The European Sub-prime Mess
In October of last year, German Finance Minister Peer Steinbrück was clucking about the financial crisis being “America’s problem”. The spate of bank rescues orchestrated across Old Europe, which inconveniently followed right on the heels of Mr. Steinbrück’s clumsy pronouncement, turned European attitudes from condescending to accusatory. It was the Anglo-Saxon model of finance and the attendant profligacy that had brought the world’s economy to the precipice.
Now, it turns out that Europe may be sliding into a hole wholly of its own devising. Western European banks’ balance sheets are dramatically deteriorating as their risky holdings in Eastern Europe head south. While it’s somewhat unfair to call it Europe’s sub-prime debacle—the impending storm is based in bad equities purchases rather than in bad debt—the end result could very well be the same: a crippled, frozen financial sector, just like in the United States.
Il Sole 24 Ore, Italy’s leading business daily, reports that UniCredit and Intesa Sanpaolo, two very influential banks, will face severe difficulties as more Eastern European economies buckle under the weight of falling stocks and commodity prices. Tuesday morning, following a sharp selloff in Polish, Czech, and Romanian stock markets, Moody’s issued a stern warning on “widespread deterioration in the economic health of core markets in Eastern Europe.” As of Friday morning in Milan, Intesa Sanpaolo is down by 4.28%, and UniCredit is down by an even more astounding 5.50% for the week.
To call Italy’s banking sector extremely exposed is an understatement. In 1999, UniCredit acquired 50.09% of Poland’s Bank Pekao. In 2007, it acquired 91.80% of Kazakhstan’s Atf Bank, and in 2008 took 94.2% of Ukraine’s Ukrsotsbank. Together that’s a value of over 4 billions euros.
Intesa Sanpaolo’s major recent acquisitions included 66.3% of Croatia’s Privredna banka in 2000, 94.47% of Slovakia’s Vub Banka, and a total acquisition of Ukraine’s Pravex last year – operations valued at over 1.343 billion euro. As the financial crisis continues apace and Eastern European banks face insolvency, these massive holdings of equity are becoming worthless.
In a study released by Moody’s Investor’s Service Tuesday, the rating agency noted that West European parent banks of East European subsidiaries account for 84% of total West European banks’ claims on Eastern Europe. The Austrian banking system is most exposed, as Eastern Europe accounts for nearly half of that country’s global bank claims, while the claims of Italy’s banks account for 27% of the total (mostly concentrated in Poland and Croatia). The report ominously intones that “modernized banking systems in Eastern Europe have only emerged over the past two decades and have not yet reached a similar level of maturity as their West European counterparts; this makes them more vulnerable in times of stress.”
Yet Italy’s business elites are in denial. As Il Sole 24 Ore has it, it’s Eastern Europe that’s at risk, not the West. “There is an eastern risk linked to the potential disengaging of Western companies, who will defend their domestic activities,” writes Vito Ops in the Italian financial paper. As early as last fall both Berlusconi and Sarkozy had declared in no uncertain terms that protecting their domestic markets would be the focus of their economic strategies for 2009.
But that’s not how economics works. With exposures this large, there is no easy way to disengage. In Italy alone, 27.5% of UniCredit’s assets are from its holdings in the east. Factoring in BankAustria, a subsidiary of UniCredit, and that figure rises to a staggering 48.9%. For Intesa Sanpaolo, 10.5% of its assets are tied up in eastern banks. Not only is there no one to sell to, but the mere act of selling would actualize huge losses for the banks.
A distrust of credit, comparatively high rates of saving, and prevalent home ownership gave many European countries the ability to stave off the crisis for a while. Back in late 2007, Italian Finance Minister Giulio Tremonti was explaining that Italian banks had not been exposed to subprime investments. Ever-conservative, Italian banks had avoided creative financing, and Italian banking’s ‘less-sophisticated character’ had protected it from self-destructing. But the staggering amount of holdings in Poland, Romania, Serbia, and Ukraine may be the undoing of Italian banks. It may well be time to recognize that, rather than being an emerging market, that Eastern Europe is a necessary part of Europe.
-Henry N. Baker is a freelance writer living in Milan.