One concomitant of the euro crisis is capital flight from European periphery countries such as Greece, Ireland and Portugal to Germany which erroneously is widely considered as the last safe haven in the euro area. As a rule, German citizens, too, would regard their country as stronghold of financial safety which refers not only to a presumed comparable strength of their banks but to the country’s state-backed system of deposit guarantees.
The question is what is meant by “state-backed”.
After some people read my latest article on CARTA in German language about savers, interest rates and inflation , there were some lively discussions, and maybe a little confusion, on Twitter, and in what follows I would like to briefly clarify my view.
When Mark Carney, the new Governor of the Bank of England (BOE), announced that the Bank would not raise its base rate until unemployment is below a 7% threshold, savers were outraged. They accused the Bank to “steal” their money as interest rates are below the current rate of inflation.
In a blog post Frances Coppola defended the BOE decision against the “unreasonable expectations of savers”, and in my CARTA article I summarize the various scenarios she described arguing that savers “have no right whatsoever to expect to receive a higher rate of return than the ability of the economy to generate that return”, whereby return is defined as the real rate of economic growth.
In my view, the merit of Frances Coppola’s article is that it is drawing the attention to the fact that in an economy nothing can be spent that is not earned. Several authors took up the idea. Two examples, an article by Tomas Hirst on Pieria on “The symbolic importance of not raising rates”, and another by Dizzynomics on “Savers are not sacred cows, redux”, may give you an impression of the reasoning.
I don’t want to go into detail here. Instead, I want to ask why savers are getting interest at all and who is paying the rising prices in an inflationary economy.
* Ich danke Wolfgang Gierls (FORAIM) für eine anregende Diskussion zum Thema Inflation und Einlagensicherheit, von der sich einiges hier wiederfindet.
Was wird geschehen, wenn die Ära sinkender Zinsen einmal zu Ende geht? Einen kleinen Vorgeschmack erhielt die Welt bereits Ende Mai, als die Andeutung des Präsidenten der US Federal Reserve Ben Bernanke, den expansiven geldpolitischen Kurs mit sinkenden Arbeitslosenzahlen allmählich zurückfahren zu wollen (to taper), der Volatilität der Märkte unvorhergesehene Nahrung gab. Obwohl Bernanke schnell zurückruderte, war der Schaden erst einmal angerichtet.
Die Fortsetzung drohte für einen kurzen Moment in Europa. Hier war in den letzten Tagen der Blick vieler Beobachter nach London gerichtet, wo der seit Juli amtierende neue Gouverneur der Bank von England (BOE), Mark Carney, seine erste Pressekonferenz abhielt. Carney aber schwenkte in einem Bruch mit der BOE-Tradition auf die Linie der Federal Reserve ein und verkündete, die Zinsen in Großbritannien würden so lange nicht angehoben, bis ein bestimmter Schwellenwert für die Erwerbslosenquote unterschritten wäre. Damit aber sei in den kommenden Jahren vorerst nicht zu rechnen.
Carney löste mit seinen Äußerungen bei britischen Sparern einen Sturm der Entrüstung aus. Sie warfen der Bank von England vor, sie mit den niedrigen Zinsen zu bestehlen, da sie mit den meisten Anlageformen nicht einmal einen Ausgleich für den jährlichen Kaufkraftschwund erhielten.
Verteidigt wurde Carney’s Entscheidung vehement von der bekannten britischen Bloggerin, ehemaligen Bankerin und stellvertretenden Herausgeberin des Online-Magazins Pieria Frances Coppola. Deren Ausführungen erregten nach einem BBC-Auftritt im Internet einiges Aufsehen. Da das Thema nicht nur für britische Bürger von Interesse sein dürfte, werden hier die wichtigsten Argumente kurz vorgestellt.
First reactions to my last blog post on German bad banks gave me the idea that the following little link list with background information might be a useful addition.
In December 2011, the IMF published a detailed Technical Note on Crisis Management Arrangements in Germany including the establishment of two public bad banks, EAA and FMSW, under the general oversight of the Financial Market Stabilisation Authority (Bundesanstalt für Finanzmarktstabilisierung) FMSA.
In contrast to its peers, WestLB was described as keen to be one of the first German banks to use the country’s bad-bank scheme. In several articles, the Financial Times commented on the transition from WestLB to Portigon and EAA which was quite a challenge. As James Wilson wrote: “The multiple separation of WestLB’s assets and risk positions is one of the largest efforts made in Germany to implement an orderly winding down of a bank.”
Tracy Alloway illuminated the role of HRE in the covered bond market and of its two subsidiaries Deutsche Pfandbriefbank and Depfa. Her article includes a chart illustrating the Pfandbriefbank collateral switch involved. The chart is part of an analyst/investor presentation of Pfandbriefbank which can be found here.
Tracy Alloway also quoted financial consultant Achim Dübel. He is the author of a detailed comment, with many annotations and links, on the reform of financial regulation in Germany including the bad bank concept, which was prepared for a hearing of the German parliamentary finance committee.
From the beginning of the euro crisis, exposures of German bad banks to periphery countries and other risks limited the scope for policy crisis management. In German exposure to Greece, a bad bank tale, Joseph Cotterill pointed to shifts of Greek debt from the private HRE to FMS Wertmanagement, the sovereign agency, and its implications.
Chris Bryant described how German banks were resisting political pressure to take a bigger writedown on their Greek bondholdings so that Athens could get past a financing crunch. He wrote:
“It is no small irony … that if German banks are ultimately required to take a larger writedown, the German state could end up being one of the biggest losers.
This is because some €10bn of Germany’s roughly €18bn exposure to Greece is held by two state-backed “bad bank” agencies set up during the crisis to deal with legacy assets belonging to troubled lenders Hypo Real Estate and WestLB.”
Bad banks’ activities are not limited to unwinding and searching for buyers for “toxic” assets. They may include considerable “hedging” activities as became apparent from reports by Spiegel Online and others about a “computational error” of €55 billion in FMS derivatives accounting. The FTD mentioned about 7,000 derivative positions at FMS with a default risk of almost €20 billion. In this context, Tagesschau.de drew attention to the following table of cumulated debt which was part of the answer to a parliamentary inquiry (p. 12). There, the discrepancy had been documented, but without noticing the “error”. BörsenZeitung emphasized that this was not the only case, pointing to the overall poor data quality of FMS.
Among the internal bad bank solutions I mentioned in the text, Deutsche Bank’s establishment of a Non-Core Operations Unit (NCOU) was widely noticed. There is a presentation by Stefan Krause, Deutsche Bank Chief Financial Officer, with many details.
Commerzbank announced the establishment of its Non Core Assets (NCA) segment in this press release.
Information about the Restructuring Unit (RU) of HSH Nordbank can be found here.
And here are some further links:
Deutsche Pfandbriefbank (PBB), the “healthy” remainder of HRE
Slowly, public awareness is growing in Germany that bank riskiness is not only a problem in Southern Europe. On July 1, for example, Süddeutsche.de had a long article about the lack of transparency of financial institutions focussing on the latest financial statement of Deutsche Bank, and on July 9, Handelsblatt mused about the risks hidden in German bad banks in an article titled “Gefährliche Altlasten” (dangerous legacy). This legacy is probably one of the reasons why, as Reuters put is, it is “unlikely that Berlin would accept the creation of a new agency in Brussels or elsewhere with powers to overrule its own national authorities on the sensitive issue of whether to save or close an ailing bank” .
In recent years, both German financial institutions and their regulators have developed a high level of bad-bank sophistication. In May 2009, a German „bad-bank law“ (Gesetz zur Fortentwicklung der Finanzmarktstabilisierung) has been established which allows banks to “clean” their balance sheets by transferring non-performing loans and other loss-generating assets to special institutions.
There are two variants: In the beginning, solutions were part of public rescue operations and the resulting bad banks are external public law entities operating under the umbrella of the Financial Market Stabilisation Authority (Bundesanstalt für Finanzmarktstabilisierung – FMSA): In December 2009, Erste Abwicklungsanstalt (EAA) was established in order to take over, and unwind, assets and risk exposures of WestLB (now Portigon). In 2010, FMS Wertmanagement (FMSW) was founded in order to take over risk positions and non-strategic operations from the nationalised Hypo Real Estate (HRE) Group. More recently, banks developed in-house solutions without public involvement. (A detailed general discussion of variants of private and official bad-bank solutions can be found in this McKinsey study on Bad Banks: Finding The Right Exit From The Financial Crisis.)
The following table illustrates the unwinding progress of major bad banks.
Compared to experiences elsewhere, the numbers appear encouraging. However, they also illustrate, that the banks still have a long way to go. Several aspects must be kept in mind:
(1) No one can say whether these amounts are realistic or only the tip of an iceberg. There are no general rules or standards to determine which assets are to be transferred to a bad bank, and banks make these decisions depending on circumstances.
(2) Exposures to European crisis countries such as Greece, Ireland, Italy, Portugal and Spain are still high. This was one reason for Moody’s downgrading of German banks in February last year stating:
“While Moody’s recognises that German banks have taken actions in recent years to address asset quality challenges, the rating agency believes that banks have only partially incorporated the downside risks posed by the ongoing euro area debt crisis and evolving global economic trends. As such, they may record further significant losses, if such downside risks materialize.”
(3) A smaller portfolio is not necessarily a less risky one. The Handelsblatt authors rightly hint to the fact that assets of comparably high-quality will probably be sold first so that the remaining bad bank portfolio may be even riskier than the initial one.
Let us hope that the EBA Asset Quality Review next year, and the following overall stress test to be conducted by EBA in cooperation with the ECB, will not uncover new unpleasant surprises.
The other day, on Pragmatic Capitalism Cullen Roche drew our attention to a fascinating Ted Talk by Didier Sornette about: How we can Predict the Next Financial Crisis.
Didier Sornette has an impressive CV which shows that he is
Professor of Entrepreneurial Risks
Professor of Finance at the Swiss Finance Institute
Director of the Financial Crisis Observatory
Founding member of the Risk Center at ETH Zurich
Associate Member of the Department of Physics (D-PHYS), ETH Zurich
Associate Member of the Department of Earth Sciences (D-ERWD), ETH Zurich.
Furthermore, he is the author of a much-noticed book on Why Stock Markets Crash: Critical Events in Complex Financial Systems.
In the Ted Talk, Didier Sornette presents his concept of the “Dragon King”.
*I want to say thank you to Markus Sagebiel, @msgbi on Twitter, for drawing my attention to many of the following links and for great comments.
After my recent bitcoin update, debates about the nature and chance of survival of the cryptocurrency were going on. Markets remain volatile and there were bad news again. One referred to Silk Road, the anonymous online market.
Willard Foxton from The Telegraph asked: “The Online Drug Marketplace Silk Road Is Collapsing – Did Hackers, Government Or Bitcoin Kill It?”
And Michael Fowlkes from the Market Intelligence Center wrote in Bitcoin Volatility Spikes Again As Silk Road Website Crashes:
“While I have argued against buying into the Bitcoin rally on more than one occasion, I will be the first to admit that illegal drug purchases are far from their only use. Bitcoins do have a place in today’s world, but the wild price fluctuations are going to continue to occur until it matures and becomes more accepted by the mainstream.”
Other incidents included
„Bitcoin: Aussichtsreich, gefährlich oder was?“ fragte Vera Bunse auf diesen Seiten im Mai 2011 als die virtuelle Währung in den deutschen Medien erstmals Schlagzeilen machte. Sie zitierte Torsten Kleinz, der damals einer aufkeimenden Euphorie mit Nachdruck wiedersprach. Er schrieb unter anderem:
„Leute, die ernsthaft Bitcoins als Wertanlage in Betracht ziehen, sind Spekulanten unterster Klasse, die auf Nicht-Leistung und Voodoo Gewinne aufbauen wollen.“
Wie nachvollziehbar diese Sicht in jener Zeit auch gewesen sein mag: Spätestens mit den jüngsten Entwicklungen in der Eurokrise hat sie viel von ihrer Gültigkeit verloren.
More on CARTA
In the few days since I published my last article on parallel currencies, Bitcoin did not stop catching the headlines. Apparently, the “cryptocurrency” easily digested the disruptions caused by hack attacks on MTGox which had resulted in a temporary drop in value of one Bitcoin from over $140 to about $120. (Remember that when Bitcoin first started in January 2009, it was trading under one penny.) But, after a short respite, market turmoil started again.
See, for example, this note from Zerohedge from a turbulent night:
“Gresham’s law, observation in economics that “bad money drives out good.” More exactly, if coins containing metal of different value have the same value as legal tender, the coins composed of the cheaper metal will be used for payment, while those made of more expensive metal will be hoarded or exported and thus tend to disappear from circulation. Sir Thomas Gresham, financial agent of Queen Elizabeth I, was not the first to recognize this monetary principle, but his elucidation of it in 1558 prompted the economist H.D. Macleod to suggest the term Gresham’s law in the 19th century.” (Encyclopedia Britannica)
Does a similar law also hold for paper money, bank loans and virtual currencies? Apparently not, because otherwise the following examples of parallel currencies would not exist. The reasons why they survive, and thrive, and why, on the other side, they do not entirely replace their rivals, are an interesting topic for future research.
Here comes my collection of samples.