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Stoneleigh: Last week, in Get Ready for the North American Gas Shock, The Automatic Earth evaluated the prospects of shale gas, a supposedly plentiful and clean fuel upon which many have placed their hopes of both energy supply and handsome profits. The first part of our shale gas analysis concentrated on supply and EROEI (energy returned on energy invested), pointing out that reserves are very much overstated and that the sector is in fact in a major bubble. In this follow up, we are going to assess the other major claim - that shale gas is a clean energy source, and would constitute an improvement in environmental terms over reliance on oil and coal.
Fracking: The Great Shale Gas RushAlong with wind, solar, and nuclear power, natural gas is crucial to Obama's goal of producing 80 percent of electricity from clean energy sources by 2035. But the drilling is taking place with minimal oversight from the U.S. Environmental Protection Agency. State and regional authorities are trying to write their own rules—and having trouble keeping up.
Stoneleigh: Shale gas is contained in impermeable reservoir formations deep beneath the surface. In order to release the gas for extraction, the rock must be hydraulically fractured (fracked). Pipes are inserted by drilling first vertically into the formation, then horizontally along it in many different directions from a common well pad. The pipes are constructed like a soaker hose, with holes along their length. A mixture of water (99%), sand and a proprietary mixture of chemicals is injected thousands of feet down under very high pressure, multiple times per well.
The water - 2 to 6 million gallons per well - (a challenge in arid regions) fractures the formation rock where it exits through the holes in the pipe. The sand acts as a propping agent, entering the fractures and keeping conduits open while providing for permeability to gas flow. The released gas then flows into and up the pipe to be collected at the surface. The long horizontal pipes allow for a large surface area in contact with gas-bearing rock, maximizing extraction.
Fracking was first implemented by Halliburton in 1949, but only became common much more recently in combination with horizontal drilling, and once the companies had been exempted from important environmental legislation.
It really wasn't until 2004 that fracking really took off, the year that the EPA declared that fracking "posed little or no threat" to drinking water. Weston Wilson, a scientist and 30-year veteran of the agency, who sought whistleblower protection, emphatically disagreed, saying that the agency's official conclusions were "unsupportable" and that five of seven members of the review panel that made the decision had conflicts of interest. (Wilson has continued to work at the EPA, and continues to be publicly critical of fracking.)
A year later, Congress passed the Energy Policy Act with a "Halliburton loophole," a clause inserted at the request of Dick Cheney, who had been Halliburton's CEO before becoming vice president. The loophole specifically exempts fracking from the Safe Drinking Water Act, the Clean Water Act, the CLEAR Act, and from regulation by the Environmental Protection Agency, and it unleashed the largest and most extensive drilling program in history, according to Josh Fox, the creator of the film Gasland.
Stoneleigh: The chemicals added serve a number of purposes, including preventing the growth of slime organisms, keeping the sand in suspension, preventing scale build-up and reducing friction. Fracking fluids typically contain biocides, surfactants, and corrosion and scale inhibitors, among other ingredients. The exact composition of the fluid is not made public, although it may be revealed to local regulators. Many of the chemicals used are toxic or carcinogenic, and their use is highly contentious.
Although added chemicals comprise less than 1% of the fracking fluid, that still amounts to a small percentage of a very large number. Given the enormous quantities of fluid involved. and the toxicity of the additives, concern is justified.
By examining drillers’ patent applications and government worker health and safety records, some environmentalists and regulators in the US have been able to piece together a list of some of the fracking fluid ingredients. These include potentially toxic substances such as diesel fuel (which contains benzene, ethylbenzene, toluene, xylene, and napththalene), 2-butoxyethanol, polycyclic aromatic hydrocarbons, methanol, formaldehyde, ethylene, glycol, glycol ethers, hydrocholoric acid, and sodium hydroxide.
Stoneleigh: Half or more of the fracking fluid, along with water from the rock formation (which can contain heavy metals and other minerals), typically returns to the surface for disposal, where it is stored in ponds. These ponds can unfortunately leak, and evaporation of volatile chemicals can cause local air pollution. Disposal is expensive, both in financial and energy terms. The need for energy-intensive disposal lowers the Energy Returned on Energy Invested (EROEI) for the shale gas extraction life cycle.
Stoneleigh: A number of states allow fracking fluid to be disposed of to land, but this can have significant consequences.
A study that argues for more research into the safe disposal of chemical-laced wastewater resulting from natural gas drilling found that a patch of national forest in West Virginia suffered quick and serious loss of vegetation after it was sprayed with hydraulic fracturing fluids.
The study, by researchers from the United States Forest Service, was published this month in the Journal of Environmental Quality. It said that two years after liquids were legally spread on a section of the Fernow Experimental Forest, within the Monongahela National Forest, more than half of the trees in the affected area were dead. [..]
Almost immediately after disposal, the researchers said, nearly all ground plants died. After a few days, tree leaves turned brown, wilted and dropped; 56 percent of about 150 trees eventually died.
Stoneleigh: The gas industry claims that there are no health or environmental effects from the fracking process, but these claims are hotly disputed. A primary concern is the potential for aquifer contamination, which can have significant adverse impacts on people’s well water. In rural areas, there may be a very large number of drinking water wells.
While the fracked formations are generally many thousands of feet below aquifers, poorly constructed well casings can leak. Also, natural faults within the rock strata could allow fracking fluids or methane or both to migrate upwards. Shale gas wells can be very densely packed, and in many places well drilling and fracking activity have increased by an order of magnitude or more in a few short years thanks to the frenetic activity brought about by the shale gas bubble.
Jessica Ernst says she’s "still getting used to" being compared to Erin Brockovich (the environmental activist made famous by Julia Roberts' film portrayal ten years ago). The comparison comes easy because the outspoken Ernst, a landowner in the town of Rosebud, Alberta, is one of the few Albertans who have publicly criticized hydraulic fracturing [..]
After her well water was contaminated by nearby fracking in 2006, Ernst decided to go public, showing visiting reporters how she could light her tap water on fire, and speaking out about Alberta land owners’ problems with the industry, especially Calgary-based EnCana. EnCana is Canada’s second biggest energy company (after Suncor) and is now also a major player in British Columbia, with hundreds of natural-gas wells in the province.
Ernst, a biologist and environmental consultant to the oil and gas industry, says EnCana "told us ‘we would never fracture near your water.’ But the company fracked into our aquifer in that same year ." By 2005, she says, "My water began dramatically changing, going bad. I was getting horrible burns and rashes from taking a shower, and then my dogs refused to drink the water. That’s when I began to pay attention." More than fifteen water-wells had gone bad in the little community. Tests revealed high levels of ethane, methane, and benzene in Ernst’s water.
Stoneleigh: Dimock, Pennsylvania, is another region where significant impacts have undoubtedly manifested. Consider the experience of the Sautner family and their neighbours:
Drilling operations near their property commenced in August 2008.....Within a month, their water had turned brown. It was so corrosive that it scarred dishes in their dishwasher and stained their laundry. They complained to Cabot [Houston-based Cabot Oil & Gas, a midsize player in the energy-exploration industry], which eventually installed a water-filtration system in the basement of their home. It seemed to solve the problem, but when the Pennsylvania Department of Environmental Protection came to do further tests, it found that the Sautners’ water still contained high levels of methane. More ad hoc pumps and filtration systems were installed. While the Sautners did not drink the water at this point, they continued to use it for other purposes for a full year.
"It was so bad sometimes that my daughter would be in the shower in the morning, and she’d have to get out of the shower and lay on the floor" because of the dizzying effect the chemicals in the water had on her, recalls Craig Sautner, who has worked as a cable splicer for Frontier Communications his whole life. She didn’t speak up about it for a while, because she wondered whether she was imagining the problem. But she wasn’t the only one in the family suffering. "My son had sores up and down his legs from the water," Craig says. Craig and Julie also experienced frequent headaches and dizziness.
By October 2009, the Department of Environmental Protection had taken all the water wells in the Sautners’ neighborhood offline. It acknowledged that a major contamination of the aquifer had occurred. In addition to methane, dangerously high levels of iron and aluminum were found in the Sautners’ water. The Sautners now rely on water delivered to them every week by Cabot.
The value of their land has been decimated....They desperately want to move but cannot afford to buy a new house on top of their current mortgage.
Stoneleigh: Frenetic activity is not the best circumstance for ensuring care and attention to detail, even when the price of carelessness can be effectively permanent groundwater contamination with highly toxic or explosive substances. Accidents can happen. For instance a well in Clearfield County, Pennsylvania, experienced a blow-out on June 3rd 2010 that was determined to have been easily preventable. Had the released gas ignited, the consequences could have been dire. As it was, gas, along with 35,000 gallons of drilling fluid, spewed from the well for 16 hours before the situation was brought under control.
DEP Secretary John Hanger announced that an independent investigation confirmed that the incident was preventable and EOG Resources ignored industry standards by failing to install proper barriers in the well and hiring uncertified operators. Hanger also said that EOG Resources failed to alert emergency authorities until several hours after the blowout, which hindered the state’s response.
"Make no mistake, this could have been a catastrophic incident," Hanger said. "Had the gas blowing out of this well ignited, the human cost would have been tragic, and had an explosion allowed this well to discharge wastewater for days or weeks, the environmental damage would have been significant."
John Vittitow, an experienced petroleum engineer hired by the DEP to conduct the investigation, made an eerie comparison to the Deepwater Horizon disaster in the gulf as he described the failed blowout preventer that led to the incident. Vittitow said that EOG Resources only installed one pressure barrier during a well clean-out procedure, while industry standards call for at least two barriers in case of failure.
Hanger admitted that state regulations on well operations are broad and regulators would have to be "more prescriptive" to ensure that well operators use at least two barriers in the future. Vittitow’s investigation also revealed that the C. C. Forbes operators lacked industry certifications that are mandatory in most companies.
Stoneleigh: It is no surprise that regulators are struggling to keep pace with events and little authoritative research has been done on environmental effects. Received wisdom has become that shale gas is both clean and plentiful, and it can be very difficult to get funding to challenge received wisdom and powerful vested interests in any field.
A team from Duke University recently undertook research on well water impact in New York and Pennsylvania, sampling 68 private wells at varying distances from from drilling activity.
The trends were immediately clear: those within 1km of an active drilling site were much more likely to have high levels of methane, on average 17 times higher than those sites more distant from active drilling. That average covers a broad range, too. Some sites were indistinguishable from the typical inactive well, while others had concentrations of methane between 19.2 and 64 mg/l, enough to pose an explosive hazard, and high enough to qualify for hazard mitigation under the Department of the Interior's rules.
Stoneleigh: The Duke team has been criticized by the shale gas industry for lacking baseline data, yet the industrial players themselves have the necessary data and refuse to release it.
Ever since high-profile water contamination cases were linked to drilling in Dimock, Pa., in late 2008, drilling companies themselves have been diligently collecting water samples from private wells before they drill, according to several industry consultants who have been working with the data. While Pennsylvania regulations now suggest pre-testing water wells within 1,000 feet of a planned gas well, companies including Chesapeake Energy, Shell and Atlas have been compiling samples from a much larger radius—up to 4,000 feet from every well. The result is one of the largest collections of pre-drilling water samples in the country.
"The industry is sitting on hundreds of thousands of pre and post drilling data sets," said Robert Jackson, one of the Duke scientists who authored the study, published May 9 in the Proceedings of the National Academy of Sciences...."I asked them for the data and they wouldn’t share it."
Stoneleigh: Air pollution can also be a major issue in fracking centres, some of which are densely populated.
The picture from Dish is not pretty. A set of seven samples collected throughout the town analyzed for a variety of air pollutants last August found that benzene was present at levels as much as 55 times higher than allowed by the Texas Commission on Environmental Quality (TCEQ). Similarly, xylene and carbon disulfide (neurotoxicants), along with naphthalene (a blood poison) and pyridines (potential carcinogens) all exceeded legal limits, as much as 384 times levels deemed safe. "They're trying to get the pipelines in the ground so fast that they're not doing them properly," says Calvin Tillman, Dish's mayor. "Then you've got nobody looking, so nobody knows if it's going in the ground properly…. You just have an opportunity for disaster here."
Dish sits at the heart of a pipeline network now tuned to exploit a gas drilling boom in the Fort Worth region. The Barnett Shale, a geologic formation more than two kilometers deep and more than 13,000 square kilometers in extent, holds as much as 735 billion cubic meters of natural gas—and the city of Fort Worth alone boasts hundreds of wells, according to Ed Ireland, executive director of the Barnett Shale Energy Education Council, an industry group. "It's urban drilling, so you literally have drilling rigs that are located next door to subdivisions or shopping malls."
Stoneleigh: Air pollution from fracking in agricultural areas can also have significant negative impacts.
According to Jaffe, ozone is more lethal to crops than all other airborne pollutants combined, and of all crops, few are more susceptible to it than clover, a nutrient-rich feed that is critical to his method of sustainable cattle raising. While ozone is normally associated with automobile exhaust, fracking generates so much of it that Sublette Country, Wyo., has ozone levels as high as Los Angeles. This, despite the fact that it has fewer than 9,000 residents spread out over an area the size of Connecticut. What it does have is gas wells.
Stoneleigh: Besides the effect of ground-level ozone on animal feed, there can be other more direct impacts on livestock and on farmers’ ability to make a living.
Last year, the Pennsylvania Department of Agriculture quarantined 28 cattle belonging to Don and Carol Johnson....The animals had come into wastewater that leaked from a nearby well that showed concentrations of chlorine, barium, magnesium, potassium, and radioactive strontium. In Louisiana, 16 cows that drank fluid from a fracked well began bellowing, foaming and bleeding at the mouth, then dropped dead.
Stoneleigh: Livestock farmers are concerned that the mere presence of wells in the area could lead to suppliers ceasing to purchase their animals, for fear of contamination, whether or not animals do in fact come into contact with noxious chemicals in the air or water. They are also concerned about the lack of regulation and oversight of the industry as it may impact of their livelihoods.
For the most part, state and federal governments have turned a blind eye to the problems brought about by fracking. The Environmental Protection Agency (EPA) claims that it has no jurisdiction to investigate matters related to food production, a contention disputed by Congressman Maurice Hinchey (D-NY), who wrote a report urging the EPA to study all issues associated with fracking. A concerned farmer who prefers not to be identified forwarded me an email written to him by Jim Riviere, the director of the Food Animal Residue Avoidance Databank, a group of animal science professors that tracks incidents of chemical contamination in livestock.
Riviere wrote that his group receives up to 10 requests per day from veterinarians dealing with exposures to contaminants, including the byproducts of fracking. Nonetheless, the United States Department of Agriculture (USDA) has slashed funding to his group. "We are told by the newly reorganized USDA that chemical contamination is not their priority," Riviere wrote.
Stoneleigh: Land owners are concerned about the value of their property, since some banks will not grant mortgages on real estate in fracked areas. As is often the case perception, particularly fear of risk, matters a great deal.
Of course on the other side of the financial equation, a lot of revenue is dependent on the shale gas business. There are both winners and losers. For instance, in some states huge amounts of state pension funds are invested in shale gas companies.
In Pennsylvania, where 2,516 wells have been drilled in the last three years, $389 million in tax revenue and 44,000 jobs came from gas drilling in 2009, according to a Penn State report.
Stoneleigh: A number of jurisdictions either have banned fracking or are considering doing so. Quebec decided in March 2011 to wait for a detailed environmental study of the process, despite the putative value of the gas contained in the Utica shale formation and the private capital committed to the industry. Acceptance of the practice there, where there is no history of oil and gas exploration, is the lowest in Canada at 22% (compared to 46% in Alberta where the oil and gas industry is well established).
It has been a swift fall from grace for junior exploration companies whose fortunes are tied to Quebec’s nascent shale gas industry. Calgary-based Questerre Energy Corp., worth $800-million only a year ago, has a market capitalization barely one fourth of that today as investors cashed out following the Quebec government’s decision in March to put commercial hydraulic fracturing drilling on hold pending a detailed environmental review. Junex Inc. and Gastem Inc. aren’t faring any better. Each has seen its stock fall more than 50% off their 52-week highs on the Toronto Venture Exchange [..]
For Questerre, Quebec’s decision forced a brutal reckoning. The company holds development rights to more than one million gross acres of farmland along the southern flank of the St. Lawrence River in Quebec, smack in the middle of what has become known as the Utica shale gas formation. It estimates its property could yield a prospective recoverable resource of 18 trillion cubic feet. Its entire business plan was focused on developing Quebec gas [..]
Quebec has now decided it will not approve shale gas development until it’s proven safe by independent study. A panel of 11 experts has been mandated to undertake a strategic environmental assessment expected to take between two and three years. In the meantime, the province has cancelled exploration permits without compensation and issued a new set of regulations to govern shale gas development. Detailed administrative practices should follow.
Stoneleigh: Others jurisdictions are contemplating lifting bans already imposed, as the supposed benefits may seem simply too enticing. New York state, underlain by the Marcellus Shale, is suggesting a compromise, by allowing fracking in some locations, while attempting to protect watersheds and other sensitive locations. The decision is not popular.
Gov. David A. Paterson vetoed a bill passed by the Legislature last year that would have formally banned hydrofracking, but effectively put a ban into place until further study was completed. The Cuomo administration is seeking to lift what has effectively been a moratorium in New York State on hydraulic fracturing [..]
The process would be allowed on private lands, opening New York to one of the fastest-growing — critics would say reckless — areas of the energy industry. It would be banned inside New York City’s sprawling upstate watershed, as well as inside a watershed used by Syracuse, and in underground water sources used by other cities and towns. It would also be banned on state lands, like parks and wildlife preserves. It will most likely take months before the policy becomes official [..]
"This report strikes the right balance between protecting our environment, watersheds and drinking water, and promoting economic development," said Joseph Martens, the commissioner of the department, a state agency controlled by the governor’s office.
Stoneleigh: It is not difficult to imagine the cause for opposition, since the Marcellus Shale lies beneath the largest unfiltered drinking water supply system in the USA, which provides over a billion gallons of water per day to New York City.
Industry insider James Northrup, recently relocated from Texas to New York State, explains a number of the difficulties associated with the Macellus Shale in particular.
In summary, Mr Northrup points out that the rock formation of the Marcellus is particularly tight. The pressure required to frack the formation horizontally can be up to 15,000 psi (equivalent to the pressure 6 miles beneath the ocean being applied to several million gallons of water), which is much higher than was necessary for the older vertical wells in the Barnett Shale where the existing regulations were developed. This is like exploding a substantial pipe bomb underground in a geologically complex area where there is poor seismic data.
In other words, no one knows where the many faults are, and no one can dismiss the risk that racking fluid will end up in an aquifer. Oil based fluids, being lighter than water, will rise to the top of contaminated aquifers, ending up disproportionately in well water. Mr Northrup explains that the industry need not use toxic chemicals, and indeed should not, especially where the risk of groundwater contamination appears to be uncomfortably high. Even without toxic chemicals, Mr Northrup argues that fracking should not happen where seismic data is inadequate, as gas migration can still represent an explosion hazard.
Geologist Arthur Berman also has major concerns regarding the Marcellus Shale. He feels that the risk of capital destruction is unusually high, thanks to the large extent of the play which will make it more difficult to identify the core areas, or sweet spots, that shale gas plays always contract to. Existing gas pipeline infrastructure is inadequate and will require time to build out, but gas wells are being drilled now.
Valuable natural gas liquids, which must be removed prior injecting the gas into a pipeline, will be difficult to separate given the insufficient fractionation plant capacity. Obtaining permission for the very high volume water withdrawals required is likely to be problematic, as is transporting waste water to the few waste treatment plants in the region.
In addition, high population density in the area of the play will make it far more difficult to assemble acreage blocks, and will heighten the potential impact of any accidents. The objections may be legion, as the large population at risk expresses its intolerance of that risk.
Given the poor economics and low EROEI of shale gas in general. It is very difficult to argue that fracking, particularly in areas like the Marcellus Shale, makes sense. Unconventional gas is far from being a clean fuel when the whole lifecycle is considered. In fact considering the substantial potential for releases of fugitive methane emissions, one cannot even argue that unconventional gas is an improvement in comparison with burning coal when it comes to climate impact, let alone an improvement on other environmental fronts.
Shale gas is simply another Faustian bargain that humanity should not be making. We run substantial long term risks, which we socialize, for the sake of short term private profits.
This is the typical human modus operandi, but it is high time we learned from our mistakes.
European Banks Drop Below Book Value for First Time Since 2009
Shares of European lenders dropped below the value of their tangible assets for the first time in two years after last week's stress tests failed to ease concern the firms are vulnerable to the region's growing debt crisis.
The 49-member Stoxx 600 Banks Index fell 2.8 percent to 166.92 at 3:53 p.m. in London, equivalent to 0.98 times the value of assets such as bond holdings and buildings. The measure, which has fallen 27 percent since its 2011 high, last traded below its tangible book value in April 2009, according to Bloomberg data.
A government study of credit risk at 90 lenders did little to convince investors that financial companies have enough money to cover loans to Europe's weakest economies. The European Banking Authority's assessments, which didn't include the possibility of a Greek default, disclosed the size and maturity of banks' holdings of sovereign debt just as yields on government bonds issued from Spain to Italy climbed.
"The twin threats of European sovereign default and the risk of suffocating regulation haunt the sector," Simon Samuels, an analyst at Barclays Plc in London, wrote in a report today. "That is just as true after the stress test as it was before."
European bank stocks last traded below tangible book value from October 2008 to April 2009, the height of the credit crisis that followed the collapse of Lehman Brothers Holdings Inc., according to data compiled by Bloomberg going back to 2002. They had never fallen below the level before then.
SocGen, Intesa Sanpaolo
Societe Generale SA, France's second-biggest bank, tumbled 4.5 percent to 33.14 euros today for its 11th straight loss. Intesa Sanpaolo SpA, Italy's second-biggest bank, sank 5 percent to 1.50 euros.
"New disclosures graphically illustrate the level of cross-border exposures and interconnectedness among the major banks across Europe," Barclays' Samuels wrote. "Now we have a complete analysis of each bank's exposure to troubled countries, covering corporate lending, retail lending, financial institutions' exposures as well as sovereign."
European banks will have to raise about 80 billion euros ($112 billion) of additional capital, according to estimates from analysts at Credit Suisse Group AG.
A team of Credit Suisse strategists led by Andrew Garthwaite advised investors in a report today not to buy bank stocks yet, saying continental European lenders should trade at 0.8 times tangible book "in a way that valuations become sufficiently compelling to compensate for the risks."
The Stoxx 600 Banks is the worst-performing industry among 19 groups in the broader Stoxx Europe 600 Index this year, having plunged 15 percent, as the European Union bailed out Portugal and as concern mounted that Italy and Spain may fail to repay all their debt. The stocks are "impossible to value" given the uncertainty about the future value of sovereign bond holdings and mortgages, Tim Price, chief investment director at PFP Group LLP in London, said last week.
"It is ultimately a game on sovereign debt and the economic situation of the periphery," said Price, who helps oversee $1 billion, in an interview. "How do you value financial shares in that environment? If the game is not sensible, we just don't try."
Banco Comercial Portugues SA slumped 4.1 percent to 30.5 euro cents and Espirito Santo Financial Group SA dropped 2.2 percent to 13.45 euros. Both Portuguese firms will increase capital or sell assets in the next three months to strengthen their balance sheets, the Bank of Portugal said on July 15.
Banco Comercial passed the EU's stress test with a 5.4 percent capital ratio and ESFG passed it with a 5.1 percent capital ratio. The EBA set a minimum capital ratio of 5 percent. National Bank of Greece SA rose 1.2 percent to 4.25 euros after passing the test.
Regulators didn't include the impact of a Greek default in the stress tests even though credit-default swaps indicate investors see an almost 90 percent chance of one. The EBA included a 25 percent writedown on 10-year Greek government bonds held on banks' trading books even as the securities traded at about 51 cents on the euro.
Spanish lenders' bad-loan ratio rose to 6.5 percent in May, the highest in 16 years, the Bank of Spain said on its website today. Investors are testing the EU's resolve to end the sovereign-debt crisis by pushing Italian and Spanish bond yields toward levels that forced Greece, Ireland and Portugal to ask for help. Italian and Spanish 10-year bond yields surged today to euro-era records of 6.03 percent and 6.37 percent, respectively, Bloomberg data show.
Contagion in Three Forms Now Has Grip on Europe
by Simon Johnson - Bloomberg
There are three types of contagion in a financial crisis, when the potential collapse of a firm, bank or country threatens to spiral out of control. The European Union today has all three.
The first type is purely psychological -- the panic of herd behavior. The second comes from thinking through the real effects that a collapse would have, as the potential spillovers dawn on people. The third, and most devastating, emerges when smart investors realize that their assumptions -- based on the pronouncements of policy makers -- are all wrong and need to be tossed overboard.
A common characteristic of the panic phase is that the bottom drops out of economic forecasts, taking with them the perceived ability of companies or countries to pay their debts. The corollary of this is that estimates of losses soar to once- unimagined levels. Some analysts now suggest that Greece might have to impose a haircut -- or loss -- of as much as 80 percent on creditors. This is up dramatically from the recent market view that 40 percent losses might be needed in a restructuring.
Emotions are taking over and the abyss looks bottomless, as it did for Russia in 1998 or Argentina in 2002. Countries, unlike companies, don’t go out of business. But in its panic, the herd tends to forget that.
Typically, in the second type of contagion, the spillover crosses borders because of trade. In the early 1930s, for example, major countries adopted fiscal policies that reduced their demand for other nations’ exports and pushed them toward recession. Some of this spillover also happened during the financial crisis of late 2008, when shrinking demand in the U.S. and Europe rippled through to Asia. Fortunately, most Asian countries were well prepared; their governments had modest debt and didn’t need to turn to fiscal austerity to meet their obligations.
While Greece, Ireland and Portugal play only a modest role in trade within the EU, they are tied into the EU’s financial and banking system. This is reminiscent of what we saw in Asia during 1997-1998. As international banks experienced or expected losses in Thailand after its currency devaluation, they became more cautious about lending to Malaysia and Indonesia. This restricted credit, pushed up interest rates and stifled the commercial paper market, an important source of funding for Indonesian corporate debt. It’s worth noting that financial linkages are more extensive within the EU today than they were across Asia during 1997-1998.
The third type of contagion is the scariest. When investors start believing that an important set of people have changed their minds about providing support to troubled firms or countries, a lot of assets need to be repriced.
This is the most plausible explanation of what happened after the collapse of Lehman Brothers Holdings Inc. and the near-failure of American International Group Inc. in September 2008. When the Federal Reserve made a loan to AIG that took priority over other creditors, the value of AIG’s senior debt fell 40 percent. The implication was clear: Morgan Stanley, Merrill Lynch and Goldman Sachs could either go the Lehman way or the AIG way. The same was true of money market mutual funds. It was time to get out.
The Germans now want to end the moral hazard of lending to weak euro-zone governments and banks, thus encouraging the belief that richer and better-run countries will provide the necessary support to prevent creditor losses. The trouble is, if you think that the problems are deeper, and that countries with independent fiscal policies can’t co-exist with a common currency, then Germany and other fiscally conservative nations will have to bail out their weaker neighbors again.
Persuading the EU
This isn’t about the policy preferences of the International Monetary Fund, the U.S. or the Group of 20. This is about what Germany is willing to do and what it can persuade its EU partners to go along with. Ultimately, German politicians can throw up their hands and say, bluntly: If you don’t like our proposals, you can do something else, but pay for it yourself.
Either way, the result is increasing risk of a debt default and losses for creditors. We’ll see the consequences as interest rates for troubled countries rise and the liquidity in their government bond markets dries up.
Exiting the moral hazard trade is a good idea. But there is no transition plan -- just a series of improvisations, gut reactions and continual renegotiations. There isn’t yet anything close to the political will to definitively end things with a comprehensive solution that tells you who will restructure and who will get unlimited bailouts. This contagion will spread, until senior euro-zone leadership decides -- once and for all -- who is to be saved and on what terms.
BofA Needs $50 Billion Cushion as Mortgage Expenses Swell
by Hugh Son - Bloomberg
Bank of America Corp. may have to build its capital cushion by $50 billion and renege again on Chief Executive Officer Brian T. Moynihan’s pledge to raise the firm’s dividend as mortgage losses drain funds.
Expenses tied to soured home loans may total $20.4 billion in the second quarter, pulling the bank further from capital ratios demanded under new international standards, the Charlotte, North Carolina-based company said June 29. The gap may equal 2.75 percent of risk-weighted assets starting in 2013 -- at about $18 billion for each percentage point -- crimping Moynihan’s ability to raise dividends and repurchase shares.
“They are likely to be in capital-building mode for longer than previously anticipated,” Jason Goldberg, a Barclays Capital analyst, said in an interview. For now, he said, “I’m hard-pressed to see meaningful capital redeployment.”
Moynihan, 51, has booked about $30 billion in settlements and writedowns to clean up mortgage liabilities at the biggest U.S. bank since succeeding Kenneth D. Lewis last year. As the costs mounted, Bank of America’s stock declined 26 percent this year, the worst showing in the 24-company KBW Bank Index. The company reports second-quarter results tomorrow and has told investors to brace for a loss of as much as $9.1 billion.
“The charges have had the effect of reducing mortgage uncertainty but have pushed dividend increases further into the future,” Richard Staite, an analyst with Atlantic Equities LLC, said in a June 30 note. Staite and Goldberg both estimate that Bank of America needs to raise $50 billion to comply with the new capital requirements, designed to build a buffer against losses and avert a repeat of the 2008 financial crisis.
Under rules prepared by the Basel Committee on Banking Supervision, Moynihan has to achieve a 9.5 percent ratio of capital to risk-weighted assets between 2013 and 2019. That’s based on a 7 percent minimum and a 2.5 percent surcharge imposed by regulators on the largest companies whose collapse would pose a threat to the banking system.
Moynihan’s task was complicated after he underestimated how big the capital surcharge would be. The bank counted on 1 percentage point, an assumption based upon “fairly senior information saying that was a reasonable number to use,” Moynihan said in a June 1 conference. The 2.5 percent announced last month means an extra $27 billion burden.
“It’s phased in over time, so there’s time to meet the requirement,” said Jerry Dubrowski, a Bank of America spokesman. “On the dividend, we know we have some work to do relative to the capital plan, and when we complete that work we’ll resubmit it to the Federal Reserve.”
Bank of America fell 16 cents, or 1.6 percent, to $9.84 in 9:45 a.m. New York Stock Exchange trading. That’s the lowest since May 2009, when the company still held $45 billion in U.S. bailout funds to help it survive the global financial crisis.
Moynihan has previously had to revise guidance about the bank’s dividend after the Fed rejected what he called a “modest” increase requested for later this year. His deals to settle disputes over defective mortgages, including an $8.5 billion accord last month, means the CEO may have to adjust another promise to investors -- a larger dividend boost by 2013. In March, Moynihan said that all $42 billion of projected earnings in 2013 and 2014 would be returned to shareholders. Bank of America was “committed” to raising its 1-cent dividend to a higher level equal to 30 percent of earnings, he said.
“We go from being a company which gets its capital in shape in 2011 and 2012 and pays a modest dividend to a company which has significant capital generation from there on out,” Moynihan said at the March 8 conference. The result would be a total of $12 billion in payouts during those two years, he said.
That plan may be stymied as Moynihan writes checks to settle disputes inherited from the 2008 takeover of subprime lender Countrywide Financial Corp., whose lax underwriting led to soaring defaults on mortgages and claims from investors who bought or insured them. He announced a $3 billion accord with Fannie Mae and Freddie Mac in January, a $1.6 billion deal with bond insurer Assured Guaranty Ltd. in April and the $8.5 billion settlement with institutional investors last month.
With the costs climbing, Bank of America last month cut its 2013 forecast of its capital ratios under the new rules to 6.75 percent to 7 percent, from 8 percent in April. That estimate is based on the premise that the rules are fully enforced in 2013. Executives and analysts expect the rules will be phased in over several years, making it less likely that Bank of America will be left short on capital and be forced to sell new shares. The added time would allow the bank to reach its goals by retaining earnings or getting rid of riskier assets that require a lender to hold more capital to cushion losses.
China Construction Stake
The bank is weighing the sale of at least part of its $21 billion stake in China Construction Bank Corp., three people briefed on the plans said last month. The sale would simultaneously raise cash and reduce assets that are penalized under the capital rules.
Bank of America, which under Basel rules may be labeled a systemically important financial institution, or SIFI, expects to have $1.8 trillion in risk-weighted assets by 2013 and said it intends to reduce that figure to ease capital needs. To meet the 9.5 percent standard, the bank would have to hold about $171 billion in capital. That compares with $122 billion for the 6.75 percent ratio.
The bank will “take a hard look at our balance sheet and the businesses that we were in if, with the SIFI, you were up at 9.5 percent,” former Chief Financial Officer Charles Noski said in March. He was replaced by Bruce Thompson last month.
The bank’s lower capital goal for 2013 may signal the company expects to earn less than it did just a few months earlier as the U.S. economy slows, said Goldberg, who has the equivalent of a “hold” recommendation. Chris Kotowski, an Oppenheimer & Co. analyst, didn’t rule out a share sale in his June 30 research note.
“Bank of America’s capital position relative to peers creates dilution risk,” wrote Kotowski, who has a “market perform” recommendation on the lender. “While we aren’t certain that an equity raise will actually happen, the risk is certainly there.” The lender may have to hoard cash until 2016 to reach the 9.5 percent capital goal, about three years behind rivals including JPMorgan Chase & Co. and Wells Fargo & Co., Kotowski said, even while those firms raise payouts and buy back shares.
Moynihan has said at least twice this year that the firm won’t need to issue common stock to meet the new capital threshold. Regulatory capital under existing international rules has steadily improved in the past two years, the company said last month.
The lender still faces more mortgage-related costs that may sap capital. The five largest servicers may pay more than $20 billion to settle probes by the U.S. Department of Justice and 50 state attorneys general over shoddy mortgage servicing practices, said two people briefed on the matter.
Bank of America may also have another $5 billion in costs tied to repurchase demands from institutional investors and could face other expenses related to securities and fraud allegations on soured Countrywide loans, the company said.
“Will the charges this quarter for all these mortgage settlements kind of be the end of it?,” said Anton Schutz, the president of Mendon Capital Advisors Corp., an asset manager that specializes in the stocks of financial-services companies and owns Bank of America shares. “If it is, they can build capital really quickly. There’s the constant fear that they need to raise capital, which I disagree with.”
Bank of America Has Record Loss on Bad Home Loans
by Hugh Son - Bloomberg
Bank of America Corp. posted the biggest quarterly loss in the lender’s history after Chief Executive Officer Brian T. Moynihan booked more costs tied to defective mortgages. The shares rose 1 percent in early trading as the outlook for credit losses improved.
The second-quarter loss of $8.83 billion, or 90 cents a share, compared with profit of $3.12 billion, or 27 cents, a year earlier, the Charlotte, North Carolina-based lender said today in a statement. Provisions for future credit losses dropped 60 percent, the bank said, and profit excluding one-time gains and losses was 33 cents a share, beating the 29-cent average estimate of 21 analysts surveyed by Bloomberg.
Moynihan, 51, is working to move Bank of America past the fallout from lax home lending by reaching settlements with bond investors and insurers and setting aside funds for future claims. The loss was smaller than the most pessimistic forecast given last month by the company, which estimated the deficit could range from $8.6 billion to $9.1 billion. “At least they’re making progress,” said Brian Charles, an analyst at R.W. Pressprich & Co. in New York. “Their losses do continue to come down away from mortgages.”
Bank of America told investors June 29 it would book more than $20 billion in second-quarter charges from faulty mortgages. The sum includes $8.5 billion to resolve claims from institutional investors that the Countrywide unit used false or missing information to create home loans that later defaulted. Regulators criticized Countrywide’s lax underwriting, which left the firm near bankruptcy before Bank of America bought it for $2.5 billion in July 2008.
The settlement followed a $3 billion accord in January to resolve similar claims from Fannie Mae and Freddie Mac, and an April agreement with bond insurer Assured Guaranty Ltd. valued at $1.6 billion. If home prices decline beyond internal company estimates, the bank may need to set aside more capital for soured mortgages, executives have said.
The costs make it harder for Moynihan to keep pledges that he’ll boost the company’s dividend ahead of new international standards. The firm has to achieve a 9.5 percent ratio of capital to risk-weighted assets between 2013 and 2019 under rules from the Basel Committee on Banking Supervision.
Using guidance given by Bank of America on June 29, the company may need to raise about $50 billion to conform to the rules, which were designed to build a buffer against losses and avert a repeat of the 2008 financial crisis. Firms can get to their goals by retaining earnings or reducing riskier assets that require a lender to hold more capital against losses.
The bank is weighing the sale of at least part of its $21 billion stake in China Construction Bank Corp., three people briefed on the plans said last month. The sale would simultaneously raise cash and reduce assets that are penalized under the capital rules.
Banks have been releasing reserves for loan losses set aside during the recession, helping some firms beat analysts’ estimates for second-quarter results. JPMorgan Chase & Co. said last week that profit for the three months ended in June rose 13 percent to $5.43 billion on a surge in investment banking and more on-time payments by credit-card customers. Citigroup Inc. said earnings increased 24 percent to $3.34 billion on higher investment-banking fees and reduced reserves.
Portugal's Prime Minister Pedro Passos Coelho discovers 'colossal' budget hole
by Ambrose Evans-Pritchard - Telegraph
Portugal's new leader Pedro Passos Coelho has told the nation to brace for further austerity measures after his government discovered a "colossal" €2bn (£1.7bn) hole in the public accounts left by the outgoing Socialists.
Yields on two-year Portuguese debt rose to a fresh record of 20.3pc on Monday, reflecting fears by investors that the country would struggle to pull itself out of downward spiral without some form of debt restructuring.
Mr Passos Coelho also appeared to caution the European authorities that his government will not tolerate heavy-handed interference in the country. "We want to take part in an ambitious European project and make our contribution so Europe can confront its problems in the most ambitious way, but as prime minister I will not stand by and let Europe govern Portugal," he told a party gathering.
There is growing rancor in Lisbon over the term of the €78bn rescue by the EU and the International Monetary Fund, and the sweeping powers of the inspectors as they impose a "structural adjustment" on the economy. The penal rate of interest charged by the EU is expected to top 5.5pc and risks trapping the country in debt-deflation. At the same time fiscal austerity, without offsetting monetary stimulus or devaluation, may tip the economy into an even deeper downturn.
EU officials are pushing hard for a 100 basis points reduction in rates on rescue loans, hoping to win backing from a reluctant Germany at an EU summit on Thursday. The revelation of a budget hole in Portugal has echoes of what occurred in Greece in late 2009, when an audit by the new Pasok government exposed a budget deficit twice the level previously declared to the European Commission.
Portugal's government will have to cover the gap with another round of spending cuts, mostly in the civil service and state-owned industries. The sacrosanct Christmas Bonus is already being slashed, effectively cutting salaries. Portugal is obliged to cut the budget deficit to 5.9pc of GDP this year under its rescue terms. This looks like a Sisyphean task since the deficit was still 8.7pc in the first quarter, and further austerity will have the side-effect of choking tax revenue.
The experience of Greece is that the country can find itself chasing its tail, with the deficit remaining stubbornly high in a shrinking economy. Portugal's central bank said the economy will contract a further 1.8pc next year. "There are limits to cutting: you can't just cut blindly," said Mr Passos Coelho.
Euro Stress Tests Tell Only Half the Story
by Simon Nixon - Wall Street Journal
Here is what the official stress tests results didn't tell you: 27 European banks would need to raise a combined €82 billion ($155 billion) in new capital to maintain core Tier 1 ratios above 7% if Greek, Irish, Portuguese, Spanish and Italian government bonds were written down in line with market prices, according to Credit Suisse. That is well above the €2.5 billion shortfall, spread across eight banks, announced Friday.
Even so, some policy makers might take comfort from this figure since it represents an apparently manageable 8% increase in the sector's €1 trillion of equity capital. That would be a big mistake. The €82 billion doesn't tell the full story.
First, policy makers should note that the biggest shortfalls lie in banks least able to access new capital. Greek banks, for example, would need an extra €27 billion of capital. If Greece is to stay in the bloc of euro-using nations, that money can only come from further bailout loans. Irish and Portuguese banks would face €16.4 billion and €6 billion shortfalls, respectively, Credit Suisse estimates.
Second, focusing on sovereign debt ignores wider exposure to fiscally stressed countries via commercial lending. The stress tests showed the full extent of cross-border lending. German and French banks rank among the most exposed. Crédit Agricole, BNP Paribas, Deutsche Bank and Commerzbank have exposure to Portugal, Ireland, Greece, Italy and Spain of more than 200% of core equity, according to Barclays Capital.
Third, the stress tests had nothing to say about liquidity, the most important source of contagion. No one knows what the second-order impact of sovereign debt write-downs will be on bank funding costs. Weaker bank balance sheets mean higher credit costs, and higher sovereign risk reduces the value of collateral for wholesale and central bank funding. Sovereign downgrades also can lead to bank downgrades, further pushing up funding costs. Finally, sovereign downgrades weaken implicit government support for lenders.
These strains have fueled the current crisis. Greek banks suffered a €18 billion deposit outflow in the first five months of 2011. Irish and Portuguese banks are heavily reliant on European Central Bank funding. Spanish and Italian banks are effectively shut out of wholesale funding markets. As a result, large parts of Europe face a credit crunch, further undermining economic growth and weakening fiscal positions.
Euro-zone policy makers have been slow to appreciate the importance of bank funding in fueling the sovereign-debt crisis. As they weigh their options ahead of a planned crisis summit on Thursday, they shouldn't imagine that simply filling the capital shortfalls revealed by the stress tests will end the crisis. So long as Europe's sovereign-debt crisis remains unresolved, the cost of resolving Europe's banking crisis will continue to rise.
Italian and Spanish bond yields jump
by Richard Milne - Financial Times
Italian and Spanish borrowing costs hit fresh euro-era records and bank shares dropped on Monday as markets increased the pressure on European leaders ahead of a crucial summit on the eurozone debt crisis.
Italy’s benchmark 10-year bond yields rose above 6 per cent and were up 27 basis points at 6.03 per cent in midday trading. Spanish yields hit 6.35 per cent, their highest level since 1997, ahead of debt auctions on Tuesday and Thursday. Investors said all eyes were on the European summit called for Thursday to discuss a Greek bail-out and how bondholders could share in losses.
As a result of the intense nervousness over the eurozone crisis and also worries about a possible downgrade in the US, investors fled into haven assets. Gold hit a fresh peak of $1,601.80 an ounce while the Swiss franc is at record highs against the dollar and euro. German and US debt is being sought out as well, with Bund yields reaching their lowest since November and Treasuries coming within a whisker of their lows for the year.
The sell-off in risky assets is knocking bank shares with UniCredit and Intesa Sanpaolo both down 3.5 per cent in Milan, despite both banks performing relatively well in Friday’s stress tests. The FTSE 100 in London is down 1.2 per cent and the Dax 30 in Germany is off 1.3 per cent.
But the focus remains on the third- and fourth-largest economies in the eurozone. The premium that Italy and Spain pay to borrow over Germany shot up by 33bp, to 338bp and 370bp respectively. Both are euro-era highs and well above levels domestic bankers have called healthy.
Analysts are particularly worried about any rise in benchmark borrowing costs to close to 7 per cent as the three eurozone countries that have so far been bailed out – Greece, Ireland and Portugal – all issued their most recent 10-year bonds at yields of between 6 and 7 per cent.
“Psychologically speaking, the attack on Italy takes this crisis to a whole new level. Not only does it shatter the illusion of a firewall, it significantly increases pressure on Spain. In the space of a week or so, market pressure on 6 per cent of eurozone GDP has morphed into mounting concerns about the creditworthiness of more than a third of the bloc’s output,” said Nicholas Spiro, head of Spiro Sovereign Strategy.
Portugal Loses Patience With Europe
by Ambrose Evans-Pritchard - Telegraph
At last, some raw emotional Gaulliste patriotism from the victims of Europe’s Maquina Infernal?
Portugal’s new premier Pedro Passos Coelho — a free marketeer — began to growl over the weekend. “We want to take part in an ambitious European project and make our contribution so Europe can confront its problems in the most ambitious way, but as prime minister I will not stand by and wait for Europe to govern Portugal,” he told the party faithful.
For Portuguese readers: “Nós queremos participar num projecto europeu ambicioso e queremos dar o nosso contributo para que a Europa saiba encontrar respostas mais ambiciosas para os problemas, mas como primeiro-ministro nunca ficarei à espera do que a Europa tenha que fazer para governar Portugal” Please correct me if my loose translation is wrong.
So, it has begun: last week Greece’s premier George Papandreou launched two angry broadsides against EU magnates. How could he do otherwise after Eurogroup chair Jean-Claude Juncker told a German newspaper that Greece’s sovereignty would be “massively limited”?
“Massively limited?” Mr Juncker should be clamped in irons if he dares set foot on Greek soil. Now the leader of what is arguably Europe’s oldest nation state (foundation 868, under Vimara Peres) has shown the first hints of frustration.
Just to remind you: unemployment in Portugal is 12.4pc (youth: 28.1) and about to rise much further as the fiscal punch hits. The figures for Spain are 20.9pc (44.4), Greece 15pc (38.5), Ireland 14pc (26.5), Latvia 16.2pc (32.9). Yet the these countries are all facing further headwinds of fiscal and monetary tightening.
For a serving prime minister to make such remarks at this delicate juncture might be taken by some as a cloaked threat to walk away from the EU project, if the country continues to be treated in a humiliating and damaging fashion.
Mr Passos Coelho is fencing with a double-edged blade. Even to hint at misgivings over EMU is to set matters in motion. The markets were very quick to pick up on political body language during the ERM crisis in 1992. The Portuguese leader also said there was a “colossal” €2bn hole in the public accounts left by… well, somebody. He refrained from blaming the outgoing Socialists. They are needed to help pass laws in the Assembleia. Any other skeletons to be uncovered?
I have great sympathy for Mr Passos Coelho and for the Portuguese people. The German-led creditor states have treated the EMU crisis as if it were a morality tale, castigating Club Med and Ireland for alleged fecklessness. All that is required — goes the argument — is further austerity, a dose of 1930s wage and debt-deflation, and virtue will be its own reward. The Left-wing Bloco calls it “social terrorism”.
Adding injury to insult, Germany has insisted that Portugal, Greece, and Ireland pay a penal rate of interest some 200 to 300 basis point over the cost of funding paid by the EU’s bail-out machinery, though this may soon be cut somewhat. As former US Treasury Secretary Larry Summers said this morning in the pink sheet, such penal rates play havoc with debt dynamics and are driving a string of countries into insolvency and depression.
This Germanic view of events is self-serving and intellectually dishonest. Southern Europe is in trouble because Europe’s monetary union is and always was dysfunctional. The Maastricht process caused interest rates to plunge in the Club Med bloc, setting off credit booms. Portugal’s rates fell from 16pc to 3pc in short order.
The ECB poured further petrol on the fire by tilting monetary policy to German needs in the middle of the last decade, when Germany was in trouble. The ECB breached is own eurozone M3 and inflation targets for year after year.
In the specific case of Portugal, the boom occurred earlier, in the late 1990s. No doubt a great many foolish errors were made in those halycon days. (I wrote about them at the time or shortly after, and was roundly reproached for my insolence). Yet over the last eight years Portugal has been relatively frugal. It did not have an Irish banking bubble, or a Spanish property bubble. It did let social transfer costs creep up to 22pc of GDP — when they should have been falling — but it also passed a string of fiscal austerity packages.
Yet at the end of the day it was punished anyway. It has failed to reap any worthwhile benefits. There has been no economic convergence or EMU catch-up effect. Productivity has remained stuck at 64pc of the core-EU average. Portugal switched from surplus on its external accounts in the early 1990s to a deficit of 109pc of GDP today.
Public and private debt has ballooned to 330pc of GDP, one of the highest in the world. Portugal will still have a current account deficit of almost 8pc this year and the budget deficit was still running at a 8.7pc rate in the first quarter. Such a profile two or three years into draconian cuts and demand compression is almost tragic.
And now they must implement yet further austerity, without debt relief or offsetting monetary stimulus or devaluation. This policy is a near certain formula for economic asphyxiation..
In Portugal — as well as Greece, Ireland, and perhaps Spain in due course — we are moving closer to the point where national leaders must decide whether to satisfy EU demands, or placate their own citizens, for it is no longer to serve these two masters at the same time?. Can there really be any doubt as to the outcome of this tug-of-war?
Southern Exposure for Europe's Banks
by David Enrich - Wall Street Journal
Europe's banks are sitting on vast quantities of loans to individuals and businesses in cash-strapped Southern European countries, highlighting how plain-vanilla loans, not just government debt, pose potential risks to the Continent's troubled banking system. The holdings are detailed in disclosures Europe's largest banks made as part of the European Union "stress tests," whose results were announced Friday.
On their face, the European Union tests portrayed a surprisingly healthy banking system. Only eight of 90 lenders flunked the exams, seeing their capital cushions dip below 5% of their risk-adjusted assets under a simulated two-year economic downturn. The small number of failures prompted many analysts to deride the tests as not being tough enough. But officials with the European Banking Authority, the regulator that conducted the tests, argue that the real value of the exercise is the mountains of data—about 3,200 pieces—each bank was required to reveal about its balance sheet. That includes detailed, country-by-country breakdowns of the types of loans and securities on their books.
During Europe's 15-month financial crisis, investor and analyst fears have centered largely on banks' holdings of sovereign debt issued by governments in financially shaky countries such as Greece, Ireland and Portugal. If those countries were to default, it could saddle banks and other holders of their bonds with big losses. But Friday's test results shed light on another potential problem for Europe's banks: huge piles of residential mortgages, small-business loans, corporate debt and commercial real-estate loans to institutions and individuals from ailing countries. As those economies struggle, the odds of rising defaults grow.
Banks tend to be holding far greater quantities of those commercial and retail loans than they are of sovereign debt, according to a Wall Street Journal analysis of disclosures accompanying the stress tests. This year's stress tests represent the first time there has been a uniform way to measure this exposure. Until now, banks have disclosed their portfolios of loans to customers in troubled countries on a piecemeal basis. That made it virtually impossible to aggregate data across the industry or to compare different institutions.
"The country-by-country exposure [data] is better than any data we've seen before," said Alastair Ryan, a London-based banking analyst with UBS AG. "It's giving me more things to be fearful of," Mr. Ryan added, referring to the disclosures of some banks' large holdings of loans to customers in troubled countries.
After Spanish and Italian banks, France's banks appear to be the most exposed. As of Dec. 31, its four largest banks—BNP Paribas SA, Crédit Agricole SA, BPCE Group and Société Générale SA—were holding a total of nearly €300 billion, or about $425 billion, in loans and other debt issued to institutions and individuals in Portugal, Ireland, Italy, Greece and Spain, the countries that are among Europe's most troubled. That is largely a result of some of the French banks having big retail- and commercial-banking operations in Greece, Italy and Spain.
The French banks' portfolios of commercial and retail loans in those countries dwarf their holdings of sovereign debt. For example, the four banks have a total of about €51 billion of loans to Spanish customers, according to the Journal's analysis.
That compares with about €15 billion of Spanish sovereign debt, according to a separate analysis of stress-test data for the Journal by research firm SNL Financial. In Greece, whose economy is in a tailspin, the French banks have €33 billion of various types of loans, more than three times their sovereign-debt holdings.
It is a similar story in Germany. The dozen German banks that disclosed their stress-test results were exposed to €174 billion of commercial and retail loans to Greek, Irish, Italian, Portuguese and Spanish borrowers as of Dec. 31. They are holding an additional €70 billion of sovereign debt issued by those countries, according to SNL.
More than half of the German banks' loan exposures are concentrated in the country's two biggest lenders, Deutsche Bank AG and Commerzbank AG. Deutsche Bank alone is holding nearly €80 billion of loans in those countries, including €7.5 billion of residential mortgages in Spain. Deutsche, which passed the stress tests with a 6.5% capital ratio under the EBA's worst-case scenario, said Friday that it "feels well prepared" to hit its capital targets.
While the tests did consider the impact of an economic downturn on banks' portfolios of loans and nonsovereign debt in Portugal, Ireland, Italy, Greece and Spain, many critics complained that the tests were overly benign. For example, the EBA's worst-case scenario for Portugal envisioned an 11.6% unemployment rate this year, rising to 12.9% in 2011. The unemployment rate there is currently 12.4%.
The stress-test figures actually understate some banks' holdings of loans in certain troubled countries. That is because the European Banking Authority required banks to disclose their loan holdings in countries only if they represent more than 5% of the bank's total loan exposures.
As a result, some banks opted not to disclose details of their loan portfolios. For example, Lloyds Banking Group PLC is in the process of shutting down its Irish banking business, which has cost the big British bank billions of pounds in loan losses. But in its stress-test materials on Friday, Lloyds didn't provide a breakdown of loans to countries other than the U.K. and the U.S. A Lloyds spokeswoman said the bank's Irish loans are included in a catch-all category marked "other."
Italy and Spain in firing line as euro's fate hangs in the balance
by Heather Stewart - Observer
Eurozone leaders are braced for another battering from financial markets this week, amid growing fears that the spiralling sovereign debt crisis is threatening the future of the single currency. "It's likely to be a very confused and volatile week, with mixed messages from markets and policymakers," said Sony Kapoor, director of the Brussels-based thinktank Re-Define.
After Italy was forced to bring forward austerity plans last week to placate anxious bond investors, European council president Herman Van Rompuy called leaders to an emergency summit this Thursday. The results of "stress tests" by the new European Banking Authority revealed on Friday that eight banks were vulnerable, and must raise €2.5bn (£2.2bn) to cushion themselves against potential losses.
The EBA did not calculate the impact of a default by Greece or other vulnerable eurozone countries, but it released detailed data about banks' holdings that will allow analysts to make their own assessment. "Everybody's sitting up crunching numbers," said one market insider. Matt Spick, banking analyst at Deutsche Bank, said: "We expect the sector to still be at the mercy of macro issues."
Unless Thursday's summit results in concrete announcements about how to contain the crisis, analysts are warning that anxious investors will continue to target Italy and Spain. Neil Mellor, of BNY Mellon, said: "Everyone expects some sort of default to come about but in the meantime contagion is rife."
Italy saw 10-year-bond yields shoot up to their highest level since the foundation of the single currency last week, before finance minister Giulio Tremonti forced through new spending cuts and tax rises. Politicians have been struggling to reach a deal on a new bailout for Greece. Germany's Angela Merkel has insisted that private sector investors must pay part of the price by taking a loss on Greek bonds.
But there is no consensus on how this "private sector involvement" would work –European Central Bank president Jean-Claude Trichet claims there are 36 proposals under discussion. With the financial panic now hitting Italy, and funding costs for banks rising, leaders are under mounting pressure to come up with a long-term rescue plan for the entire eurozone. That could mean beefing up the European financial stability facility - the bailout fund created last year. The EFSF has the power to issue bonds and lend the money to crisis-hit economies; but it is much too small to rescue Spain or Italy, and it cannot buy embattled countries' bonds directly, in the event of a crisis.
Jürgen Michels, of Citigroup, warned that any change in the rules for the EFSF would have to be passed by national eurozone parliaments, which could take too long to tackle an emergency over the summer. "Only in situations of emergency are the individual member countries able to overcome the divergent national interests," he said in a research note.
"As a result, we have seen only ad-hoc emergency measures so far, mainly designed to deal with problems in individual member countries. Hence, with the warnings that the euro as a whole is at risk now, a more far-reaching ad-hoc emergency measure looks likely to us, but we still do not expect a comprehensive programme any time soon." Kapoor said: "On the single biggest source of risk, which is sovereign debt, the policy remains as fraught and unresolved as ever."
A modest proposal for eurozone break-up
by Ambrose Evans-Pritchard - Telegraph
The eurozone can in theory still be saved, if two sets of conditions are fulfilled; if the leaders of Germany, Austria, Finland, and the Netherlands accept fiscal union and a common pooling of debt, and can persuade their parliaments and courts to ratify such a revolution.
If the Germanic bloc agrees to tear up the mandate of the European Central Bank, letting it switch from inflation-targeting to job-targeting ("Unemployment must not exceed 10pc in two or more EMU states, or some such formula), effectively instructing the ECB to embark on Fed-style stimulus for three to five years. This might allow Spain to work off a total debt load now topping 300pc of GDP without having to deflate wages and tip further into a Fisherite debt-deflation spiral. It might allow Italy at 250pc of GDP to claw back lost competitiveness without self-defeating perma-slump.
Yet such ECB stimulus would have a nasty side-effect: inflation threatening 5pc or 6pc in Germany. Berlin would find itself in much the same trouble as Madrid and Dublin six years ago: expected to twist itself in knots by undertaking massive fiscal tightening and financial repression to offset a massively inappropriate monetary policy.
I strongly doubt that the Bundestag, Tweede Kamer, or Finland's Eduskunta will accept such conditions. Why should they? The citizens of the German bloc never voted for an EU treasury, tax union, or debt pool, or for the emasculation of parliamentary prerogatives that this implies, if they were allowed to vote at all. Indeed, they were told this would never happen. Germany's Social Christian leader Edmund Stoiber japed after Maastricht that a future German rescue of any EMU state was as likely as "famine in Bavaria".
Given that these sovereign diets will not efface themselves lightly, the wise course is to prepare for an orderly break-up of monetary union. Only one option can be orderly. Germany and its satellite economies must withdraw from EMU, leaving the Greco-Latin bloc with the residual euro and the institutions of monetary union. Let us call the legacy group the "Latin Union" in memory of its 19th Century forebear.
The Latin euro would fall sharply against the yuan, yen, won, zloty, etc, as well as the new Teutonic Mark, allowing the Latin Union (with Ireland) to regain economic viability and largely honour existing euro debt contracts. The IMF should stand ready with flexible credit lines to tide Latins through the first weeks of this rupture. Once the dust had settled, it would become clear that Italy, Spain, Ireland, and perhaps Portugal had regained enough competitiveness to hope to grow their way out of debt traps. Fear of domino defaults would recede.
The alternative is to impose austerity and debt deflation without offsetting relief – à la grecque – on a string a countries until their polities shatter, and capital flight sets off disorderly EMU exit by the weaker states, with a concomitant chain of defaults reaching Italy, the world's third biggest debtor. As the bond jitters of the last two weeks have shown, we are already uncomfortably close to this.
France is of course a stumbling bloc. The country is not a hopeless case within EMU, though deteriorating trade and debt figures are slowly eating away at French viability as well. The Élysée would view any separation from Germany as a catastrophe. Yet this is surely outdated thinking in the 21st Century. Germany no longer needs to be tied down by silken chords of EU statecraft. It is a pacific democracy in an aging continent on the margins of the Sino-American global order.
France might instead find a new role as leader of a Latin Union with 220m people and over 60pc of the eurozone's GDP, with economic sway over North Africa. The ECB headquarters could transfer to Marseilles, that great millenial hub of civilization, to be renamed the Mediterranean Central Bank. The currency bloc would quickly become a force in Europe.
Ireland has no place in this venture. It should bide its time and then break away when the Latin euro is weakest -- and therefore Ireland's euro debts most devalued -- to launch its own Punt Éireannach. This currency would arguably rise, not fall. Ireland should henceforth run monetary policy in its own interest as Israel, New Zealand, Chile, and Sweden all do successfully.
How low would the Latin euro fall? HSBC has crunched variants of this scenario. It calculates that the "peripheral euro" (EUP) would crash to $0.65 against the dollar, while the "core euro" (EUC) would replicate the recent moves of the Swiss Franc and surge to $1.83.
I think this overstates the case, but the fact that HSBC's currency team reckons that the South would see a two thirds devaluation against the North if market forces were not supressed is a harsh indictment of EMU's existing structure. How has such misalignment come to be? HSBC places France in the core. If France opted for the Latin Union it would be a very different story. The rate might stabilize at a 30pc discount after the initial overshoot.
The Teutonic Union might naturally comprise Germany, Netherlands, Finland, Austria, Slovakia, (and Flanders?). It would be a formidable bloc, but the smaller part.
Temporary capital controls might be needed to smooth the break-up. Teutonic area banks would suffer big and instant paper losses on holdings of devalued euro-Latin debt. Governments would have to recapitalize and perhaps nationalize some of these lenders to preserve the financial system, but that would be cheaper than the €2 trillion to €3.5 trillion sums now being floated by analysts as the likely cost of staunching the eurozone crisis, and easier to justify to their parliaments. The North would in any case enjoy a windfall gain on the implicit reduction of national debts denominated in euros.
If EU leaders instead allow events to run their current course they risk a euro-Lehman and a repeat of the meltdown that occurred from May to October 1931 when central Europe's banking system was allowed to disintegrate (due to lack of leadership and a rigid adherence to a fixed-exchange Gold Standard that had long since gone haywire). The crisis ricocheted back into London and New York, set off the second phase of the US banking crash, and turned recession into global depression.
It is worth reading The International propagation of the financial crisis of 2008 and a comparison with 1931 by William Allen and Richhild Moessner, a hair-raising account just released by the Bank for International Settlements, if you wish to understand what happened to the nexus of global banks and interlocking counter-parties during the Lehman crisis. Only Washington (Fed, Treasury, White House) prevented collapse.
A euro-Lehman would be worse because there is no Washington in Europe and creditors have in the meantime lost a degree of confidence in sovereign states themselves. It would instantly embroil London and New York through multiple channels. A study by Fathom Consulting found that German, French, Dutch, and Belgian banks have insured much of their Club Med debt with Anglo-Saxon peers through credit default swaps (CDS) . Gross CDS contracts are $292bn on Italy, and $168bn on Spain.
If a euro break-up was properly planned and handled, with all back-stop measures in place, it might prove less traumatic than assumed. As Czech premier Vaclav Klaus once said, it is surprisingly easy to end a currency union: the Czechs and Slovaks did it calmly in a morning.
There is no necessary reason why the EU could not weather such a crisis, continuing such useful functions as competition enforcement and global trade talks. A more modern EU shorn of its great power pretentions and 20th Century imperial nostalgia would be a healthier organization. The Schengen system of open borders could continue. Life would go on. Citizens would soon wonder what the fuss was about.
Will any EU leader grasp the nettle? Unfortunately, most of Europe's governing elite is ideologically compromised by the Project and will attempt to defend an unreformed EMU with scorched earth policies. We can only hope that the less compromised judges of Germany's Verfassungsgericht bring matters to a swift head in September.
Eurozone's citizens split amid battle to stop debt crisis spreading
by Heather Stewart - Observer
Rome became the latest European capital to feel the wrath of the mighty bond markets last week, when a political wobble over austerity measures was punished by a threatened downgrade from the ratings agencies. For ordinary Italians, the result was tax rises, higher health costs and lower pensions.
As the eurozone's leaders prepare for yet another crisis meeting next Thursday, their room for manoeuvre is limited – not just by how much more austerity the ratings agencies will demand from debt-burdened member states, but how much their own voters will bear.
It's not just the economics of the eurozone that risk tearing it apart but the increasingly fraught politics. Not only does the Brussels elite need to agree among itself, it has to sell any solution to the eurozone public. In other words, politicians must convince German, Dutch and Austrian taxpayers that it is worth signing up to some kind of Europe-wide rescue fund – or even a common euro bond – to keep the single currency alive, while persuading the Spanish, Portuguese, Greeks and now the Italians to keep taking the pain.
In the short term, leaders must come up with a convincing solution for Greece. It desperately needs a fresh bailout, and some form of "selective default" on its debts may be unavoidable; but there is still no agreement about who will bear the costs and the European Central Bank still insists that it is unthinkable. A series of plans, including French proposals to exchange expiring bonds for new loans, and a separate German debt-swap proposal, have so far come to nothing.
Friday's stress tests of European banks revealed a bumper bundle of new information about the health of the sector; but they didn't calculate the likely impact of a Greek default. As Andrea Enria, the leader of the European Banking Authority, carefully put it at Friday's press conference, "a further deterioration in the sovereign crisis might raise significant challenges".
At the same time, eurozone policymakers must think about how to tackle the longer-term problem of the unsustainable debt load spread through much of the single currency area. If they concede that a Greek default is acceptable – and force banks to pay part of the price – the spotlight will rapidly turn to the bailed-out economies of Portugal and Ireland, closely followed by Spain and Italy.
That would probably require a Europe-wide plan, including recapitalisation of banks across the single currency area, and acceptance that many of the investments made in the good years have since turned sour. "What they should really be doing is to say 'the public sector needs to take a haircut, the ECB needs to take a haircut'. Only then will we have a chance of resolving this," says Graham Turner, of consultant GFC Economics.
The logic of the current approach seems to be to delay any default until as much of the debt as possible is held by states instead of the banking sector. The European stability mechanism (ESM), which comes into play in 2013, does envisage the possibility of default on future sovereign borrowing, potentially providing a get-out clause.
Yet the details of the ESM remain sketchy and there is a cost to delay: as our foreign correspondents discovered when they asked some of the eurozone's voters last week what they thought of the patchwork of bailouts, cutbacks and frantic summitry. Voters are bitterly divided about what should happen next, who should pay, and who is to blame.
The passage of time – and of one cuts package after another – could increase the chances that voters in either the austerity-hit periphery or the indignant core could decide that enough is enough, and force their political leaders to walk away from the euro.
The view from Europe:
Italian politicians peppered their speeches this week with the words "Greece", "contagion" and "speculators", but as the eurozone crisis threatened to engulf Italy the public preferred to point at politicians and utter words such as "crooks", "idiots" and "fat cats".
Rather than blaming Italy's flirtation with financial meltdown on neighbouring Greece and the dithering in Brussels, an Observer straw poll showed most Italians were happy to blame their leaders for Italy's painful austerity budget packed with pension cuts, higher medical charges and tax rebate reductions, which is designed to keep the markets at bay and will cost the average family €500 (£440) a year. "Greece is just an excuse," said taxi driver Sergio De Carni. "These cuts have been forced upon us by the usual caste of politicians seeking to keep their own privileges."
Given that its banks are in good shape and its budget deficit is down, Italy had a right to feel hard done by, as stocks crashed and its bond yields ballooned last week, but it remains hostage to the €1.9tn public debt built up by successive governments, the "monster" from the past ready to "devour our future and that of our children", as treasury minister Giulio Tremonti described it.
And the present crop of politicians has not made things better. When a measure was slipped into the budget to liberalise the cosy world of Italian lawyers – part of a drive to unshackle Italy's underperforming economy – MPs threatened to sink the budget.
Markets looking to Tremonti to wield the axe were alarmed to see Silvio Berlusconi sniping at his finance minister's new budget as he sulked on the sidelines following years of doing little to reform the economy and loudly claiming Italy was crisis-proof. To the eight million Italians, or 14% of the population, living in poverty, the crisis is close at hand.
"Restaurants and shops are full of Italians making payments in instalments and eating into the savings their parents built up decades ago," says Gianni, a government employee who takes home €1,100 a month. "The lawyers elected to parliament are taking care of themselves but if this budget means I have to stop spending money, how will the economy pick up?" he says.
As the shutters come down on thousands of small family-owned high street stores up and down Italy, they are being replaced by slot-machine parlours, with hard-working Bergamo now boasting 7,000 slot machines, up 40% on last year. The new gambling licences are a cash machine for the government, but gambling addiction is soaring as Italians seek to turn their last few euros into a fortune. In the region of Lazio around Rome, 70,000 Italians are believed to be in hock to loan sharks.
"Parliament is full of rascals and the future is grim," said Emiliano, a tarot card reader on Rome's Via del Corso. "People are scared, which means business is up for me, but the questions I get asked are different. They used to be about love, but now all they want to talk about is work and money."
Compared to most of the rest of Europe, Germany is booming. Its export-driven economy is set to grow by 3.2% this year, according to the IMF, and the high unemployment level is almost down to post-reunification levels. Yet the mood is far from celebratory. The latest polls show that the ruling coalition's support is eroding. And there is widespread unease at the fact that the country, the biggest and richest in Europe, is now being asked to contribute the lion's share of the funds to bail out Germany's profligate neighbours. Germans want to know why they have to rescue spendthrift nations when they have been so prudent themselves.
Mathias Böhmers, a 56-year-old self-employed electrician from Berlin, doesn't see why Germany should be forking out to help Greece and Portugal. "I take responsibility for myself without needing to have the state help me," he says. "I could go for us helping really needy people in a country. I don't think we should help an entire country – rescuing an entire country is a bit too much."
Student Nico Lang says he doesn't mind that Germany is helping out other EU countries. "But they do need to get their house in order. I feel sorry for what they are going through, but they brought it on themselves."
Jacqueline Ruge, 44, a bookkeeper from Berlin, says she understands the need to help out Germany's neighbours, but this generosity should not be abused. "When I think of my own family, I have to be responsible for our finances. If I can't afford something, then I can't afford it."
Jonas Bröcke, a 20-year-old heating fitter, thinks Germany can afford the bailouts but has a problem with countries that have not dealt properly with their economies. "What you hear is that there's all these people doing work under the counter and things like that. Well, I have to work myself and I pay taxes, rightly so."
Rudi Böhm, a pensioner from east Berlin, reckons the southern European countries were offered favourable conditions to join the EU. "They got cheap credit and lived off this. The governments there have botched it but it's the ordinary people who have to pay for it."
While tens of thousands have protested against the austerity measures imposed by the ECB and the IMF, there has been little or no violence on Irish streets compared to Greece. Dublin-based novelist Ed O'Loughlin says that perhaps one reason why the Irish are proving so docile is that for the first time in centuries the British can by no stretch of the imagination be blamed for their problems.
The author of the political satire Toploader adds: "The lack of clearly stratified classes – as they have in England – breeds insecurity, a fear of losing caste, of being pushed outward. To protest at the rules of this game would be an admission that you no longer have a hand to play in it; that you are a loser and a sucker."
At times of mass emigration, just staying in the country was felt to be a victory in itself, although often a pretty hollow one. "The fact that everyone's class system is centred exactly on themselves tends to make people, naturally, very self-centred. The Irish term for this is 'mé féin-ism', or 'myself-ism', a play on Sinn Féin, or 'we ourselves'. Mé féiners do not stand together for the common good. They are not good citizens."
Dublin barber-shop owner Arthur McGuinness said he could see no end in sight for the recession, despite the billions pumped into the Irish economy from the ECB and IMF. McGuinness added that the republic was better off when it had its own currency, the punt. "At least when the punt was around we could control our own interests.
When our boom started we were still using the punt. I don't think being in the eurozone has worked for Ireland. I and other small business people wish we could go back to the punt. The British were right to stay out of euroland."
John Kearns, who went abroad in previous recessions and now works in Dublin's Irish Writers Centre, says it is too early to rule out social unrest. "It's quite possible there will be Greek-style riots. The cuts are affecting people now. People are having their utilities cut off. I know of families, a mother of two, who had their electricity cut off. People can't take that lying down. "And there is still a mortgage crisis coming down the track with increasing interest rates that are coming later this year.
"I can certainly see social unrest ahead, although I don't see what can be achieved by it. It's strange that the main demonstrators so far have been pensioners and students rather than industrial workers. The workers so far have been far quieter," Kearns said.
Why The Drop In Foreclosures Is Not Good News
by Jennifer DePaul - Fiscal Times
It sounds like good news: Foreclosure filings declined by 29 percent in the first half of 2011, according to a midyear report by RealtyTrac. But U.S. homeowners just can’t catch a break. The decline isn’t due to a recovering real-estate market, but rather to the fact that shoddy foreclosure practices last fall have led to long processing delays.
As many as 1 million forecloses that should have taken place in 2011 will be pushed back to 2012, or perhaps even later, according to the experts at RealtyTrac. “This casts an ominous shadow over the housing market, where recovery is unlikely to happen until … the inventory of distressed properties can be whittled down to a manageable number,” said James Saccacio, chief executive officer of RealtyTrac. Some 1.17 million homes or one in 111 had at least one foreclosure filing in the first half of this year.
Foreclosure filings during the second quarter decreased 32 percent from the second quarter of 2010. In June, fillings dropped 29 percent from 2010, marking the ninth straight month where foreclosure activity decreased on a year-over-year basis.
In January, RealtyTrac had forecast up to 3.2 million foreclosure filings for 2011. Now, due to the processing delays, total filings for the year will be around 2 million, compared with 2.9 million in 2010, according to Rick Sharga, senior vice president at RealtyTrac.
In the months ahead, experts say foreclosures may tick up slightly as loan servicers work through the big backlog of filings. Sales of foreclosed and bank-owned properties are largely responsible for the downward pressure on home prices, which experts say will keep falling through 2011. Prices won’t bottom out until the first quarter of 2012, says Celia Chen, an economist with Moody’s Analytics. She estimates the market still needs to work through 1.9 million distressed properties.
“We are still searching for the bottom in housing,” says Anika Kahn, an economist at Wells Fargo. “We’re in the middle of home buying season and for it to be limping along is definitely not the most encouraging progress.”
Some experts say they don’t expect a real turnaround in housing until there is a significant increase in job creation and income. June’s jobs report showed a paltry gain of 18,000 jobs, while the unemployment rate inched up to 9.2 percent.
The decline in foreclosures comes as the Obama administration is ramping up efforts to resuscitate the battered housing market. In a Twitter town hall event last week, president Obama said housing remained the “most stubborn” problem facing the country. There hasn’t been a clear list of policy ideas, but the administration has floated a proposal to require taxpayer-owned mortgage giants Fannie Mae and Freddie Mac to relax their rules for loans to investors, among other measures.
Unsold properties on estate agents' books hit record high
House asking prices have fallen for the first time this year as the number of unsold properties on estate agents' books reaches record levels, a report revealed today.
The average asking price for a home dropped 1.6pc, or £3,797, to £236,597 in July, bringing to an end a run of six months of rises, according to property website Rightmove. Greater competition to attract buyers amid "muted demand" has prompted the largest July fall since 2008 when asking prices fell 1.8pc.
Seven in 10 properties put on the market so far this year have yet to find a buyer. This has helped push the average number of homes registered with estate agents up to 78 - the highest ever for the time of year.= So many sellers are struggling to sell their homes partly because mortgage approvals are running at about half the rate they were before the financial crisis, while some buyers are staying away, fearing that prices have further to drop.
Miles Shipside, director of Rightmove, said: "Summer sellers are more nervous about their selling prospects than the early birds who asked ever higher prices during the first six months of this year." But he warned that many home owners may not have sufficient equity in their homes to drop their prices any further and may be "trapped" in their current properties.
Asking prices are still 0.1pc higher than a year ago but are now 14% lower than they would be if they had risen over the past four years at the same rate as inflation as measured by the retail prices index (RPI). Mr Shipside added: "While property has a good long-term record as a hedge against inflation, in the short term property prices have become significantly cheaper in real terms as the cost of living has gone up, while the cost of housing has stood still or gone backwards."
Brazil’s boom teeters on personal credit bubble
by Bradley Brooks - AP
[Brazil's] Central Bank expects that by the end of the year, 28 percent of Brazilians' disposable income will go toward servicing debts, compared to 16 percent in the still-recovering U.S. and single-digit figures in other developing nations. The bank also reports that 28 million Brazilians out of a population of 190 million are carrying more than $3,000 in debt, up 250 percent from six years ago. Some economists fear that these consumers have taken on too much debt and are being buried by Brazil's sky-high lending rates. They worry that if debt erodes their buying power, Brazil might face a recession.
Silas Xavier pulls credit card bills from a pocket on the door of the taxi he drives, more from the glove box and still more from a pouch behind his seat, waving them as his voice rises in frustration and desperation. Like many of the 40 million Brazilians who have joined the middle class since 2003, he got a taste for American-style consumption and dived headlong into the enticing world of easy credit, once available only to the wealthy. He defaulted three times in four years. Now he’s in over his head again, struggling to provide for his wife and 4-year-old daughter.
Xavier is one more debtor adding to fears that the economic boom in Brazil may be partly built on a bubble in personal credit, even with interest rates on credit cards often topping 200 percent. Economists worry that if it pops, it could severely damage an economy that has come through the global downturn better than almost every other nation. “The amount I owe keeps growing. I pay, but I can’t stop this snowballing of the debt. The interest each month is too high,” said Xavier, pointing to the latest credit card bill, showing he still owes $2,200. “I’ve tried to learn from hard experience how to better manage my debt, but I’m too far behind.”
Brazilian leaders have praised newly empowered consumers such as Xavier as drivers of the nation’s economic rise. Their spending helped the country emerge from the global economic crisis at a time when people in other countries pulled back. Now some economists fear those same consumers are being buried by sky-high lending rates. They worry that if debt erodes middle-class buying power, Brazil could face a recession.
The interest rate on credit cards in Brazil’s financial hub of Sao Paulo averages 238 percent, according to a study conducted earlier this year by Fecomercio, a federation of commerce. That means carrying a balance of $1,000 for a year results in a $3,380 tab. That cost is expected to rise, with the Central Bank of Brazil likely to raise interest rates to battle inflation.
Before, people such as Xavier, who is 24 and makes about $2,000 a month driving his cab, couldn’t get credit. Brazil was beset by hyperinflation in the 1990s and economic turbulence in the early 2000s. When the nation brought its economy under control, banks started expanding credit offers. The number of bank credit cards in circulation has tripled to 150 million in the past eight years. Economists say many people here are getting credit cards without knowing how to manage the debt. But for those who want to buy things and don’t have cash on hand, there is no alternative.
The sky-high interest rates mean Brazilians must pay off their cards every month or quickly drown in debt. For the first six months of this year, the number of Brazilians in default was up 22 percent from the same period in 2010, the biggest jump in nine years, credit rating agency Serasa Experian said. Private economists say one in 10 Brazilians is in default. By the end of the year, the Central Bank expects 28 percent of Brazilians’ disposable income will go toward servicing debt, compared with 16 percent in the United States and less than 10 percent in other developing nations.
Consumer confidence in Brazil sank to a two-year low in June, according to the latest survey from the National Industry Confederation. That’s mostly because rising interest rates and inflation of 6.71 percent, above the government’s target ceiling of 6.5 percent, are pummeling poorer Brazilians. That all this is happening while Brazil’s unemployment is at a historic low and the overall economy remains strong particularly worries some economists, who expect the situation to get worse as Brazil’s growth slows. The economy, which grew 7.5 percent last year, is expected to slow to 4 percent growth this year.
“I wouldn’t underestimate the potential that we see a recession in Brazil in the next three years as a result of this,” said Neil Shearing, senior emerging markets economist at Capital Economics in London. Finance Minister Guido Mantega denies that Brazil’s economy is overheating and fueling a credit bubble. The government’s most recent economic review noted that private-sector credit debt is equivalent to 54 percent of Brazil’s total economic output — well below the 120 percent in China and South Africa, where interest rates are much lower.
Central Bank President Alexandre Tombini told a Senate panel he thinks the number of consumer defaults in Brazil should level off and then drop as Brazilians become more prudent with credit. David Beker, head of Latin American economic and fixed-income strategy at Bank of America Merrill Lynch in Sao Paulo, said Brazil’s economy is adjusting to the rapidly growing role of credit, “but from that to say there is a bubble or that it is going to burst is an exaggeration.”
The Central Bank could take more steps to rein in credit, including requiring banks to hold more money in reserve and taxing some credit card purchases. It has used both measures before. Samy Dana, an economics and finance professor at the Getulio Vargas Foundation, worries that a credit bubble could lead to bubbles in other sectors of the economy, such as real estate, as Brazilians spend far beyond their means. Rent for prime office space in Rio de Janeiro is the most expensive in the Americas, recently overtaking New York, and the fourth-highest in the world, according to Cushman & Wakefield, a real estate brokerage.
For Xavier, the cab driver, being in debt in Brazil means working nights instead of playing with his daughter. He is resigned to working for a long time to pay off his $2,200 debt. And he knows any sudden misfortune will put him further in the hole.