In an interview with Swiss daily Tagesanzeiger, a well-known economist has warned that Switzerland risks bankruptcy, if the recent market turmoil centering on Eastern Europe is not contained quickly. At issue are loans made in Swiss francs to Eastern European debtors. With many countries in the region falling into depression, currencies and asset prices are plunging. Therefore, debtors domiciled in Eastern Europe are increasingly expected to have difficulty with mounting foreign debt loads — and that spells trouble for Switzerland.
Below is my translation of the Tagesanzeiger article.
Switzerland threatened with bankruptcy
Swiss banks have given billions of credit to Eastern Europe – now the customers cannot pay back the money. Switzerland is threatened with the fate of Iceland, says economist Arthur P. Schmidt.
In countries such as Poland, Hungary and Croatia, the Swiss franc has become an important currency. Thousands of households and small firms took out loans in Swiss francs, and not in the national currency zloty, forint, or kuna because of lower interest rates. In Hungary, 31 percent of all loans are in Swiss currency. Amongst household loans, they are almost 60 percent.
Borrowers in distress
Now, the financial crisis has ended the era of cheap credit. As a result, Eastern European currencies are falling. At the end of September, one had to pay 46 francs for 100 Polish zlotys. Today it is 30 francs. That means more and more borrowers are having problems with interest payments and repayment. So the question is what effect this has on the Swiss financial marketplace. One who sees a dark future for Switzerland is economic expert Artur P. Schmidt. He believes that the Swiss franc is in danger because of the loans in Eastern Europe.
In Poland, Hungary and Croatia, the Swiss franc has become an important foreign currency – the dollar, so to speak, of Eastern Europe. Thousands of households and businesses have franc loans. Why?
The rapid growth in many countries of Eastern Europe was stimulated through loans in Swiss francs. Swiss banks and offshore institutions loaned the local banks francs, which passed the francs onto their customers. The loans were attractive because borrowers pay interest rates much lower than required for loans in local currency.
Now, this system has been shaken?
Yes, the system has only worked as long as the exchange rate between the franc and the currencies were reasonably stable. But that is not currently the case. For example, the Hungarian forint and Polish zloty have lost over a third of their value against the Swiss franc in recent weeks. Because of the devaluations of the national currencies, the debt to Switzerland has increased by more than one-third. Many of the Eastern European countries have serious payment difficulties, and are virtually bankrupt.
What does this mean for Switzerland?
It is likely that a significant proportion of the total 200 billion U.S. dollars of Eastern European loans were issued in Swiss francs. According to a report by the Bank for International Settlements worldwide franc loans equivalent to around 675 billion U.S. dollars are in circulation – which was about 150 billion directly from Switzerland, 80 billion of Great Britain and about 430 billion U.S. dollars through offshore financial centres. How many of these loans have gone bad is not known. But even if the failure rate is 20 percent, the banks would lose a lot of money.
Is the federal government going to intervene now?
If the banks require a massive writedown of such loans, above a certain magnitude, the government must intervene. This is already happening via the Swiss National Bank. In Poland, it has made several billion francs available to the local central bank so that Polish banks can cover the loans. At the same time, the Swiss National Bank inquired by the European Central Bank whether it could borrow money in an emergency. This is a clear warning sign that the Swiss franc could be under huge devaluation pressures in the near future.
Swiss banks were too careless in their lending in Eastern Europe?
Yes, indeed. Many bankers wanted to earn a lot and neglected the risks. The National Bank is also at fault as it did not intervene. In addition, the regulator and the politicians completely failed.
What Switzerland must do now?
Now, the possible losses caused by these loans must be made transparent. Above all, all of the Eastern European risks must be fully disclosed. Together with the loan losses from UBS and Credit Suisse, the entire writedown for Switzerland could exceed the Swiss gross domestic product.
That is to say?
Switzerland, like Iceland, is threatened with a potential national bankruptcy. One consequence would be that the Swiss currency could fall massively in value — possibly even crash. Another would be that Switzerland’s credit rating would be massively downgraded. That would be a trauma for the country: Switzerland was always as a stronghold of stability. The franc could become an unstable soft currency. Then Switzerland would perhaps be forced to abandon the franc and take on the euro.
This article fills in a lot of gaps for me. Two weeks ago, I happened to catch another post in the Swiss press about the Swiss government issuing debt in U.S. Dollars. In my post "Why are the Swiss now issuing debt in U.S. Dollars? I asked an open question as to why the Swiss were issuing debt in dollars. No one knew and I had yet to hear a satisfactory answer to this question.
However, my post also pointed to central bank swap lines between Switzerland and a number of countries in Eastern Europe as a related event. The Tagesanzeiger article makes clear that these swap lines are needed due to Eastern European exposure to loans in Swiss Francs. I expect the U.S. dollar swap lines and dollar debt issuance are related – as are the Euro swap lines with the ECB – for liquidity in case of emergency.
These machinations are a testament to the continued fragility of the global financial system. The interconnectedness across currencies and countries is staggering. One domino falls and the whole global financial system is at risk.
Welcome to the dark side of globalisation.
[Update - 18 Feb 2009 730PMEST]: The Berlingske Tidene, a Danish newspaper is now covering this story. Here is the link, if you speak Danish:
Schweiz truet af stats-bankerot – Berlingske Tidene
And Willem Buiter has some words to say about this crisis that are of a similar nature. He suggests capital controls are coming to Eastern Europe:
The return of capital controls – Willem Buiter
SNB schliesst Swap-Abkommen auch mit ungarischer Zentralbank – Money Cab Finance News
Der Schweiz droht der Bankrott – Tagesanzeiger