Zombification of EU banking system gathers momentum.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
The past week’s events in Europe were dominated by the pound sterling’s spectacular flash crash to its lowest point in 31 years. As is often the case with flash crashes, we will probably never know what exactly triggered the currency to free-fall by 6% during Asian trading hours, though the most cited cause, apart from a “fat finger,” is the gathering realization that a so-called “hard” Brexit is a very real possibility.
But it’s an eventuality that can be expected to play out in roughly two and a half years’ time, at the earliest, and in light of the powerful forces arrayed against it, it may never occur at all.
In the meantime, something far more dangerous is happening on the other side of the English Channel: the slow-motion meltdown of the Eurozone’s banking system.
In its Global Financial Stability Report, the IMF warned that banks in Europe were too weak to generate sustainable profits even if — and here’s the kicker — the region saw strong economic growth. That hasn’t happened for years.
The IMF also cautioned that the banks’ weak profitability, caused by subdued growth in the Eurozone and ultra low or negative interest rates — something the ECB vehemently denies, preferring to blame the crisis on Europe’s smaller regional or local banks — could further erode their financial buffers and undermine their ability to support economic recovery.
“In Europe, about one third of the system – representing some $7.5 trillion euros in assets – remains weak and unable to generate sustainable profits,” said IMF economist Peter Dattels as he presented the report in Washington. As such, European banks need “urgent and comprehensive action” to address a legacy of non-performing loans and bloated, inefficient business models, he said.
“Urgent” and “comprehensive” are two words you’d rarely associate with the Eurozone, especially at a time when the region faces a relentless gauntlet of political threats, from the rise of “populist” movements in central and northern Europe to December’s do-or-die constitutional referendum in Italy. That’s not to mention what promises to be tightly fought national elections in the Eurozone’s two biggest economies, France and Germany, scheduled to be held respectively in April and October, 2017.
The last thing either Merkel or Hollande needs during election season is a region-wide banking crisis, which is why every effort will be made to keep a lid on the problem until the votes have been cast. But that is not going to be easy, not with Germany’s flagship lender, Deutsche Bank, continuing to sink at an alarming rate.
Things have got so desperate for the Frankfurt-based bank that it may soon be in need of corporate charity. According to a rumor unleashed on Thursday by the German daily Handelsblatt, the chief executives of several German blue-chip companies have discussed Deutsche’s problems and are — if needed — ready to offer a capital injection to shore up the bank.
If that doesn’t steady investor nerves, there’s always Plan Z: create new rules that would allow the ECB to effectively contravene recently introduced rules that forbid it and other EU institutions and nations from directly bailing out financial institutions without first bailing-in some of their creditors. According to Bloomberg, Plan Z is already under way. But instead of being used to bail out the region’s banks, the new legislation will be used to bail out clearing houses, Europe’s new too-big-to-fail monstrosities:
Draft EU legislation seen by Bloomberg sets out rules on saving or shuttering clearinghouses that would apply to firms such as London-based LCH. The proposals cover everything from the creation of resolution authorities to the powers they would have when winding a company down, including writing down shares, debt and collateral.
The ultimate aim is to dampen investor concerns about the threat posed by the global derivatives time bomb, much of which is tick-tocking on and off the balance sheets not only of Wall Street’s finest, but also of Deutsche Bank. Here’s more from Bloomberg:
The authorities would be able to recapitalize the clearinghouse by seizing variation margin, exercising cash calls defined in recovery or resolution plans and writing down capital and converting debt securities. They would also be able to auction off the defaulters’ positions, tear up some or all contracts and access default funds. The relevant central bank would be able to facilitate resolution by supplying temporary liquidity.
And here’s the real kicker (emphasis added):
“Should these options be unavailable or be demonstrably insufficient to safeguard financial stability, government participation in the shape of equity support or temporary public ownership could be considered as a last resort,” according to the proposal. Those steps would need to comply with EU rules on state aid.
As recent months have shown, EU rules on state aid are extremely elastic, especially when it comes to saving the hide of the continent’s biggest banks and corporations. In August, it was leaked that the ECB has bought bonds from the issuing corporations via “private placements,” thus putting freshly printed cash directly on corporate balance sheets at no cost to the corporation. Yet there’s not been a single whiff of protest from Europe’s competition commissioner.
It’s now clearer than ever that the ECB, the IMF, the BIS and all the other supranational alphabet soup creations will do “whatever it takes” in the coming months to keep Deutsche Bank and its brethren whole. But will it be enough? After all, the problems are not remotely contained to just Germany.
In Italy, JP Morgan Chase’s master plan to save Monte dei Paschi continues to flounder as investors show zero appetite for more MPS capital. In fact, expectations are so low that rumors have already began surfacing that an alternative plan, under the aegis of Italy’s former Industry Minister and senior banker Corrado Passera, is now in the works.
It all reeks of desperation.
So, too, does the semi-clandestine bailout of Spain’s state-owned Banco Mare Nostrum. With the markets showing zero interest in taking the bailed-out entity off the public’s hands, the government is trying to usher it into a forced marriage with largely state-owned Bankia. The message, once again, is resoundingly clear: the only way the bank can be maintained as a going concern is through continued and growing public support.
The zombification of Europe’s banking system — the legacy of years of doing “whatever it takes” to save giant insolvent banks — continues to gather momentum. Things are now so serious that some of the world’s most senior policy makers are not only beginning to warn of a new financial crisis, they’re beginning to turn on each other in public. They include Germany’s dour Finance Minister Wolfgang Schaeuble who, much like the IMF, lays most of the blame for Europe’s current problems on the “ultra-loose monetary policy” pursued by the ECB.
But as always with Schaeuble and Merkel, their complaints are meant for public consumption. When crunch time arrives for Deutsche Bank, and the only institution that can save it is the ECB (perhaps with a little help from the Fed, as on countless occasions before), such criticism will very quickly die down. By Don Quijones, Raging Bull-Shit.
Italy’s Monte dei Paschi’s cleverly concealed debt bomb has had explosive consequences, now associated with a gargantuan crime scene. Read… Rescue of Monte dei Paschi Gets ‘Dark’ & ‘Complicated’
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