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Aftershocks, Part 1: That Austrian Bank

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.

10 thoughts on "Aftershocks, Part 1: That Austrian Bank"

  1. I recall the 1930s Great Depression really began when the largest bank in Austria collapsed in 1931 and the contagion “led to European residents rushing to banks where they had their money deposited and (this) affected banks not previously in financial trouble. This run on banks led to the failure of German banks by mid-June. As a result, Germany announced it could no longer keep paying its debts resulting from World War I (1914–1918). This led to economic problems in other European nations and the United States, reliant in part on those payments to fund their own government operations.” Will history repeat itself?

  2. I’m a bit surprised that you didn’t mention Creditanstalt. “[It] had to declare bankruptcy on 11 May 1931. This event resulted in a global financial crisis and ultimately the bank failures of the Great Depression.”, according to wikipedia. This is the Austrian mega-event that most closely resembles the Heta bank failure.

    In any event, that is not a rhetorical question you asked. How many of these bail-ins is it going to take to trigger the start of out and out hyper inflation? Not too many, I’m betting.

    1. An oft-cited and misleading event: (from Louis Sullivan’s Prelude to Panic, 1933): The Depression in the U.S. was triggered by Britain’s abruptly abandoning the gold standard in 1931. Americans, seeing what had happened began exchanging their gold receipts (dollars!) for bullion as prescribed by law. But the banks had only $40 in gold for every $100 loaned out, and of course they began toppling one after another. Creditanstalt had nothing to do with it!

      1. Not really. Busts are caused by the prior booms. I would suggest that you read some Mises, lol. To paraphrase Mises, once you blow up an economic bubble, there are only two possible end games. One is that the government quietly lets the insolvent entities fail. The other is that they bail out those entities deemed ‘too big to fail’, eventually resulting in hyper inflation.

        This is why the world’s central banks come across as being totally befuddled and unsure of themselves. You would be too if you had two choices and they were equally horrible in outcome.

        1. “befuddled and unsure of themselves” is a LOL interpretation of the vipers known as central bankers. Au contraire, they are pigs in sh*t. Definition of paradise: doling out funds virtually interest-free to the very banks that own you, courtesy of the taxpayers’ signing off on ever-increasing debt, while in the process costing the banks nothing in interest to savers. Who is the befuddled one?

  3. As an inevitable as a financial collapse my be, as much as we all try to follow and analyze every blow by blow event, whatever happens and whenever it happens will probably still be a shock to most people. JR must be thinking something similar by titling this piece “Aftershocks, Part 1…” Chances are this inscrutable mess with Austrian banks of similar “Archduke of Ferdinand” level of fame and ridiculously f _ _ cked up names like Hypo Alpie-Adria-Bank International AG and Heta Asset Resolution AG will probably come and go without much clarity, and some new and equally convoluted situation will crop up somewhere else as a new crisis. It may happen so many times and for so long that even those of us who want to follow this minutia will lose the interest or the will. But until that day comes we can continue to wonder if this is the snowflake that causes the avalanche.

  4. A break in the Uber Easy Money Dike starts with only a pinhole of a leak. Based on all of the fancy financial engineering via Credit Default Swaps, etc., the eventual effect on the global financial system is multiples of the initial estimated costs and exposures. And I thought it would be a Chinese default that caused the fragile and once again over-leveraged global Ponzi Debt Scheme to come unglued. The derivatives crapola that should have brought down the system in 2008 is back again and in some instrument classes, is larger in outstanding obligations than it was in Fall of 2008. Greed does not allow homo sapiens to learn from history, and complicit politicians and Central Bankers have once again looked the other way while leverage gets out of control. In fact, they welcomed and instigated this leverage via printing money and lax lending standards and should be fitted with Orange Jumpsuits along with the Speculators that include the Banksters again. This collapse will be the Dike Break and Helicopter Ben or Janet will not be able to drop enough Fiat fast enough to stop the tsunami coming.

  5. Never fear, the never-to-be-audited-Fed will just print and “back door” whatever is necessary to keep the system alive. Juuuust like before…

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