Wednesday, 13 February 2013

The Bust Without A Boom - Part 3

Every so often, the contradiction between appearance and reality breaks out. A recent sharp reminder was the nationalisation of Netherlands' fourth largest bank, SNS Reaal, which also had to be bailed out with a further €3.7 billion. It had suffered losses on its property portfolio, particularly in Spain.

It was not alone. Spanish banks fell heavily again last week, as they were forced themselves to fess up about some of their own property losses. BBVA profit fell 44%, and wrote off € 10 billion; Santander wrote off € 18.8 billion, and its profits fell 59%; Caixa Bank's shares plunged 78%, and it wrote off € 10.3 billion; and Banco Popular wrote off € 9.6 billion, whilst its previous year's profit of € 480 million turned into a loss of € 2.5 billion.

Yet, most analysts believe that with more than 26% unemployment and 60% youth unemployment, and with the economy shrinking even further, the banks will face further pressure in coming months. The banks have been kept afloat by money from the ECB, and they have hidden their property losses as best they can, but they cannot “extend and pretend” forever.

They are under pressure to clean up their balance sheets or be named and shamed, if they don't declare property on their books at more reasonable prices. But, the problem even then is what is reasonable. I'm in Spain as I'm writing this (now returned) and what comes over again is just how opaque the market is, and just how much corruption still exists.

The latter comes out in the allegations in the Spanish press against Prime Minister Rajoy and other members of the Government, accused of receiving payments from construction companies via a slush fund. Paul Mason has previously written of similar corruption in relation to Bankia and various regional banks.

Banks are also selling repossessed properties, often at massively reduced prices. I've seen places in the Costa Blanca going for between €20,000 – 40,000. Yet, this process is far from transparent. For example, some of these properties are sold in auctions, but they are not open auctions. Only selected companies are allowed to take part. That means that in some of the more sought after locations, for example, around Javea (Xabia), these companies can buy up property at very low prices, thereby relieving the bank of a liability, whilst the property company can put it on its own books at a similar price to the rest of its portfolio, in the process preventing it from putting downward pressure on their prices.

Yet, as in the case of the UK, the consequence of this failure for prices to correct is that the overhang of supply relative to demand continues to rise. One agent told me that he had 900 properties on his books! Many analysts believe that just to match what happened in the US and Ireland, prices in Spain would have to fall by as much again as they have already fallen. The prices of property on Spanish Bank books certainly do not reflect that. Yet, its likely they need to fall more than that. After all, Spain is in a Depression that is getting worse. Neither the US nor Ireland faced the same kind of fall in GDP, neither suffered 26% unemployment, and 60% youth unemployment.

Even in the more affluent areas of the Northern Costa Blanca that is apparent. About half the shops are closed down. Moreover, although rich Europeans will continue to be able to buy property in exclusive areas anywhere in the world, it is not the rich who are the backbone of the property market in the costas. That comes from middle class and working class Northern Europeans, looking to retire to the sun, or who have found themselves employment in more pleasant surroundings. But, with wages and pensions being squeezed, interest rates on savings next to zero, and for Britons, uncertainty and additional costs arising from not being in the Euro (especially with a sharply falling pound) conditions for the property market in the Costas are not good either.

And, of course, its not just European Banks that are still in trouble. UK banks, like Spanish Banks are engaged in a huge attempt to paper over the cracks of the housing market. Like the Spanish Banks, there balance sheets remain a fiction based on grossly overvalued property assets, and with debtors that are clinging on by their finger nails, only due to extensive forbearance and near zero interest rates. The same banks now face, new large pay-outs like those for pensions mis-selling, and PPI mis-selling, this time for mis-selling interest rate swaps to small businesses. They may also face civil actions for compensation over the LIBOR scandal, and Barclays is under investigation over the Qatar deal that enabled it to avoid a state bail-out in 2008.

With European banks now having to pay back some of the cheap money they borrowed under LTRO (effectively money printing by the ECB) the potential exists again for a tightening of credit conditions within Europe. That comes just as the Euro itself has leapt to new recent highs, as a renewal of global currency wars has seen the US, China, Japan and the UK act to reduce the value of their currencies. That means peripheral Europe will be squeezed even harder, as it finds it even more difficult to export.

Yet, as I have pointed out before, the paradox could be that as the global economy experiences a cyclical upturn, during the second part of this year, so that could provoke the bursting of the asset bubbles previously described. It may be that there is a bust without a preceding boom, but also that the bust, collapsing those asset prices is the necessary precondition for any such boom to occur. Only when its no longer possible to reflate those bubbles, creating fictitious capital, will money begin to flow again into productive investment, creating real economic growth. Without that, the US, and Europe will continue to fall behind China, and those economies in Asia and Latin America that now represent the vanguard of global capitalist advance.

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