The Austrian government has nationalized the insolvent bank Hypo Group Alpe Adria (HGAA). The financial institution, which has 40 billion Euros in assets, is the country’s sixth largest bank. But, in relative terms, this is a very large bankruptcy – using GDP at purchasing power parity, an American HGAA would have assets of $2.5 trillion, larger than any of the American banks. So, this is a very big deal and it speaks to the size of Austrian banks’ international exposure, renewed risks in banking and the possibility of contagion.

HGAA is considered a subsidiary of the troubled German state-controlled bank of Bavaria BayernLB.  Just last month BayernLB pointed to trouble when it reported a huge loss over 1 billion Euros for the second quarter running. The trouble: HGAA.

The FT reported at the time that:

HGAA would report a significant loss for the year and a capital injection for its subsidiary would be unavoidable, BayernLB said. The bank warned it would take a goodwill impairment charge at the end of the year on the value of its HGAA investment.

“Increased risk provisions and the expected impairment at HGAA will weigh significantly on… earnings in the fourth quarter. It is not yet possible to quantify it exactly, but it can be expected that as a result of these effects, the group will report a loss of well over €1bn,” BayernLB said in a statement.

The problems are the latest sign of how Germany’s Landesbanken – regionally owned public banks – have been thrown off course by risky attempts to boost profits by diversifying away from their core regional lending activities. BayernLB lost more than €5bn last year after writedowns on its huge stock of toxic assets, forcing it to seek a bail-out from the Bavarian regional government.

The bank’s purchase of HGAA in 2007 is already the subject of an inquiry by Germany state prosecutors, who are considering whether the former chief executive of the German bank committed a breach of trust by paying too high a price for HGAA.

Along with other Landesbanken, including HSH Nordbank and WestLB, BayernLB is reducing the scale of some of its foreign ventures. Michael Kemmer, chief executive, said the “more focused business model” was improving the bank’s performance.

This is what is commonly known as reckless lending and it happened in spades during the boom in Eastern Europe. Most of the actors are banks in Scandinavian and German-speaking countries.  HGAA was most exposed to the former nations of Hapsburg empire, with the Balkans in first place on that list.  The purchase of HGAA by BayernLB even after a global housing bubble had popped needs investigation and reminds me of the flyer taken by Hypo Real Estate in Ireland via its purchase of Depfa. And the fact that two large German institutions increased international exposure into Austria, the Balkans, and Ireland at the top of the market demonstrates the laxity in banking regulation globally.

The fact that the HGAA bankruptcy is happening now should remind you of the Dubai situation again.  When the crisis there first struck I talked about exogenous shocks and contagion, saying:

But now that Dubai is back in the news, I have looked back in my archives to see what (if any) links I have had on the situation in the country. The last two were in April about developers defaulting and in May about an S&P debt downgrade. Since then – as the global equity markets have turned up – nothing.

What does this tell me? First and foremost, it hints at the fragility of this recovery and the real risk exogenous shocks pose.  We are barely recovering now and a lot of debt and unemployment put us at stall speed, making the risk posed by events of this nature that much greater.

More importantly, however, the Dubai World events underline the unpredictability of exogenous shocks. All of these potential crisis situations — dollar carry trade unwind, debt crisis in the Baltics, oil price spike, an unexpected surge in interest rates, war in the Middle East — are still there lurking in the background. We don’t see coverage in the press on them everyday, but they are still there.

I have been optimistic about the near-term prospects for the global economy in large part due to the myriad pro-cyclical effects of recovery. Longer-term, however, there are some serious obstacles to a sustainable recovery.  This is not a garden-variety recession and recovery. It is a recession within a longer-term depression.  And while we are in a technical recovery, I believe much of the fundamental problems which triggered this downturn are still there, lurking. The debt troubles at Dubai World bring this point home.

[emphasis added]

The first signs of Dubai contagion popped up in Greece and Ireland because of similarities to Dubai regarding mountainous sovereign debt problems. Now that we have this rather large bankruptcy in Austria, we can talk about further contagion. Looking back in my archives at Austria this time, it has been a long time since I have discussed the banking situation in Austria.  It was most critical in the December 2008 to March 2009 time frame when we were in serious crisis mode.  Below are the posts I wrote relating to that topic.

That’s it! As with the situation in Dubai, it was radio silence until the Dubai World panic. 

I should add that no post on banking in Austria is ever complete without reference to Creditanstalt’s 1931 bankruptcy as the trigger event for the global banking crisis which gave the Great Depression its ‘greatness.’ So when we we talk about contagion, Creditanstalt is the gold standard of contagion, if you will.

The most telling statement in my earlier posts on Austria is this one which comes via the Vancouver Sun about comments by International Economy magazine’s David Smick:

Internationally, Smick said export-dependent developing countries, and the western banks that financed their growth, are particularly vulnerable.

“If too many of these emerging markets go down, the IMF (International Monetary Fund) lacks the necessary resources to mount rescue operations,” writes Smick, author of the 2008 book The World Is Curved: Hidden Dangers to the Global Economy.

“To put things in perspective, Austrian banks have emerging-market financial exposure exceeding $290 billion. Austria’s GDP is only $370 billion.”

As in the U.S., the critical thing in Eastern Europe is maintenance of asset prices underpinning this financial exposure. There is zero chance Austria will survive a further collapse in asset values in Eastern Europe without EU or IMF support.  This is the major reason central banks are flooding the system with liquidity.

Now, if the Dubai contagion does result in renewed weakness in asset prices, then I may have to eat my words about how unlikely it is that Ireland or Greece leave the Eurozone. My comments from last January on Ambrose Evan-Pritchard’s Euroscepticism are still my thinking today:

My take on events is that a number of countries within the Eurozone will face banking crises, starting with Ireland.  At that point, leaving the Eurozone will make no sense because the damage has already been done.

Evans-Pritchard’s calculus is more to the point: Ireland must threaten to leave now if it wants to maximize any EU help it expects to receive, before the scope of other EU banking crises become apparent.  Weakness in the financial sector has infected all of the Eurozone members. I have mentioned that Austria has a weak banking system (see posts here and here). But, there is even growing evidence that Germany too has a fragile banking system.  To be clear: this is an ‘every nation for itself’ strategy pitting Eurozone members against each other, where those nations savvy enough to request help sooner are likely to benefit at the expense of others. The question is whether the Germans would go along with this.  If they do not, tensions will rise and that will change the calculus for Portugal, Italy, Ireland, Greece, and Spain. I don’t have a view on this as yet because the situation is still evolving.  However, I lean toward believing the Eurozone will remain intact even while individual nations or banking systems collapse.

This is a guest post by Edward Harrison. A version of this post originally appeared at Credit Writedowns. See also Too big to rescue as the Icelandic collapse is the scenario feared by every government in a small country with a large banking system that is too big to bail.  Has the policy response in Europe been enough to avert renewed crisis? Let’s hope so.

Category: Bailouts, Currency, Finance

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

17 Responses to “Austrian bank collapse furthers fears of contagion”

  1. Marcus Aurelius says:

    Knowing Europe, this will end violently.

  2. Why does it seem like all the financial explosions are timed to go off at psychologically palatable intervals? It seems it is being done this way to keep the herd quietly grazing and not stampeding. At this rate it could take ten years to work through all the bad debt worldwide

  3. rj says:

    I don’t know about the credibility of the source, but another strained Austrian bank is supposedly OeVAG. http://www.benzinga.com/62194/paper-austria-may-nationalize-oevag-bank-loss-up-to-%E2%82%AC20-billion

    Why does it seem like all the financial explosions are timed to go off at psychologically palatable intervals?

    Because you look at a peanut and see a controversy.

    In the case of the weekly bank failures the FDIC do, I think it’s just a question of available manpower on offer.

  4. wally says:

    “And the fact that two large German institutions increased international exposure into Austria, the Balkans, and Ireland at the top of the market demonstrates the laxity in banking regulation globally.”

    Unlike the US, of course, where it is OK to push the agencies and the FHA to lend more and to urge banks to make loans whether or not there is any demand or any sound business venture to fund.

  5. bsneath says:

    Why does it seem like all the financial explosions are timed to go off at psychologically palatable intervals?

    Because all governments know we are not out of the woods yet and there may be a whole lot of behind the scenes market management going on. (although the available manpower may also be legit)

  6. jeffg says:

    Is it any wonder that the US government and US banks hurridely went to the capital markets before Christmas to rope in private money into the banks? If it all starts to unwind again, the US banks will have a nice cushion with those capital raises (and not having to pay the government interest on TARP money) and the US Treasury will have some money they didn’t have to supplement their deficit spending. Smart move Obama, maybe you deserve that B+ you gave yourself on “Oprah”

  7. ZackAttack says:

    Nothing on the ‘partial nationalization’ of two Irish banks? Seemingly much larger dollar figures involved, at least for the sale of assets to their version of the RTC.

    http://www.bloomberg.com/apps/news?pid=newsarchive&sid=adHHGndrjYxM

  8. Jessica6 says:

    @rj – I saw that too, along with reports that the company issued a press release claiming to be well-capitalized enough for any catastrophe and that they’re not on any watch list. But who knows…

    This article is why I could never understand Schiff and others who are so bearish on the US but not on Europe even though according to some, European banks are in even worse shape than the US ones.

    As for ‘psychologically palatable intervals’ – this is occurring at the same time as the Dubai World troubles. Lehman and AIG blew up at pretty much the same time too. Probably all the backstops and bailouts work but only for a while and because there’s been little serious reform in a lot of areas the same problems arise yet again. That, and probably debt schedules.

  9. call me ahab says:

    good post Ed-

    I saw you were posting pretty heavily at NC for a while-

    in response to the article- it is apparent the financial markets around the globe are very fragile- with everyone sticking there chest out for the appearance of confidence

  10. foxorrabbit says:

    Seriously, did you just try to compare this to a hypothetical $2.5 trillion U.S. bank? That is outrageous sensationalism for a 40B Euro enterprise. Sure it’s big for that country, but using “purchasing power parity” to balloon this to the equivalent of a $2.5T enterprise is the kind of tactic that is the reason I spend more time on blogs than main stream media sites. Don’t use their tactics. Say that it’s xx% of Austrian bank assets, or xx% of GDP, and *compare that to other countries’ or companies’ metrics* to show us if it really is big even for Austria (perhaps bank assets as a share of GDP are more in Austria than in the U.S.?). But the word “trillion” has no place (no place!) in this article.

  11. yogi9 says:

    I’ve never seen a tuna swallow a whale…but maybe someone else has…can anyone enlighten me on $2.5T? Three too many zer0′s perhaps?

  12. foxorrabbit, the number $2.5 trillion is to give readers a sense of both the relative size of the balance sheet to the domestic economy and the size of the banking problem in Austria. Austria has an outsized banking sector because of the sectors international adventures.

    When I wrote the figure $2.5 trillion, I was thinking more Iceland or Switzerland than the U.S. initially because they also had/have outsized banking sector. But, the fact that this was the sixth largest bank and is the equivalent in assets to economy of Citigroup in America should tell you they will have major problems if asset prices in Eastern Europe fall.

  13. TakBak04 says:

    As an American Business doing Business with Germany…..this is an important post. We are just in the process of our “Partners Review” where we focus on what we are focusing on for the 2010 Market…and there are some “Supply Side” folks in our partnership who think ….RECESSION IS OVER and that American Companies can do great business with American Companies for that “Entreprenuerial thingy that Bushy and Obama and his and their folks always rail on about “24/7.”

    It was a great read and Kudo’s to Todd Harrison. My read is that “caution is in the wind”…..and those of us depending on salaries from Germany/Austria/Switzerland..(that group) need to be awar of what goes on here in US does “spill over.”

    We are hanging on in our business…but this does eventually affect what we do with our Euro Partners in these countries.

    Thanks!

  14. TakBak04 says:

    As an American Business doing Business with Germany…..this is an important post. We are just in the process of our “Partners Review” where we focus on what we are focusing on for the 2010 Market…and there are some “Supply Side” folks in our partnership who think ….RECESSION IS OVER and that American Companies can do great business with other American/Euro Companies for that “Entreprenuerial thingy that Bushy and Obama and his and their folks always rail on about “24/7.”

    It was a great read and Kudo’s to Todd Harrison. My read is that “caution is in the wind”…..and those of us depending on salaries from Germany/Austria/Switzerland..(that group) need to be aware of what goes on here in US does “spill over.”

    We are hanging on in our business…but this does eventually affect what we do with our Euro Partners in these countries.

    Thanks!

  15. Schade says:

    Dear foxorrabbit, yogi9 and TakBak04:

    Lets talk about the 2.5 trillion number you are so hard pressed to undrstand. Just imagine Germany with 80m people and 4 of them. Thats what the US population is. Somewhere around 300m. So if Germany has about EUR 500 bn or USD 750 of troubled eatern commercial real estate loans on thir books, which thy do, thn multiply that tims 4. I would say $2.5 is less than 4x of Germany’s current debt (not to mention social welfare problems…i.e. Hartz IV, population decline, higher taxes, etc.) . Or if you were a kinder again, just imagine you wer playing with your mini fort schloss and then imagine you as a grown up eltern and you are playing with a huge fort. Got it? I know math is not one of European schools best attributes.

    I was just a banker for the last 3 yrs in Germany. I saw all of this coming. The US subprime problems will dwindle in comparison to Western & Eastern Europes problems begining the next few years. The US has a Treasury and a central bank setting policy for “one country”. The ECB is only setting “inlfation” policy for “too many nations”. At the bgining of the crises th ECB raised their rates. The US & UK devalued their currency and took it on the chin. Europe cant do this and will see vast structural, political and monetary problems starting now. Greece, Italy, Ireland, Portugal….Austrian banks, Italian Banks, Belgian Banks and German Banks will go under. Mass unemployment, immigration and riots are coming and Germany still will claim its just an “Anglo Saxon” problem or “Casino Capitalism” however, all of th free and asyy credit that was available to Eastern Europe is about to go under… Typical German attitude. Russia can take you this time around…. Schade…

  16. Schade says:

    Europe RIP…

  17. jc says:

    I really don’t understand the details of these euro problems but it seems a lot of the smaller euro nations are financially overextended in various ways and don’t have the formal coordinated bailout mechanisms of the US and these small nations are depending on Germany to save them when the shit hits the fan.

    Maybe the US will be using the repaid TARP bucks to keep CA,MI etc out of bankruptcy?