If there’s one thing European governments really shouldn’t do these days, it’s mention the word ‘default’, says Buttonwood on Economist.com. “It’s a bit like hesitating when your spouse asks if you’re having an affair; your subsequent guilt tends to be assumed.”
Last week Hungary’s government said that talk of default was “not an exaggeration”. Those remarks came a day after it said that Hungary had only a “very slim chance” of avoiding a Greek-style crisis. The Budapest stockmarket and the forint tanked. By Monday,the government was frantically back-pedalling.
Another headache for the eurozone
The comments are best explained as “a careless attempt to buy domestic support for a renewed fiscal squeeze”, says Capital Economics. Hungary’s sovereign debt position isn’t too bad. Overall, public debt of 78% is well below Greek levels and the budget deficit has fallen to around 4%.
Nonetheless, Hungary is “yet another worry” for the troubled eurozone, says Ian Campbell on Breakingviews. Its “big weakness” is the large level of domestic lending by local and eurozone banks in foreign currencies, notably the Swiss franc and the euro. According to RBS, Swiss-franc loans accounted for 61.5% of the banking sector’s overall outstanding loans at the end of last year.
Falls in the forint following the global credit crisis have made these loans and mortgages much more expensive for Hungarian borrowers. “Foreclosures are exploding,” says local economist Peter Rona in The New York Times. “This risks becoming a huge social and economic problem.”
Why fear is stalking the banks
Potential losses in eastern Europe have reinforced jitters about the eurozone banking system. With the peripheral economies looking ever more sickly, a big chunk of the massive pile of private and public loans to these countries looks set to go bad, says Jack Ewing in The New York Times. According to RBS, more than e2trn of public and private debt from Greece, Spain and Portugal is on the balance sheets of financial institutions outside these countries worldwide. So there’s ample scope for contagion to spread across the system. The problem, says Ewing, is that nobody “knows exactly which banks are sitting on the biggest stockpile of rotting loans”.
The OECD says that the capital cushion in the German and French banking systems barely covers total exposures to Greece, Portugal and Spain, says the FT. This implies that plenty of banks are thinly capitalised and vulnerable to crippling losses. Investors “know that some eurozone banks are dead men walking, but they are having to guess which ones”.
What next?
The reason for all this uncertainty is that eurozone banks were never publicly stress-tested, like their American or British counterparts. So it’s no wonder the system is seizing up – banks don’t trust each other. On Monday, the three-month euro-Libor interbank lending rate jumped by the most in a month; it is now at a six-month high. Overnight deposits at the European Central Bank hit a record high late last week, implying that banks are increasingly willing to accept sub-market interest rates to ensure their cash is safe.
Public stress tests, which the EU is now working on, should help restore confidence. Meantime, as Capital Economics notes, we face, at best, a new credit squeeze that will further undermine the eurozone recovery. At worst, we could be heading for another banking crisis.