailout with more strings attached. In the coming year we shall almost certainly see more Club Med countries attacked by the bond markets, and told by their euro zone/IMF masters that the only alternative is to accept dramatic cuts and to slash ‘unaffordable’ welfare spending. In the absence of fundamental euro zone reform, piecemeal fire-fighting will fail,” professor Irvin writes in a blog post after the Irish bailout.

As professor Irvin rightfully points out, we Europeans have never had a real common community spirit.

VISIONARIES: Robert Schuman and Jean Monnet, founders of the European Union.

The European Union is the  result of – in this bloggers opinion – a well-meant, but unrealistic, political idea of equality and cohesion.

An ideology that in theory is a very nice thought, but in reality very hard to achieve.

The cultural differences in Europe has roots going back several centuries – it’s not gonna change in a mere decade or so.

George Irvin believes that a shared political identity amongst Europeans has to be forged.

He may be right, but again; it will take time – probably lot’s of time.

Meanwhile – our political leaders are trying to fix things by implementing systems and mechanisms that might work in one place, but causes anger and frustrations elsewhere.

In an article published back in 2008, I said that this crises calls for leadership of the unusual kind – the kind that one might be willing to die for.

At that time I did not see any political leaders in Europe at that possessed such qualities.

I still don’t.

Well, without further comments, here’s honorary professor at the University of London, George Irvin:

“The problem is that Europeans don’t want to accept that currency union means genuine economic and political union.”

Another EU debt crisis and another inadequate bailout with more strings attached. In the coming year we shall almost certainly see more Club Med countries attacked by the bond markets, and told by their euro zone/IMF masters that the only alternative is to accept dramatic cuts and to slash ‘unaffordable’ welfare spending. In the absence of fundamental euro zone reform, piecemeal fire-fighting will fail.

Ireland’s pre-emptive drastic austerity measures taken last year were meant to have solved its problems.

Harvard’s Kenneth Rogoff told the New York Times that “if you want to escape default, the Irish path is the only way to go”.

The aim of public expenditure reduction was to reassure the financial markets that the government was serious about cleaning up the damage to the banking system caused by the collapse of the country’s huge property bubble.

According to Jean-Claude Trichet, speaking earlier this year, Ireland’s cuts provided a role model for Greece.

But now it’s all gone wrong.

Self-imposed austerity has meant that Irish GDP has contracted by over 10% since 2008 and its GNP even more so; the latest unemployment figure stands at 14% and rising; the budget gap is enormous and the country’s largest banks need bailing out.

As in the past, with jobs disappearing, the young are emigrating.

At the heart of the crisis is double denial: in Ireland, while the Finance Minister, Brian Lenihan, has spent weeks denying that his country needed help, Ireland has turned increasingly to the ECB for money it could not find on acceptable terms elsewhere.

Denial too in Europe: the euro zone and the IMF have come to the rescue with a package of €90bn (to which Britain, whose banks hold nearly half of Irish banks’ debt, has contributed about €10bn).

But the stringent conditionality imposed will push a stricken economy deeper into misery.

Euro-sceptics claim it’s all the fault of the euro: if only Ireland had kept the punt and could devalue, they argue, all would be well.

The argument is faulty for two reasons.

First, there are numerous examples of countries with their own currencies which have been pushed into IMF receivership: Mexico in 1995, Asia in 1997, Russia, and so on.

Secondly, Ireland is devaluing ‘indirectly’ through pushing down wages: that’s what the phrase ‘internal devaluation’ means.

George Irvin is a retired professor of economics . He is now honorary professorial research fellow in development studies at the University of London, SOAS.

No, it’s not the euro that’s at fault; the problem is that Europeans don’t want to accept that currency union means genuine economic and political union.

In the USA, the individual states may have considerable autonomy (just as Canadian provinces or German laender do), but their economic survival is ultimately the responsibility of the federal government which issues bonds and can borrow on international markets.

Think of what would have happened to Louisiana after Katrina had it been dependent on selling its own dollar bonds to the international market to raise money!

Others will argue, not without reason, that Europe has no polis, no shared political identity and culture.

They tend to forget that until the mid-19th century, Americans identified far more with their home state or region than with Washington—and some still do.

A shared political identity needs to be forged; it is the product of a vision which transcends local boundaries.

At the moment, economic crisis is eroding any sense of European community we might have.

That’s what ultimately could kill the euro.

By George Irvin

(Original post at the EUobserver.com)

Related by The Swapper:

• EU Budget Talks Collapse
• Warns Against Euro Zone “Elite”
• Brussels Tells Athens To Shut Up And Take The Pain
• Bundesbank: Ireland Will Destroy The Euro Zone
• EU Member States Disagree On Debt Figures
• EU’s Bank Rescue Turning Into Political And Economic Catastrophe
• EU Leaders Trigger Another Market Panic
• From Greece With Anger
• Greece About To Enter The Death Spiral
• A European Revolution by December?

Related Articles:

• €90bn Irish bailout ends in turmoil – Now Europe fears crisis will spread – The Guardian (news.google.com)
• IRELAND BAILOUT: Britain pays out billions as country implodes (dailymail.co.uk)
• Banks’ bailout news drives Irish government to brink (thestar.com)
• EU bailout endangers Irish government, slams banks – BusinessWeek (news.google.com)
• Ireland to prune its banks as part of bailout (msnbc.msn.com)

Investors; Fasten Your Seatbelts!

Is this the next leg of euro-crisis 2010? Hungary will be in focus when markets open on Monday, as IMF and EU now have cancel the $25 billion rescue loan access. This comes on top of the revealing of the European bank stress test on Friday. It’s gonna be an interesting week, that’s for sure.

“One would definitely expect a weakening forint Monday. A 10-forint weakening versus the euro is quite plausible, and nobody knows how nervous the market’s reaction might be.”

Zsolt Kondrat

Hungary’s prime minister Ferenc Gyurcsany

One of the most surprising news this weekend, is that the IMF and the EU effectively suspended Hungary’s access to the remaining funds in a $25 billion rescue loan package created in 2008 to prevent a financial meltdown of the country.

The timing of this development is most extraordinary, as only a month ago Hungary served as ground zero for yet another scare that pushed European sovereign bond spreads to new records.

The reason given for this dramatic, and very destabilizing action is that the nation must “take tough action to meet targets for cutting its budget deficit,” Tyler Durden at Zero Hedge writes.

Ostensibly Greece continuing to lie about its own economic deterioration is a necessary and sufficient condition for escalating IMF lauding. Yet, with Europe set to announce results of its Stress Test kabuki next week, the last thing the continent needs is a real liquidity crisis to counteract the smooth talking bureaucrats dead set into hypnotizing the union into “all is well” submission

Reuters reports: “Negotiations with the lenders had been expected to finish early next week. Analysts said the forint currency could fall sharply when financial markets reopen Monday due to uncertainty over the international safety net for Hungary, which has financed itself from the markets since last year.”

“In an environment of heightened market scrutiny of government deficits and debt levels, the fiscal deficit targets previously announced — 3.8 percent of GDP in 2010 and below 3 percent of GDP in 2011 — remain an appropriate anchor for the necessary consolidation process and debt sustainability, and should be adhered to, but additional measures will need to be taken to achieve these objectives,” the IMF says.

Hungary’s politicians proves once again they are complete dilettantes when it comes to dealing with the IMF – instead of taking Greece’s lead and promising they would not only cut pension to zero, but demand the citizens pay for the privilege for working for the government, Hungary’s new political party apparently had the temerity of telling the IMF it can shove its demands.

Hungary’s new center-right government, which swept to power in April elections, says it wants to extend its current financing deal with lenders until the end of 2010 and seek a precautionary deal for 2011 and 2012.

Economy Minister Gyorgy Matolcsy made clear the government was keen to resume negotiations: “The government will of course continue talks with international organizations including the IMF and the EU,” he said in a statement published by the national news agency MTI Saturday.

Christoph Rosenberg, who led the IMF delegation to Hungary, signals that the Fund wants more on next year’s budget. “By definition when we come next time — unless we come next week — the government will have made more progress on the 2011 budget and that will be a very important budget,” he tells Reuters.

In an interview, he also says yhat the IMF have not discussed the possibility of a new financing deal for 2011 and 2012.

“We are aware of what has been said in public but in our meetings we didn’t really get to that point, because we obviously needed to first resolve the policy issues and those have not been resolved,” Mr. Matolcsy said.

Here’s the most likely scenario: The next Hungarian bond auction will fail, as will the HUF on Monday. Look for a plunge in the currency, and a surge in Hungarian, and Romanian and Bulgarian CDS when the market opens Monday.

Adding: “One would definitely expect a weakening forint Monday. A 10-forint weakening  versus the euro  is quite plausible, and nobody knows how nervous the market’s reaction might be.”

“If we do not have the safety net of international lenders, that hits us where it hurts most,” MKB Bank analyst Zsolt Kondrat says.

And for the version straight from the horse’s mouth, here is the non-hyperbolized perspective straight from portfolio.hu:

“Although Hungary, seeking to secure a precautionary loan deal with the International Monetary Fund, was to continue discussions with officials of the IMF and the European Union on Monday, the mission from the Washington-based lender decided to return home. The EU also postponed the conclusion of the review of the country’s EUR 20 billion credit facility granted in the autumn of 2008. The reason is that “a range of issues remain open” and the cabinet that will need to provide clarification for these. Brace yourself for Monday, folks!“

The morning market reactions will be especially crucial as the central bank’s (NBH) Monetary Council will hold a rate setting meeting that day.

According to the consensus forecast of analysts in a Portfolio.hu poll, the MPC will keep the base rate on hold at 5.25%.

But a sharp HUF depreciation and a rise in Hungarian CDS (Credit Default Swap) spreads might convince the MPC to hike rates.

This, of course, will not help boost lending and economic growth.

h/t Zero Hedge

Related by the Econotwist:

Stress Level Rising In Europe; Some Banks Might Not Survive

EU Stress Test May Trigger Capital Injection Of EUR 85 Billion

European Banks Hunting For EUR 1,65 Trillion

German Banks With More Than 200 Billion Euro In Faul Credits

Fitch: Global Economy At Critical Juncture

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