For months, I have been confident that Europe would suffer a financial crisis and a depression, as in a real economy catastrophe accompanied by a market crash. It might not be as severe and lasting as 1929, but the breadth would mean there would not be 1987 quick bounceback nor a 2008 derivatives crisis concentrated at the heart of the banking system. Even though that looked like financial near-death experience, the same factors that made it more acute in many respects also made it easier for the officialdom to identify and shore up the key institutions that took hits below the water line.
That view was based simply on the level of damage Europe seemed determined to suffer via the effect of sanctions blowback on supplies of Russian gas. There are additional de facto and self restrictions on Russian commodities via sanctions on Russian banks and warniness about dealing with Russian ships and counterparties. For instance, Russian fertilizer is not sanctioned; indeed, the US made a point of clearing its throat a couple of months back to say so. Yet that does not solve the problem African (and likely other) buyers suffer They had accounts with now-sanctioned Russian banks and have been unable to come up with good replacement arrangements.
Another major stressor is the dollar’s moon shot. It increased the cost of oil in local currency terms, making inflation even worse. It also will produce pressure, and potentially defaults, in any foreign dollar debtor because he local currency cost of interest payments will rise. Given the generally high state of nervousness in financial markets, anyone who had been expected to roll maturing debt will be in a world of hurt (Satyajit Das in a recent post pointed out that investors typically don’t expect emerging market borrowers to repay).
Yet another big concern is hidden leverage, particularly from derivatives. A sudden rise in short term interest rates and increased volatility can blow up derivative counterparties. It’s already happening with European utility companies, many of whom are so badly impaired as to need bailouts.
And the failure of regulators to get tough with banks in the post-crisis period is coming home to roost. Nick Corbishley wrote about how Credit Suisse went from being a supposedly savvy risk manage to more wobbly than Deutsche Bank due to getting itself overly-enmeshed in the Archegos “family office” meltdown and then the Greensill “supply chain finance” scam. Archegos demonstrated a lack of regulatory interest in “total return swaps” which in simple terms allow speculators to create highly leveraged equity exposures. Highly leveraged equity exposures was what gave the world the 1929 crash. The very existence of this product shows the degree to which the officialdom has unlearned big and costly lessons.
The Governing Council today decided to raise the three key ECB interest rates by 75 basis points. This major step frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to our two per cent medium-term target. Based on our current assessment, over the next several meetings we expect to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations.
Inflation remains far too high and is likely to stay above our target for an extended period. According to Eurostat’s flash estimate, inflation reached 9.1 per cent in August. Soaring energy and food prices, demand pressures in some sectors owing to the reopening of the economy, and supply bottlenecks are still driving up inflation.
Price pressures have continued to strengthen and broaden across the economy and inflation may rise further in the near term.
Very high energy prices are reducing the purchasing power of people’s incomes and, although supply bottlenecks are easing, they are still constraining economic activity. In addition, the adverse geopolitical situation, especially Russia’s unjustified aggression towards Ukraine, is weighing on the confidence of businesses and consumers.
At the ECB, you better be gung-ho pro-EU. You better believe negative interest rates are a good idea. And you must back the idea that targeting 2% inflation makes sense.
Finally, if somehow you find yourself at the ECB disagreeing with any of those things, you are expected to shut your mouth so the consensus view never shows any dissent.
At FRBNY, I recall the people who ran Treasury markets, money markets, etc. literally had no relevant experience or expertise. The job of staff was to make them appear competent, but it didn’t really matter what they did because Fed can’t fail and they can’t get fired.
This creates a culture where anyone with talent or ambition GTFO ASAP. There are exceptions, but those who rise tend to be those who have no where else go. It’s a weird structure where the higher you go, the more incompetent you are.
At the height of the last big wave of Turkey’s ongoing crisis, in August 2018, the European Central Bank issued a warning about the potential impact the plummeting lira could have on Euro Area banks heavily exposed to Turkey’s economy via large amounts in loans — much of them in euros — through banks they acquired in Turkey. The central bank was worried that Turkish borrowers might not be hedged against the lira’s weakness and would begin to default on foreign currency loans, which accounted for 40% of the Turkish banking sector’s assets.
In the end, the contagion risks were largely contained. Many Turkish banks ended up agreeing to restructure the debts of their corporate clients, particularly the large ones. At the same time, the Erdogan government used state-owned lenders to bail out millions of cash-strapped consumers by restructuring their consumer loans, many of them foreign denominated, and credit card debt.
But concerns are once again on the rise about European banks’ exposure to Turkey. On Friday, as those concerns commingled with fears about the potential threat posed by the new omicron variant of Covid-19, Europe’s worst-affected stocks included the four banks most exposed to Turkey: Spain’s BBVA, whose shares fell 7.3% on the day, Italy’s Unicredit (-6.9%), France’s BNP Paribas (-5.9%) and the Dutch ING (-7.3%).