It is not often that the head of a bank regulatory agency and taxpayer-funded bailout mechanism pulls out a megaphone and proclaims that the stocks of teetering banks under its jurisdiction are in fact an incredible buy, that they’re undervalued because the market is too dumb to value them correctly. But that’s what Danièle Nouy, chair of the ECB’s newfangled Single Supervisory Mechanism for “significant” Eurozone banks, just proclaimed.
It fits the theme of hype and obfuscation around the hermetically sealed European banks that are still teetering after years of crisis, numerous bailouts, €450 billion in capital injections from taxpayers and private sources, implicit and explicit taxpayer guarantees, multi-trillion-euro interventions by the ECB, countless scandals of all kinds, and years of near-zero interest rates that punish savers for the sins of the banks.
Nouy’s nascent agency won’t actually become active until November, but she has been out there hyping, rather than regulating, the “significant” banks in her bailiwick. In February, she’d announced her intentions with an elegantly Draghian flair; under her leadership, the SSM would “do whatever has to be done” so that the Eurozone banking sector would be “seen as sound and safe and transparent.” Hence her efforts to hype bank stocks.
So this time, when asked what kind of condition the European banks were in and why the ECB would carry out stress tests, Nouy had nothing but praise for the banks.
OK, 27 banks are at risk of failing the stress test, Bloomberg estimated earlier. No one really knows. Results will be published in October. These banks are dogged by problems that have been swept more or less neatly under the rug, including ballooning extend-and-pretend loans. The amounts of this forbearance are mostly secret in Europe for fear that public knowledge might topple some of the banks, blow up profits and capital ratios of others, and leave executives who were showered with rich compensation packages red-faced. Some banks disclose snippets, a third of the 39 largest banks in the Eurozone, including Societe Generale, BNP Paribas, Credit Agricole, and Commerzbank, don’t disclose anything about their extend-and-pretend portfolios.
What little they have disclosed about their loans is bad: nearly €1 trillion in nonperforming loans as of last June. Or 6.7% of total loans! Spain’s largest bank, Banco Santander confessed that reclassifying some of its extend-and-pretend loans nearly doubled its nonperforming loans to 7.5% of its total loan portfolio. At Italian banks, nonperforming loans reached 9.1% of all loans, admitted Bank of Italy Governor Ignazio Visco, as he warned of “more ambitious interventions.”
Unperturbed, Nouy proffered this gem:
The situation of European banks is better than the market assessment. The market has underestimated the work that has been done in terms of repairing the balance sheets of European banks.
Buy, buy, buy! And while you’re at it, bid up their share prices. In case people still didn’t get it, after explaining how Tier 1 capital ratios have been rising, she added:
I consider that, for the time being, markets have not seriously taken into account these improvements, as reflected in banks’ stock market values, which are lower than their book values.
That’s the real reason for the stress tests, she admitted. They’d “enable markets to evaluate properly the improvement of bank balance sheets.” Not a word about the nonperforming loans hidden under extend-and-pretend policies, though markets have come to their own conclusions about them. Her logic: if speculators can be duped into bidding up these bank stocks, banks could raise capital more easily by issuing more shares at peak valuations to cover any “capital needs which might emerge.” A bit of a conundrum: if a bank is about to collapse and needs lots of capital to survive, it needs a high stock price to raise that capital – just when its stock would normally crash. Hence the need for a good dose of official hype.
And issuing shares should easily be possible under these circumstances, she said, given the “adequate liquidity” sloshing through the system. Problem solved – though not for investors buying a collapsing bank at these prices. They’d bail out bondholders and taxpayers alike!
But this idyllic scenario wouldn’t work in a situation where banks would try to raise money all at the same time, while their shares are crashing. “In this case they would have to have recourse to public backstops at the national and, as a last resort, European levels,” she said. So that’s the taxpayer-funded Single Resolution Fund under the SSM and other entities. And if the taxpayer-donated endowment of €55 billion runs out, the Single Resolution Fund can utilize its borrowing authority to borrow more, possibly from the banks, to bail out these banks and their bondholders.
“What is important is that the situation today is much safer than what it was at the beginning of the crisis,” she said soothingly. Safer for whom?
But she gingerly reaffirmed the threat to shut down banks that “are no longer viable.” There were a lot of banks in Europe, she said, and getting rid of some of the weaker ones “in an orderly manner” would “be good for strengthening healthy competition in the sector.” In theory, she said, “a bank can be resolved in a weekend.” How that would work for a dinosaur like Deutsche Bank remains to be seen – if the German government would even allow it, deal or no deal. Which is unlikely. There simply is no political will anywhere to ask junior and senior bondholders of a big bank, any big bank, to get in line for a high and tight haircut. It’s much easier to shanghai taxpayers into bailing out those bondholders.