Thursday, June 7, 2012

The Bad News Continues: German Banks Downgraded

Moody’s has been traveling around Europe over the past four weeks or so and leaving its mark about everywhere it has gone.

On June 6, Moody’s lowered the credit rating of six German banks and three Austrian banks. 

Deutsche Bank was not included in this round of downgrades for it will be examined later this month when Moody’s does a review of the “biggest global banks” with large capital market operations. 

The latest round of bank downgrades followed three downgrades in Sweden on My 24, sixteen downgrades in Spain on May 17, and twenty-six downgrades in Italy on May 14.

The news release that accompanied the June announcements stated that the German banks still had a large exposure to structured credits, a substantial exposure to peripheral countries in the eurozone, and exposure to industries that were going through hard times, like shipping and finance. 

In addition the banks still faced a great deal of exposure to possible loan charge-offs due to weak profitability. 

And, these banks had only small amounts of capital relative to total assets.

The weak profitability can be attributed to the fact that German banks…and European banks in general…are not expanding their lending.   On reason is the reality of the current recession taking place in Europe.  However, with weak capital ratios and additional regulatory pressure to re-capitalize, the banks are not in any mood to move more aggressively on the lending front. 

The whole re-capitalization issue is also caught up in the discussions about forming a European banking union that would make almost all banks in the eurozone, European, and not just a member of a particular country.  This is not a non-issue!

And, if the banks are not lending, it will be difficult to achieve faster economic growth. 

One can see why the issue of a possible bank run on continental banks is being tossed around.  And, one can see why European officials are concerned.

The problem here is that if one ignores a problem for a long, long time, the problem does not necessarily go away.  And, in many cases, the problem can get worse.

The banking situation is Europe has been ignored for a long, long time and combined with the sovereign debt crisis, which was also ignored or action was postponed for a long, long time, things got worse. 

The added problem is that when things get worse, the solution is not always the same as in situations where the problem did not get worse.  And, when the problem gets worse, it often takes a much longer time for things to get back to normal. 

Liquidity actions on the part of central banks and deficit spending on the part of national governments may resolve a “more normal” banking or “more normal” sovereign debt problem within a reasonable period of time.

When the problems become ones of solvency and bankruptcy, the “more normal” prescriptions to solve the problems may not work and the time to return to “business-as-usual” may be an extremely long time.  But, when the problems become this great, officials often deny them and try to postpone getting to the real core of the issue for as long as they can.

We have seen this situation evolve in Europe. 

Now, the solutions have become structural and the potential disruptions to the existing culture have become enormous.  Where all this will end is unknown.

But, the pressures to act are growing.  Everything seems to be culminating in the need for eurozone officials to do something.  Financial markets react to news about what officials seem to be doing.  If it looks like the officials are moving to resolve an issue…financial markets improve.  If it looks as if the officials are deadlocked due to irreconcilable differences…financial markets tank.

Economic news does not do that much to move the markets these days.  The conditions of official discussions are the primary thing that the participants in the financial markets seem to be focusing upon.

Here again is another factor that arises when action is postponed.  The news never quite seems to be positive.  The German banks have been downgraded today.  Moody’s will soon have a report out on the “biggest global banks.”  And, then there will be something else. 

I know that the nations of the European continent have issues with one another that go back centuries.  I know that it will be very difficult for many people to lay down these issues and get on to what is real.  But, all I can say to the officials in Europe is…GET OVER IT!  Get on with business. The rest of the world cannot wait for you to fight another world war…if only on the conference table.          

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