Credit Writedowns

Spain and Italy reported today that the share of bad loans have continued to rise. There is nothing to suggest that this is the peak. In fact, further deterioration is likely.

In spite of the divergence in the chart, the “loans create deposits” axiom still stands – deposits are still created through bank credit. Two key developments explain much of this divergence without violating these principles.

In the links today, the biggest threads outside of the NSA scandal were on Greece and Europe. I believe the economy there is bottoming and I want to discuss some of the news flow. There was also a rate decision by the Japanese central bank that was met with disappointment. Let’s put this into context regarding the viability of Abenomics.

Europe has been postponing the recapitalisation of its banking sector. This column argues that it has been doing so for far too long. Without such a recapitalisation, the danger is that economic stagnation will continue for a long period, thereby putting Europe on a course towards Japanese-style inertia and the proliferation of zombie banks.

Editor’s note: The following press release was issued by the FDIC last week regarding bank accounting gains in the quarter through 31 March.

Just to follow up on the last post, which was relatively optimistic about the eurozone, I want to show you this chart of non-performing loans in the periphery. I believe it tells a story of debt deflation and explain why the contraction in GDP has been so sharp.

Moody’s has changed its outlook on the U.S. banking system to stable from negative, reflecting continued improvement in the operating environment and reduced downside risks to the banks from a faltering economy, says Moody’s Investors Service in its latest “Banking System Outlook: United States of America.” The outlook had been negative since 2008.

Retail savers in the US are abandoning certificates of deposits (CDs). The amount of CDs outstanding that are $100K or smaller has been on a sharp decline since the recession and is now at the lowest level since the Fed began keeping track of these balances.

When I see the chart for Euro zone NPLs and look at the numbers, I think debt deflation. And this is exactly the problem with the euro zone’s policy mix.

ECB President Draghi suggested last week that the central bank was taking a fresh look at the deposit rate. There does not appear to be any economist that thinks it is a good idea. The reasons vary, but the two main reasons are that it would likely prove ineffective in boosting lending and would be potentially disruptive to the money markets and financial institutions.

Portugal is going to market with a 10-year sovereign bond issue, its first since 2011. I think this is a pretty big deal. Think of it as a complete return to public market access for the Portuguese government, one of the critical pre-conditions for an OMT-style bailout. This is a Herculean achievement by the Portuguese that I did not believe the Portuguese could pull off just three months ago. Ironically, I would credit the deposit tax in Cyprus for this turn of fortune. I will explain why below.

I just finished watching the ECB’s monetary policy committee press conference led by Mario Draghi. And the ECB has just announced a series of actions I believe constitute a new economic paradigm for the euro area, one that moves away from front-loaded austerity and comes with non-interest rate monetary accommodation. I want to briefly outline here what this means outside the paywall.