Saturday, February 11, 2012

A Note on Greek Banks Recapitalization

A Note on Greek Banks Recapitalization

You might have noted in the news stories about the Greek government debt problem that there was talk of needing to recapitalize the Greek banks later. What is going to happen, one way or another, is that the Greek banks, as well as other banks all over Europe eventually (and maybe a few elsewhere), will have to recognize, on their balance sheet, that the Greek government bonds that they hold are worth less than when they were purchased. It is true that the Greek government debt has been worth less on the secondary market for some time, but accounting rules do not necessarily require that that change be recognized on a balance sheet at that time. (I will let an accountant explain that issue, which isn’t necessarily corrupt.)

For the bondholder, buying the bond is the same as loaning money. The bond will pay a certain interest rate for its lifetime, and at a certain point, the issurer, which could be a government or a business, will return the borrowed amount, called a redemption. It is a timed, interest-only loan.

The bank holds the loan as an asset, just as it does all of its loans. But it does have to evaluate the loans that it has on its books. Are they performing? That is, is the borrower following the terms of the loan? Will the borrower be able to pay back the loan?

Accounting rules for banks recognize that loaning money is a risky business. Borrowers can get into trouble and fail to pay the interest and fail to repay the loan itself. In order to protect itself, a bank has to maintain reserves against potential default of a borrower. With this reserve the bank is protected from becoming insolvent and bankrupt when borrowers default. The reserve is actually capital. The more reserves a bank holds against potential loan losses the more of its capital it has tied up. That capital cannot be working and adding to the revenue or profit of the bank when it is held as a reserve. (Do confuse reserves the bank has with “reserves” required by banking authorities, such as the Fed. Those are not reserves in fact, but deposits that provide no protection or income for the bank.)

Due to the standard statist misunderstanding of how banking works, how capitalism works, and what the real benefits of government controls are, governments have established regulations as to what percentage of reserves a bank must have in its loss-loan reserves for different types of loans. Banks in the European Common Market have been heavily regulated for at least as long as U.S. banks, most likely much longer. They are well used to doing what they are told. I think that the experience and knowledge of how to properly rate the risk of most loans does not exist in Europe. Furthermore, the government decisions as to what percentage of a loan the bank must hold in reserve is heavily influenced by political considerations and populist biases. Certainly, if the ability to repay debt were a consideration, the debt of most of the European nations would be rated very low.

The developed governments of the world have gotten together over the years in Basel Switzerland to establish international standards of loan-loss reserve percentages, hence, the Basel Accords and Basel I and Basel II (Basel III is in the works, I think). They agreed that loans to sovereign, national governments required either low or zero percentage reserves. That’s right, a loan to Greece was considered safer than a loan to Apple or Microsoft or GE.

What banks did was to load up on government loans because those loans required fewer reserves. Reserves cost money, that is, reserves are idle cash. If no reserves are required, then the bank’s funds can be loaned and contribute to operating income, and maybe profits and bonuses for employees. Even European banks have some characteristics of a business.

In addition, European banks are much closer to their governments than U.S. banks. They are sensitive to the interests, biases, policies, and intentions of the ruling politicians. They have to be. The politicians have a lot of power and use it against the banks if they wish. What the politicians have wanted, in all of the European countries, is for the banks to help fund the government spending, cheaply. The banks have helped the central European bank and each country central bank to keep interest rates on government debt low by buying significant amounts of government bonds. The Greek banks have done this perhaps more than others and hold massive amounts of Greek government debt (which is a direct path of the country’s savings into the hands of the government, which spent it in a continuous, drunken shopping spree – buying votes, really). The estimate I have seen is 50B euros.

As a result of the various government actions and the way the governments have set things up, the Greek banks are now looking at losses on Greek government debt of seventy percent or more, yes, that is 70% losses. Losses for which they have little or no loss reserves. This degree of loss means that the banks’ total capital, its investment from its shareholders, whatever profits it has ever retained, and all of the reserves of any kind, have been wiped out. The Greek banks are bankrupt. They are bankrupt right now. It just hasn’t appeared on their balance sheet yet.

So, if there are to be any banks in Greece, they need to have an injection of capital. Not loans, but new ownership money. The requirement being discussed is ten percent of loans by 2013. Remember, Greece is something like five percent of the Euro zone. I have seen estimates that the recapitalization of all Euro zone banks, with all of the Euro debt problems, is one trillion euros, which is about $1.3T.

Who would want to put money into Greek banks? Not foreign investors. Not domestic investors (if there is anyone with real money to invest). No, there is only one source: the government.

Yes, the bankrupt Greek government is going to put money into Greek banks. The Greek government doesn’t have any money so it aquire the funds from outside the country, just as the government is doing for all of the other help the government is getting. The way it will probably work is that some one like the IMF, the European Central Bank, or one of the two entities that have been created to deal with the sovereign debt crisis will give/loan the money to the Greek government which will then put the money into the banks.

But, the Greek government won’t just hand over the money to the banks. No. It will “invest” the money, i.e., it will buy stock. The Greek government will nationalize the banks. There is some talk about making the stock the government buys a special, non-voting stock, thus preserving an illusion that the original owners have some standing in the bank’s ownership. But, that is what it is, an illusion. The banks will be even more tied to the Greek government than they were.

So, as an overview, here is what we have:
The Greeks (actually you can insert any European Common Market country you want because the pattern is consistent throughout) borrowed from anywhere they could for a massive spending spree.
They required the banks to be a major lender.
They required the banks to have little or no reserves against the loans to the government.
The government can’t repay the loans.
The banks are failing.
The government, with money acquired from elsewhere because it has done stupid, insane things, is going to buy the failed banks.
The banks are even more tied to government policies than before.
The government has ownership and control of the banks.
Does anyone think that the Greek banks will be better off?

Makes sense, doesn’t it. When you live by force, you “win” by force. And you all go down the tubes together. Moreover, I have seen no comment or hint that anyone writing about the European situation has anything to say about the matter. Perhaps they haven’t even noticed.

But the failure of putting two and two together is a common theme in the entire European debt crisis. It is most blatant with the Greeks.

This week there have been more “strikes,” riots, and protests against the terms required by the agencies that would bail out the Greeks. Many of the chanted slogans and posters and banners declare that the foreigners are dictators and imperialists. The protestors want the politicians to “resist”! The Greeks appear like angry four year olds who have been told that they can’t have the toy on the shelf because mommy doesn’t have the money. How and what are the politicians suppose to resist? They are suppose to resist the requirement that they do not incur more debt. They are suppose to resist the requirement that they try to pay back their existing debt. They are suppose to resist the requirement that if they are given money they spend it wisely instead of like a drunken sailor (my apologies to sailors). The Greek protestors have no contact with reality. None. They have no idea that money has some connection to real things. That real things are made by someone who wants to be paid for their efforts. That borrowing actually means that the lender expects to be paid back. The Greek country is a testament to modern education and economic “thinking.”

1 comment:

  1. Well said. I've marveled at how the Europeans have propted up Greece for so long, but the debt problems are too great to overcome. It sounds like they are bleeding the banks dry to make it happen.