Is Europe Still in Denial?

Here's an interview with Simon Johnson, former chief economist of the IMF, in which he claims Europe is still "in denial" (4:55) about the extent of the looming financial crisis:

In the New York Times, Johnson says:

"It’s one big trans-Atlantic money market out there, and these banks lend money to each other all the time," said Simon Johnson, another veteran of the monetary fund who is a now a professor at the Sloan School of Management at the Massachusetts Institute of Technology. "Deutsche Bank and UBS and Goldman Sachs and Citi are all intertwined."

...

For Mr. Johnson and other students of financial history, the latest developments in Europe — especially in Austria, whose banking industry is heavily exposed to its Eastern neighbors — raise eerie parallels with the 1930s. Mr. Johnson notes that it was the failure of a Viennese bank, Creditanstalt, in 1931 that was a turning point in what became the Great Depression.

And in other news, Britain's Telegraph newspaper reported: "according to a confidential Brussels document," European banks are sitting on on 16.3 trillion in toxic assets (mainly from Eastern Europe). The Telegraph then apparently removed the specific figure in later online editions: 

The Telegraph released this information including the 16.3 trillion pound figure only to have second thoughts about it for some undisclosed reason. They then changed the article without changing the URL title and also without this sleight of hand escaping readers. The original article title made its way onto Digg and into the mainstream consciousness.

I don't have much to add here, I just thought I'd pass this along.

Comments

[Don]

I think it's useful to ask what a 'toxic asset' means in this context. I would define it as an asset which cannot be easily sold on the market because of fears of the value it has already lost and fears that it may more.

But the nonexistent market may be undervaluing the asset. Large portions of the portfolios may continue to perform and yield income streams to the holder, even if it is not saleable.

I recently read a piece advocating that the US government buy up such assets, not at the bank's book value (which would overpay the bank) and not at current market value, which would bankrupt the bank, but rather at a price determined by the net present value of the income streams produced by the asset over time as determned by the government, not by the banks.

I guess what I'm saying is that 16.3 trillion euros may not be a 16.3 trillion euro loss, but rather a much smaller loss than that. It depends upon whether the investments made in Eastern European industries pay off in the longer term. I suspect that they shall, at least substantially. Luxury condos in Latvia are probably a large loss, but modern factories in Hingary are likely to pay again at some point....

[Don]

Just read some amazing information about foreclosures on the Floys Norris blog at the New York Times.

http://norris.blogs.nytimes.com/2009/02/25/foreclosure-sale-continues/

Norris lists the 20 areas where prices declined the most in the US in 2008. What is most striking is what isn't there as well as how bad it is in those areas.

What isn't there is any metropolitan area outside of California, Florida, and Nevada. Nevada has only one entry on the list (Las Vegas), Florida has seven entries, and California an amazing twelve among the top 20 cities.

Norris also shows declines or advances over prices five years before (in 2003). It appears that most of the hardest-hit areas are still positive over 5 years or only slightly negative, but four California cities are strongly down even over five years.

California is increasingly looking like a major economic basket case. The government had huge troubles closing a $41 billion deficit this year, and the solution looked fishy to many. No wonder, seeing what is happening to the economy.

I see another bailout coming like the New York City bailout of the late 70's. That bailout worked because New York was put under painful strictures and was forced to make hard reforms. If California is treated similarly with tough love, I'm all for it.

[Don]

Well, that is frightening - and it was meant to be frightening of course.

I think that in the end the US government is going to have to nationalize much of the banking sector, if only to get most of the toxic assets into one set of hands so that many of them can be unraveled into simpler forms which the markets can value more easily. This has been called a 'liquidity crisis', but the liquidity crisis lies in lack of information about the 'toxic assets' and the unavailability of funds to refinance even debt which remains realively sound.

I think the government is going to have to do it to a degree, perhaps helping to bail out mortgageholders who are owner-occupants and not too far under water.

There is also a housing crisis forming in the US and perhaps elsewhere. Not a housing shortage per-se, because if anything I'd say there is a housing surplus if anything. But we're seeing increasing amounts of homelessness and underhousing (families trying to live in very small quarters) at the same time when there are increasing numbers of empty houses which have been foreclosed upon.

If the US government nationalises the rotten parts of the banking sector it will end up de-facto owner of a lot of empty real estate. They could solve a lot of the housing problem by somehow arranging to rent these houses under a variety of schemes. Some 'rent to own', some renting of shared houses to several occupants.l Perhaps renting neighborhoods to housing associations in an attempt to build neighborhoods and social cohesion.