There’s a lot of trash in the European banks.
A lot of loans that shouldn’t have been made. Loans where there hasn’t been a payment of interest or principal for… well, a while. Best not dwell on that. Let’s just say “too long”. There are varying definitions around the world for what constitutes a “non-performing loan” (NPL), and in Europe the rules are especially lax…
Some of these loans were first created a very long time ago – possibly as far back as the early days of the euro itself. There’s likely a large glut of them from the European boom of the noughties still sticking around, stagnant.
They weren’t written off when they should’ve been, for that might’ve forced some of the functionally insolvent banks to reveal that they were actually insolvent. And so the trash has just sat there, lingering like a blight on their balance sheets, attracting flies.
In the few years of relative stability within the euro banking system after the sovereign debt crisis, there have been attempts to pack this trash into bags and sell them to those brave enough to search them for loose change and bits of scrap. Trawling through the old dead loan book where there still might be some income or asset which can be recovered with the right approach.
But the amount of garbage shifted in this way has been very small relative to the amount of trash out there, and the rate has been too slow – the “binmen” had a hell of a shift still ahead of them, and that was before the WuFlu struck. Right now, an entire new wave of debt is in the process of turning into NPLs – the trash heap is about to get substantially larger.
This is one of the main reasons why I see the lockdowns as so dangerous for the eurozone. The banks there already had unprofitable trash filling their vaults. They already had bad debt on their balance sheets and were struggling to earn any income on their good debts due to the incredibly low interest rates. How will they survive when those good debts join the bad ones – when what yielded cash turns to trash?
The eurocrats have the answer: a giant trash can, where all the garbage can be flushed.
The plan is to create one big “bad bank”, where banks with trash on their books can dump the assets in exchange for cash. From Reuters:
… One of the people familiar with the plan said the ECB had set up a task force to look at the idea of a “bad bank” to warehouse unpaid euro debt and that work on the scheme had accelerated in recent weeks.
The ECB declined to comment on whether it was working on a bad bank scheme.
The amount of debt in the euro zone that is considered unlikely to ever be fully repaid already stands at more than half a trillion euros, including credit cards, car loans and mortgages, according to official statistics.
That is set to rise as the COVID-19 outbreak squeezes borrowers and could even double to one trillion euros, weighing on already fragile banks and hindering new lending, the people familiar with the ECB plans said.
While the idea for a euro zone bad bank was discussed and shelved over two years ago, the ECB, under its new President Christine Lagarde, has consulted banks and EU officials about a scheme in recent weeks, one of the people said.
The proposed method in which all the trash could be flushed into one bad bank would be as follows:
The bad bank – “Garbage and Sons”, let’s say – would be created, importantly with the explicit backing of the European Stability Mechanism (ESM) – a technocratic institution created to maintain financial stability in the eurozone. The ESM would function as a guarantor to Garbage and Sons.
This next bit is where the magic comes in.
The European banks with trash debt on their balance sheet then exchange it with Garbage and Sons… for debt owed by Garbage and Sons.
The European banks would no longer be owed money from failing and failed European businesses and customers – they would be owed money from Garbage and Sons which has an ESM guarantee. It’s alchemy – swapping trash for gilt-edged guaranteed loans.
The European banks can then take that debt owed by Garbage and Sons, and pawn it with the European Central Bank for cash to then lend out elsewhere. They’re off, scot-free at last…
And the trash debt?
That liability now rests with Garbage and Sons, who can then dig through the trash to find anything of value. If it doesn’t find anything however, it’s alright – It can try to borrow from other banks and financial institutions to maintain its solvency and if all else fails, it’s backed by the ESM, which is again backed by the governments of the eurozone.
Even if Garbage and Sons then goes bust and the ESM refuses to bail it out, much of the debt which it owed should be in the possession of the European Central Bank, which can take any loss and still remain functioning.
In this way, all the trash gets taken from eurozone bank balance sheets, and placed in a trash can where it is no longer subject to market forces – only to political ones.
This “bad bank” plan is still being drafted up, but it’s clear that the issue of trash is becoming a big problem for the eurozone.
When you think of the plan itself, it’s relatively simple. The question is one of political will – do eurozone member governments want to take on the liability of the great glut of bad debt that has accumulated in the eurozone after all these years? How will they share the responsibility if it goes wrong, and will eurozone members with stronger and more responsible banks really want to bail out the countries that have been careless?
Considering the route that has been taken so far in the eurozone, and which those in charge continue to tread, I doubt much thought will be given to the consequences of financing an escape strategy for banks that have made terrible lending decisions in perpetuity. Future moral hazard will once again be set aside to keep the wheels in motion, just for a little longer…
With that in mind, I have a suggestion. Why bother conducting a bailout, if you’re gonna do it half-cocked? Get some speculators involved, and keep the recent speculative frenzy in stocks going: the eurocrats should IPO the bad bank and let investors contribute their capital to the eurozone cleanup.
Don’t IPO it in Europe though, as that’s not where all the hot bullish money is. Go to the Nasdaq in the States, and take the bastard public there under the ticker $TRASH. Bankrupt companies have been making triple-digit gains in recent weeks – surely Garbage and Sons, an exotic investment bank from abroad, will stands to receive similar treatment…
Wishing you a good weekend,
Boaz Shoshan
Editor, Capital & Conflict
For charts and other financial/geopolitical content, follow me on Twitter: @FederalExcess.
Category: Market updates