Sometimes little things are the start of much bigger things. Probably the
most famous historical example of this is the June 1914 assassination of an
Austrian archduke who, it's safe to say, 99% of the world had neither heard
of nor cared about. But the aftershocks of the deed produced the biggest war
in human history.
More recently, the US government's 2008 decision to allow mid-tier investment
bank Lehman Brothers to fail is frequently blamed for turning a mortgage bubble
into a global financial collapse.
So in trying to understand the world it pays to look beyond the headlines
to the secondary and tertiary effects of whatever is happening. And right now,
more than the usual number of events and/or trends seem capable of turning
a sector-specific story into a broader crisis. This series of columns will
look at some of them, beginning, appropriately, with Austria, where the government
has decided to "bail-in" rather than a bail out a failed bank. Already, the
collateral damage is mounting:
Heta
Damage Spreads in Austrian Downgrades, German Losses
(Bloomberg) -- Austria's decision to wind down Heta Asset Resolution AG sent
ripples through the financial system, causing credit rating downgrades in Austria
and bank losses in Germany.
Moody's Investors Service cut the rating of Carinthia province, which guarantees
10.2 billion euros ($11.1 billion) of Heta's debt, by four levels to Baa3
from A2, and said it may lower the ratings of three state-owned Austrian
banks exposed to it. Dexia SA's German unit, Deutsche Pfandbriefbank AG and
NRW Bank said yesterday they own Heta bonds that may suffer losses.
"Notwithstanding the intention of the central government to protect taxpayers
under the new banking resolution regime, Moody's sees the steps taken so
far as adding higher uncertainty to developments," the ratings company said
late Friday in a statement on the Carinthia downgrade. "Susceptibility to
an adverse scenario has increased as a result."
Austria paved the way for imposing losses on Heta's bondholders when it
ruled out further support for the "bad bank" of Hypo Alpe-Adria-Bank International
AG March 1. Using powers set out in European Union and Austrian bank laws
covering debt reorganization, the Finanzmarktaufsicht regulator ordered a
15-month debt moratorium while it plans resolution of Heta's 18 billion euros
of assets.
Carinthia's guarantees, which peaked at 25 billion euros in 2006, were the
main justification for Hypo Alpe's public rescue in 2009 and the biggest
conundrum in its wind-down.
Can't Pay
With budgeted revenue of 2.36 billion euros this year, the southern province
of 556,000 people would be unable to honor the guarantees if they came due
now or in a year's time, Governor Peter Kaiser told Austrian radio ORF on
Tuesday.
The guarantees "could exceed Carinthia's liquidity resources, lead to increased
financial leverage and could require some form of extraordinary central government
support," Moody's said.
Finance Minister Hans Joerg Schelling has said repeatedly that the Austrian
government isn't liable to cover Carinthia's guarantees.
German banks yesterday also emerged as major Heta bondholders. Dexia's Dexia
Kommunalbank Deutschland AG said it owns 395 million euros of Heta bonds
and will take an unspecified charge in the first quarter. Deutsche Pfandbriefbank
AG also owns 395 million euros of Heta bonds and said it will write them
down by 120 million euros, cutting its expected pretax profit by two-thirds.
Some thoughts
It's amazing how fast credit ratings revert to their intrinsic value when
artificial government support is removed. And the above list of potential victims
doesn't include the counterparties on whatever credit default swaps are out
there on Heta-related bonds. So more scary headlines are coming.
It's also important to note just how tiny these numbers are. Not a single
amount mentioned in the above article is over 25 billion euros. That's chump
change in today's mega-bank world. Yet in the absence of a government backstop
it's enough to cause cascading credit downgrades and maybe even the bankruptcy
of an entire Austrian state.
So Austria and by implication the rest of the eurozone now face a tricky choice:
Stick with the bail-in program and risk a highly-unpredictable cross-border
contagion. Or go back to the tried-and-true bail out, with the higher deficits
and rising debt -- and angry voters -- that that implies.
Over the past couple of decades, governments have generally blinked when confronted
with the prospect of actually letting markets clear bad debts and other misallocated
capital. Starting in the mid-1990s with the what came to be known as the "Greenspan
put" governments around the world have made it clear to the financial sector
that no mistake is too egregious to be unworthy of a central bank backstop.
So leverage up, roll the dice, collect those bonuses, and don't worry about
the consequences. The result is a bunch of banks, pension funds and hedge funds
whose balance sheets are stuffed with paper that has value only if 1) accounting
rules continue to support "mark to fantasy" bookkeeping and 2) governments
(via taxpayers) stand ready to convert that bad paper to newly-created currency
upon demand.
As taxpayers and voters have caught onto the scam, they've raised the political
costs for governments, forcing Austria's leaders have to decide which group
-- unstable financial markets or an appalled electorate -- is more dangerous
to cross heading into the next election. Either choice brings its own series
of aftershocks and systemic risks.