Deepening EU Banking Crisis Meets Euro-TARP and Taxpayers

If the ECB scales back stimulus, banks face even greater risk of collapse. But now there’s a new solution.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Events are moving so fast in Europe these days, it’s almost impossible to keep up. While much of the attention is being hogged by political developments, including the election in the Netherlands, Reuters published a report warning that the European banking sector may face even higher bad loan risks if the ECB begins to scale back its monetary stimulus programs, something it has already begun, albeit extremely tentatively.

The total stock of non-performing loans (NPL) in the EU is estimated at over €1 trillion, or 5.4% of total loans, a ratio three times higher than in other major regions of the world.

On a country-by-country basis, things look even scarier. Currently 10 (out of 28) EU countries have an NPL ratio above 10% (orders of magnitude higher than what is generally considered safe). And among Eurozone countries, where the ECB’s monetary policies have direct impact, there are these NPL stalwarts:

  • Ireland: 15.8%
  • Italy: 16.6%
  • Portugal: 19.2%
  • Slovenia: 19.7%
  • Greece: 46.6%
  • Cyprus: 49%

That bears repeating: in Greece and Cyprus, two of the Eurozone’s most bailed out economies, virtually half of all the bank loans are toxic.

Then there’s Italy, whose €350 billion of NPLs account for roughly a third of Europe’s entire bad debt stock. Italy’s government and financial sector have spent the last year and a half failing spectacularly to come up with a solution to the problem. The two “bad bank” funds they created to help clean up the banks’ toxic balance sheets, Atlante I and Atlante II, are the financial equivalent of bringing a butter knife to a machete fight. So underfunded are they, they even strugggled to hold aloft smaller, regional Italian banks like Veneto Banca and Popolare di Vicenza, which are now pleading for a bailout from Rome, which in turn is pleading for clemency from Brussels.

What little funds Atlante I and Atlante II have left are hemorrhaging value as the “assets” they’ve been used to buy up, invariably at prices that were way too high (often at over 40 cents on the euro), continue to deteriorate. The recent decision of Italy’s two biggest banks, Unicredit and Intesa Sao Paolo, to significantly write down their investment in Atlante is almost certain to discourage the private sector from pumping fresh funds into bailing out weaker banks.

Which means someone else must step in, and soon. And that someone is almost certain to be the European taxpayer.

In February ECB Vice President Vitor Constancio called for the creation of a whole new class of government-backed “bad banks” to help buy some of the €1 trillion of bad loans putrefying on bank balance sheets. Constancio’s idea bore a striking resemblance to a formal proposal put forward by the European Banking Authority (EBA) for the creation of a massive EU-wide bad bank that, in the words of EBA president Andrea Enria, would “make it much easier to achieve critical mass and to create a well functioning market for (impaired) assets.”

Here’s how it would work, according to Enria (emphasis added):

The banks would sell their non-performing loans to the asset management company at a price reflecting the real economic value of the loans, which is likely to be below the book value, but above the market price currently prevailing in illiquid markets. So the banks will likely have to take additional losses.

The asset manager would then have three years to sell those assets to private investors. There would be a guarantee from the member state of each bank transferring assets to the asset management company, underpinned by warrants on each bank’s equity. This would protect the asset management company from future losses if the final sale price is below the initial transfer price.

One of the biggest advantages of launching an EU-wide bad bank is that it would avoid the sort of public “resistance” that would occur if it was done at a national level, says Enria. Italian lenders would presumably be able to continuing pricing bad loans at or around 40 cents on the euro on average, even though their real value — i.e. the current value priced by the market — is often much lower. The difference between the market price, if any, and the price the banks end up receiving for their bad debt will be covered by Europe’s taxpayers.

If given the green light, the scheme would pave the way to the biggest one-off bail out of European banks in history. It would be Euro-TARP on angel dust, with even fewer checks and balances and much less likelihood of ever recovering taxpayer funds. According to a banker source cited by Reuters, while Germany has not yet endorsed the EBA plan, the EU documents describe the development of a secondary market for NPLs as a priority. According to Enria, the EBA hopes to finalize matters “at the European level” in the Spring.

The documents also include proposals for a wider “restructuring of banking sectors” as states address the NPLs problem. This “could lead to mergers among EU banks after they offload their bad loans,” a banking industry official said.

In other words, EU taxpayers would have to spend potentially hundreds of billions of euros saving yet more banks from the consequences of their own acts and bail out their bondholders and potentially their stockholders too, with funds desperately needed in other areas. Those banks, once saved and their balance sheets cleansed, would then be handed on a platter to much bigger banks. In return, taxpayers would end up with an even more concentrated, consolidated, interconnected financial system that is even more prone to abuse, corruption, and excess. By Don Quijones.

The ECB’s policy isn’t about creating inflation but about keeping a financial system and a currency union from collapsing upon each other. Read…  ECB Trapped in its Own “Doom Loop” as Inflation Surges

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  39 comments for “Deepening EU Banking Crisis Meets Euro-TARP and Taxpayers

  1. Chip Javert says:

    I’m the retired CFO of a large public financial company. Even so, I’m not used to seeing national levels of bank NPL; in my career, individual bank NPL was infinitely more useful. Generally speaking, a regulator (or legislator) would have much more use for national NPL numbers.

    Even so, the NPL numbers in this article are truly shocking. Further, without meaning to be derogatory to DQ, these probably are not the real (and much worse) numbers. in the US investors still do not believe the NPL numbers from Citi & BofA management. In the US, a bank is usually closed (technical term is “resolved”; banks cannot go bankrupt) when NPL reaches 8%; 10% NPL is like the inner-ring of bad bank hell.

    Fortunately, about 85 years ago, the USA learned two critical things about NPL:

    1) “Fixing” excessive NPL is never inexpensive; however, the sooner it is “fixed , the less expensive it is.

    2) Allowing some excessive NPL to hang around (hoping it fixes itself) simply causes more NPL.

    The latest EU GDP number I can find is $US16.3T (2015). Therefore, 1T euros ($1.050T) is 6.1% of the entire annual EU GDP (6.1% US GDP = $1.098T). All this to bail out bad bankers & failed regulators and cowardly EU politicians.

    • chip javert says:

      Just for context: a stack of one trillion dollar bills would be 68,000 miles high (1/4th the way to the moon).

      • indubitably says:

        Just for context perhaps people can better relate to time rather than distance:

        one million seconds is 11.6 days
        one billion seconds is 31.7 years
        one trillion seconds is 31,700 years

    • mean chicken says:

      Silly me, all this time I was under the impression ballooning taxpayer debt was for the children.

      Someone has to pay this debt eventually? but in the US those who gambled on TBTF won big time. Would high public debt be considered inflationary or would it consume consumer purchasing power thus leading to lower corporate profit and likely fewer jobs? Robots have displaced many workers too, I’d imagine.

    • Spanky Bernanke says:

      Yes, “bad bank” or not, the situation is hopeless because the global economy cannot grow its way out. Those numbers are truly horrifying–they are all exponentially insolvent. I suspect we will resolve this very soon, and it won’t be the unicorn-riding-on the skittles-rainbow BS that the Fed was able to pull off during the financial crisis (it was more than just the Fed–the ESF and PPT lit up the algorithms in ’09). It will end in a political paradigm. Germany won’t let go of the whip, and the indebted countries don’t wanna pay. You can bet your bazookas a LOT of money-printing and trade wars (pun intended) are about to engage…
      BUT, if the U.S. “learned” that the problem should be resolved immediately to reduce the consequences, why did the Fed and Congress commit to the exact opposite in ’09??

      • Kent says:

        They officially forgot in the ’80’s with deregulation of the S&Ls. Then went full Alzheimer’s in the 90’s under Clinton.

  2. Spanky Bernanke says:

    The “bad bank” idea MIGHT actually work, as long as the European public is as delusional as the U.S. sheeple. The Fed bought up all the MBSs and worthless T-bonds at 100% of their value and promised on the Bible they would sell them to the investors just as soon as the economy, and commercial bankers started receiving their $27 million bonuses again. And, look at how strong JP Madoff Chase is now??? So what if we only have a few major banks and they are all corrupt? I’m quite confident Janet and Stanley will unload the $3.5 trillion of bad debt any day now, and Jamie Demon will be rehabilitated and only issue loans to worthy creditors, and the Euro Banking Authority leadership will swear they will never make poor decisions that require bailouts ever again. Hey, are those skittles raining from the sky???

  3. Nik says:

    Its like Yogi Berra said…”Its Deja Vu all Over again”….simply bombastic thinking to say the least…

  4. mean chicken says:

    When’s the best time to buy TBTF euro-banks? Man those who bought TBTF US banks made a killing (It’s all for the children).

    Nice work if you can get it!

  5. Gw says:

    Hi Wolf,

    It seems to me, not to be too conspirator,

    that the powers that be,

    terrified of the financial crimes,

    committed against the people of the EU,

    launched revolutions in the Middle East,

    put up advertisements,

    causing the great migration to Europe to keep the serfs occupied while making their great getaway with their ill gotten gains…

    Comments anyone?

    • Chris Wagner says:

      Well, a (professor) friend fears the distraction will lead to WAR. That has always worked wonders: remember Mrs. Thatcher’s surge in popularity during the Falklands war?!?

  6. Emanon says:

    “War is peace. Freedom is slavery. Ignorance is strength.” – George Orwell

    “Banks cannot go bankrupt.” – Chip Javert

    It’s a bit unfair to pin that quote on Mr. Javert, as he is not the source of it, but it does show that we are in an era where words have been deliberately redefined to mean the exact opposite of their original meaning.

    Banks are also now doing the exact reverse of what they should be doing. They are now empowered to simply steal the money that is deposited in them whenever they get into trouble via “bail-ins”.

    I wish that more banks WOULD be ruptured because the damn things create more problems than they solve.

    Maybe we need to think again about why banks exist in the first place, and whether or not we should allow them to continue to exist.

    They seem to have devolved from instruments of raw capitalism, into instruments of socialism for plutocrats. They steal from the 99% to enrich the 1%.

    It’s an upside down world when people and countries can go bankrupt but banks can not go bankrupt, and the money promised for the relief for people and countries always ends up bailing out a tiny minority of bankers.

    • Kent says:

      Capitalism and socialism for the 1% have always been the same thing. In bad times, it just becomes more exposed for what it is. And banking is the piece that makes it work. Hence they can never go bankrupt and can print money out of thin air.

    • cdr says:

      The globalists own and / or control the politicians, the media, the relevant parts of academia that make up the bogus theories which support globalism and monetarism, and they own the central bankers, which means they control the central banks.

      Yes, the world is in a bad place. It will get worse for most, but not the globalists. It’s a slow social stratification process.

      The only thing you can do is recognize it and try to stay ahead of the deterioration.

      PS: Interest rates are they keys to the kingdom. Control them and control the world. See them fall and go negative and see dystopia begin. Get them back up to more historical levels and keep them there and the globalists are stopped in their tracks.

  7. Frederick says:

    The numbers for Greece and Cyprus look very ominous but what percentage of homeowners have mortgages in those countries? That would give you a clearer picture of the health of the housing market

    • Wolf Richter says:

      Cyprus has had an enormous title-deed scandal, with many properties having two mortgages, for example one from the developers that the developer didn’t pay off when he sold it, and one from the homeowner obtained when he bought it – all with the connivance of one of the most corrupt banking systems in the world. This was in part responsible for the financial collapse of Cyprus.

      I think much of this still hasn’t really been cleaned up. Hence, mortgages both from homeowners and now bankrupt developers are tangled up in the high NPL numbers.

      I wrote about it in Oct 2011. I was among the first in the US to define Cyprus as the next Eurozone bailout country and pinpoint some of the reasons.

    • MC says:

      According to the latest figures I could find (Eurostat for 2015), both Greece and Cyprus have low mortgage ratios: in Greece only 11% of the homeowners and tenants lives in a house with a mortgage on it while in Cyprus the same figure is 19%.
      Germany has about the same figure as Italy (18%) and considerably lower than France (26%).
      The true lords of mortgages however are the Dutch (55% of homeonwners and renters have an outstanding mortgage) and Scandinavia (excluding Finland) where the figure is everywhere over 60%.

      • Chris Wagner says:

        For Germany, much less than 45% are homeowners. (Althought more c o u l d own a home, if they would go about it like the Brits)

        • MC says:

          According to the same data, homeownership rate in Germany is 52%. The only European countries with similar figures are Austria (54%) and Switzerland (47%).

  8. Sound of the Suburbs says:

    All the toxic sub-prime NPLs now lie on the FEDs balance sheet.

    All bankers need someone to clear up the mess they create, this is why we have Central Banks.

    We need to treat bankers like puppies and wipe their noses in the mess they leave behind.

  9. unit472 says:

    From where I sit it looks like the really big pile of NPL are not the loans Unicredit made to Aldos Auto Parts but the sovereign bonds of the PIGS. Does anyone really think that, once the ECB ends its QE program, that Italy, Spain, Portugal can endure 5,6 or 7% interest rates on their 10 year bonds?

    Because they are constrained by the Euro and the EU’s fiscal compact they have no way to inflate their way out of their predicament or run fiscal deficits large enough to finance it.

    • WorldBLee says:

      Your point strikes me as very valid and pertinent. Without control of their currency, the southern European countries are very constrained–and to make it worse the plan of feeding them more loans to paper over the mess only leaves them more indebted as they crumble under the weight of austerity programs that starve their economies.

    • MC says:

      People tend to forget how high “normal” rates used to be.
      Before the EMU came into being 10Y French sovereign bonds yielded over 8%. The EMU cut them exactly in half starting at around 1998. Sub 4% yields are a post-2010 novelty, with the major drop between 2014 and 2015.
      Italy benefited even more from the EMU, seeing interest rates on her 10Y bonds literally plummet from 13% to 4% in less than four years. Yields picked up somewhat after 2000 but rarely breached 6% and then only for brief periods of time. Like with France, the big drop happened only recently and following massive purchases of sovereign bonds by both the ECB and Italian banks.

      Part of the reason French and Italian bonds had such high yields in the days before the EMU was because both countries were known to suffer from high monetary inflation and hence investors demanded an extra compensation.
      Intriguingly enough when France and Italy entered the EMU, both countries completely overhauled their inflation calculation mechanisms, with easily imagined consequences.
      Between 2003-2005 both France and Italy suffered from extremely high CPI growth (later calculated by independent researchers such as Milan’s Chamber of Commerce to be around 6% in both countries), the so called Teuro Effect which to the best of my knowledge nobody at the ECB has so far explained satisfactorily.
      Real life inflation thus far outpaced yields, creating a de facto NIRP environment: 4% yield minus 6% CPI growth = -2% bond yields in real world money.

      Morale: all these countries can survive high yields on their debt, but that requires very high inflation, something to which their economies are not geared for anymore after the post-2008 moderately inflationary climate.

    • Chris Wagner says:

      Hear, hear! This is the ECB’s conjuring trick #1. Fooling investors into thinking that all EU sovereign bonds bear the same negligible RISK. Getting cheap funding to Italy & the Club Med countries has been Super Mario’s #1 goal.

  10. Hkan says:

    EU survival comes down to one thing:

    Keep European tax cattle from understanding they pay the bill.

    They understand paying for this gigantic mad corruption it will be the end of EU.

    Will media play this game?
    Will politicians look straight into the camera and lie….once again?
    Will the public buy their lies?

    Nomatter what…we are yet another step closer of ending this EU madness.

  11. Hkan says:

    Countries with a resonable good economy gets a bit deeper in debt in order to even out the dept of southern European banks.

    As i see it the total debt will still be excisting just shared among European countries.

    Moving debts around?

    Or is there a risk of confiscating bank assets over 100 000 Euro?

  12. Rob says:

    Hi Don/Wolf,
    Want to revisit your, to date, very negative views on BREXIT?

  13. cdr says:

    I can only wonder about what level of financial and social cesspool Europe will look like in a few years. I also wonder about the perspective of history from maybe 100 years in the future beyond that. (The Euro-response to that “Ill be gone, you’ll be gone”)

    The Eurozone will kick the can until it can’t. It might start a war as a misdirect and a scapegoat. The media will go along. The people will believe whatever the media tells them. Open border refugee immigrants will assist with the dead weight that brings them down.

    Given the Eurozone capacity for stalling, the fall will not happen for several years. The ECB will step up it’s purchases for some new bogus reason. Draghi will be replaced by the Euro-equivalent of Yellen after his term expires. Perhaps Paul Krugman will come on board as a favorite consultant. The financial media will ask no hard questions in fear of losing access.

    The fall will not happen until the farce can not longer be ignored. This is a long time off. Lots of sheep to fleece in the mean time. The Eurozone will look like Venezuela and it will still kick the can, probably successfully.

    Although the Eurozone is responsible to make up any shortfall in the ECB capital account in case of loss, we can all be sure that will never happen. Laws will be passed and/or ignored. Thus, all debt owned by the ECB or the like will be written off. The debt bomb will be reduced by whatever amount this involves. Debt owned by real people and bank deposits are at risk.

    • cdr says:

      The only way to protect wealth in the Eurozone – long term – is to not use the Euro banks or invest in euro debt and be sure assets are beyond the reach of any new Euro laws passed that would allow confiscation. Europeans need to emulate the Chinese in this regard. In other words, get as much as you can out of the Eurozone and into someplace less corrupt.

      • Obiwan says:

        which place is that exactly?
        I would love to know.

        • cdr says:

          Good point. “I’m from the government and here to help” is even more threatening than before. Incompetence has been replaced by a new game.

          Globalists are the new socialists and their tricks are impressive. Marx never saw them coming.

  14. Sound of the Suburbs says:

    Many of the Euro’s problems stretch right back to the beginning; they just didn’t become apparent until the Euro-zone crisis.

    The financial sector made an assumption that Germany would backstop all debt within the Euro-zone and set interest rates as if lending to any nation was like lending to Germany.

    Later this turned out not to be the case, and caused sustainable debt to become unsustainable debt in many of the nations at the periphery of the Euro-zone.

    Everyone could see what was happening, but no one stood up and said there was not going to be any debt pooling.

    Many of the Euro-zones periphery nations had been high risk as far as lending was concerned and had previously had very high interest rates.

    Central Bankers lower interest rates to encourage spending now and raise interest rates to defer spending into the future.

    Spending had been encouraged throughout the Euro-zone periphery and they were only too willing to follow the incentives being given them.

    The nations that were most incentivised to borrow and spend by massive falls in interest rates were those that would have the most trouble when interest rates corrected to their normal very high levels.

    The mispriced lending within the Euro-zone carried on for many years and the money creation from new debt allowed the countries to really boom, e.g. the Celtic Tiger, Ireland. Housing booms blew up in Greece, Spain, Ireland and Holland. The new money fed back into wages and prices at the Euro-zone periphery increasing the under-lying imbalances already present.

    “historically the German D-Mark had been strengthening since its introduction in 1948 against the currencies of its neighbours, and this reflected – and compensated for – increased German competitiveness. Their weakening currencies allowed German trade partners to keep their export industries in business and their workers employed. By introducing a single currency, future revaluations of the German currency were disallowed. This amounted to a de facto future devaluation of German purchasing power, revaluation of the currencies of the other European countries, and hence would render non-German economies less and less able to compete against German exports over time.” Professor Werner

    The under-lying problems of the Euro-zone were magnified by early mismanagement.

    The ECB wasn’t designed as a full Central Bank and didn’t have the power to intervene when interest rates returned to their correct levels without debt pooling. This allowed the suddenly unsustainable debt problems at the periphery to grow with no mechanisms available to deal with them. Bailing out their banking sectors added to their woes and added to their debt problems.

    Can we put Humpty Dumpty back together again?
    Wait and see.

    • Mike says:

      I find it astonishing that the press and politicians now talk as if the financiers automatically deserve to be protected from the consequences of their own mistakes and assumptions. “The financial sector made an assumption” and other statements made in discussing the problems facing the EU, which will later face the US, when the reckless derivatives gambling of the US banks results in the inevitable TBTF bank’s failure, reveal the truth. The financial sector is made up of millionaires and billionaires. The owners of the banks are millionaires and billionaires. They made mistakes and “assumptions.” Why is it that the “assumptions” and “mistakes” of these millionaires and billionaires must be paid for by poorer, bottom-99% tax payers. The solution to these problems is piercing the veil of the banks. Businesses that operate without adequate capital to cover expected losses, as these banks do, should have their corporate veil pierced. These banks receive a risk premium for making risky loans. To believe that these banks are like dodo birds and unthinkingly, stupidly make loans at low interest rates is foolish. The banks also do not engage in massive derivatives gambling for fun. Both the risky lending and the massive derivatives gambling result in the banks being able to pay massive dividends or reporting massive profits and increasing their stock prices. Thus, the millionaires and billionaires make profits from such gambling. With the profit should come the loss. Capitalism means that the florist or the banker that run their businesses into the ground should both suffer the ends of their businesses. Bad banks and other such tricks are only necessary to protect the banksters from the consequences of their own mistakes. I hope that Italians will reject bail outs. Getting out of the EU, defaulting on their loans, and getting rid of the banksters seems like a much better choice than what Greece or Ireland have had to do. It is better to suffer for a year or two than for decades, like Greece and Ireland will suffer.

  15. KiwiinCanada says:

    If the exchange rate mechanism is removed than the adjustment mechanism to maintain competitiveness must be internal prices. However the portion of the labour market that is amenable to downward adjustment in these euro peripheral countries is quite small. Therefore the diminishing competitiveness results in unemployment. This can be partially de-politicized with welfare financed by sovereign debt purchased by the ECB at low interest rates. The excessive bond issuance however can only cover uncompetitiveness for so long. The end game of re introducing old currencies and devaluation instantly creates a sovereign debt crises of some magnitude. The write offs to be carried by public tax payers in the remaining Euro area countries?A lot of this debt is held by financial institutions not necessarily confined to the Euro area. Therefore a concurrent recapitalization of to big to fail institutions may also be necessary.

    This scenario if it unfolds is likely to be highly deflationary with the work throughs generating political turmoil in the peripheral Euro area.

  16. Ambrose Bierce says:

    Which private investors do they sell these loans to? The Fed still has a bloated balance sheet comprised of MBS from the housing bubble, which they hold tightly. Why? For one thing it gets in the way of issuing new debt. Going ahead three years what makes this debt attractive? Short answer, even lower, or NIRP rates and as you can begin to see, that globally these loans extend the collective maturity date, so that even if the Fed’s MBS paper matures, the ECBs overhang, and the bad debt from any future credit crisis begins to pile up. Now some are saying go out the curve with new issue, to 40 year. Where does it end, when the one constant, 2% inflation begins to diverge too far from rates, not just negative rates, but really negative rates. This one be one reason why the 30yr TIP note is the real winner.

  17. Charles Long says:

    The whole world needs to take a cue from Iceland. The bankers created the problem, let them suffer the consequences of their greed & stupidity! There is NO reason that banking should be supported by the public. Let everyone of them default, go bankrupt, or whatever. Most of these loans are owed to other banks anyway (read: Goldman Sachs.) It worked pretty well for Iceland. Maybe then some of these Bankers would learn a little restraint. Also for USA, reinstate a stronger Glass-Steagal, & an equivalent law for the EU. There is no other way to stop them from sucking us dry! Chuck L.

  18. DV says:

    1 trillion Euro is what is really bad, but who knows how many other hidden bad stuff those banks carry on and off their balance sheets. We will not know untill we see another melt-down.

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