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The Deficit Paradox John Mauldin May 26, 2009 1:30 pm |
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"As we have repeatedly said, Spain is set for a long, painful deflation that will manifest itself via a spectacularly high unemployment level, a real-estate collapse and general banking insolvencies. Consider this: The value of outstanding loans to Spanish developers has gone from just €33.5 billion in 2000 to €318 billion in 2008, a rise of 850% in 8 years. If you add in construction-sector debts, the overall value of outstanding loans to developers and construction companies rises to €470 billion. That's almost 50% of Spanish GDP. Most of these loans will go bad.
"Spanish banks are now facing a very bleak outlook. Spain's unemployment rate reached over 17% last month; there are now 4 million unemployed Spaniards and over one million families with not a single person employed in the family. Spain and Ireland had the worst housing bubbles in the world and now Spain has as many unsold homes as the US, even though the US is about 6 times bigger.
"Why are Spanish banks not insolvent? Spanish banks aren't marking their real-estate loans to market. We've often wondered how it is that our thesis for Spanish real estate and industrial collapse hasn't created more victims. The answer is simple according to an article in Expansion, the Spanish equivalent of the Financial Times, from the April 19 titled 'Spanish banks control half of all real estate appraisals.' You can't make this stuff up. We haven't even begun to see the worst in Spain yet."
European banks are in far worse shape than their US counterparts. That's because they utilize far more leverage, on an average about 30 times leverage. How can that be in what's supposed to be a conservative industry?
"European banks were only restricted on the basis of risk-weighted assets, unlike the US where it's the total leverage ratio that matters, so most European banks bought assets that were rated by Moody's and S&P, who couldn't rate their way out of a paper bag, and for anything that wasn't highly rated, they bought credit default swaps or guarantees from AIG and MBIA. Because of that European banks were able to lever up a lot more than their US counterparties. Given the much higher leverage levels and general worsening of collateral values, we think that all the shoes in Europe haven't dropped."
European banks have assets of about 330% of their GDP, compared to US banking assets, which are about 50%. They have over $700 billion in loans to Asian businesses (which are watching their exports collapse) and $1.3 trillion in loans to Eastern Europe (which is in a very serious recession). So many of those loans are simply not going to be worth anything. There's going to be a need for massive amounts of money to bail out European banks, or we'll watch their economies implode.
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