BRUSSELS
-- A common currency drove investors to Europe's outer reaches, then scared
them away.
The first
decade of the euro intertwined the Continent's financial systems as never
before. Banks and investment funds in one euro-using country gorged on the
bonds of others, freed of worry about devaluation-prone currencies like the
drachma, lira, peseta and escudo.
But as the
devaluation danger waned, another risk grew, almost unseen by investors: the
chance that governments, no longer backed by national central banks, could
default.
The first
hints of such a peril came with Greek budget problems, and as investors grew
increasingly wary of Greece, debt worries spread until they set in train a
reversal of the historic process of European financial integration -- with
manifold consequences now being played out.
Banks,
insurance companies and pension funds in Northern Europe have slashed their
lending to overextended countries to safeguard their money. Many now are
comfortable investing only at home or in the safest markets such as Germany.
"We
are seeing this deglobalization, a 'de-Euroization,' of the euro zone,"
said Andrew Balls of Pimco, head of the big bond shop's European portfolio
management. "Investors are going back to their own markets. They may still
hold bonds, but they won't have them spread across the euro zone as they had
before."
If fiscal
recklessness in some quarters sowed the seeds of the euro crisis, it was
investment decisions inside the euro zone that worsened it and made it
intractable.
Having
beaten a retreat, the big investors in Northern Europe aren't likely to return
to bond markets in the periphery any time soon, participants say. Carsten
Brzeski, an economist at ING Bank in Amsterdam, believes that a "home
bias" will persist even if political leaders can find a solution to the
immediate crisis. "Investors do not forget easily," he said.
Said
Philippe Delienne, president and chief executive officer of Convictions Asset
Management in Paris, which manages 776 million euros in assets: "Everyone
has stopped investing in certain parts of the euro zone."
He added,
referring to Germany's bonds: "You can't say any longer that Italy is like
the bund . . . To protect ourselves now, we are buying bunds."
For the
heavily indebted nations that must repeatedly replace maturing debt, the
investment ebb tide portends a long struggle.
The scale
of the shift suggests that the euro zone isn't merely suffering from a
short-term confidence crisis but that the financial lifeline of some European
states is ebbing away, perhaps not to return for years, leaving some countries
exposed and in danger of financial breakdown.
At worst,
the squeeze could spell a wave of sovereign bankruptcies that threatens to
cripple Europe's banking system, provoking a deep recession in the process. One
result could be a departure by one or more countries from the monetary union,
or even its breakup.
Investors'
retreat showed no sign of letting up this week after a summit of European Union
leaders last Friday failed to deliver measures that appeared able to resolve
the crisis.
The euro's
first decade was much different. The currency was introduced in 1999. Investors
-- their devaluation worries banished -- viewed the bonds of Mediterranean
economies as a close substitute for those of Germany and other solid economies,
and were drawn to them by slightly higher yields.
Another
lure was that pension-fund clients preferred investments in the currency their
liabilities were denominated in, the euro.
Regulatory
incentives gave a push, too. The European Central Bank lets any bank in the
euro area deposit government bonds in return for short-term loans, under
so-called repurchase, or "repo," agreements. This was profitable for
banks, since bond yields exceeded their interest cost for repo loans, and was
initially a spur to buy euro-zone bonds.
The ECB
monetary operations helped make it easy for weaker nations to borrow at
rock-bottom rates. And the operations fostered the view that a euro-zone sovereign
borrower would never be allowed to fail, say Simon Johnson, a former IMF chief
economist, and Peter Boone in a paper they wrote for the Peterson Institute for
International Economics.
Because
the default risk was seen as zero, European banks didn't have to hold capital
in reserve against euro-zone government bonds they owned. That gave banks a
further motive to buy them, especially after the 2008 financial crisis ate into
banks' capital buffers.
A rare
dissenter from the clamor to own these bonds was Heineken NV's pension fund. It
dumped tens of millions of euros' worth of bonds from less-solid governments as
early as 2005. "The yield pick-up . . . was so low compared with the risk
involved, we decided to sell everything around the Mediterranean and invest
only in Dutch and German government bonds," said Frank de Waardt, managing
director of the 2.2 billion euro fund. "We sold Greece, Italy, France and
Portugal. We even sold Finland," he said.
The fund's
performance suffered versus its peers, as many others glommed onto the debt of
nations on the periphery.
In Greece,
where the preponderance of its bonds were once Greek-owned, foreign holdings of
them reached 55% by 2003. By the third quarter of 2009, it was 76%.
That was
just weeks before a new government in Athens disclosed the country's budget
deficit was far worse than believed. The assumption that euro-zone government
bonds were almost interchangeable and none could default steadily began to
crumble.
First,
Greece was forced to go hat in hand to the International Monetary Fund and
other euro-zone nations. Then, Germany made plain it didn't intend to foot the
bill indefinitely for the debts of what it saw as profligate governments.
German
concerns were crystallized into euro-zone policy.
In October
2010, on the boardwalk of the French resort of Deauville, German Chancellor
Angela Merkel and French President Nicolas Sarkozy agreed that any bailouts
after 2013 would require involvement of the private sector, which would have to
take reduction in the value of its government-bond holdings.
That
possibility sent investors scurrying away from a wider group of governments,
leading to a surge in their interest costs that was slowed, in some cases, by
ECB bond buying.
The share
of Greek bonds in the hands of investors outside Greece has since fallen
steeply to well below 50%.
Figures
from Fitch Ratings show how foreigners have retreated from weaker euro-zone
sovereign-bond markets across the board, leaving the bonds in the hands of
domestic investors.
It isn't
only in sovereign debt that Europe's financial integration has gone into
reverse. Euro-zone banks' holdings of assets of all types, including corporate
loans, in Cyprus, Greece, Ireland, Italy, Portugal and Spain hit $1.9 trillion
in 2007, up sixfold from 2001, but then declined 44% as of June 30, according
to Barclays Capital. Barclays based its calculations on data from the Bank for
International Settlements, or BIS.
Portugal's
Banco BPI SA had been an enthusiastic buyer of government bonds from elsewhere
in the euro zone. By September, it had sliced its portfolio about 30%,
according to regulatory disclosures.
Now,
"we will invest most likely in German bonds or something similar,"
said Fernando Ulrich, chairman of the executive committee.
Volatility
is a factor in the disenchantment. That itself increases risk, according to
institutions' pricing models.
Downgrades
by rating firms have also deterred investors, some of which have limits on how
much low-rated paper they can hold.
Italy's
bonds long remained fairly stable. For instance, French banks were buying more
of them earlier this year, and owned 9% more at midyear than at year-end 2010,
BIS data show.
The
stability didn't last. Italy's market turned volatile in July and August
following disagreements between then-Prime Minister Silvio Berlusconi and his
finance minister Giulio Tremonti over a series of issues.
A turning
point for euro-zone investment came in July. European leaders, in negotiating
an expanded Greek bailout, confirmed that investors in its bonds would take
losses.
"It
was a wake-up call for the industry," said a top French bank executive,
who soon started dumping his Italian government bonds. Deutsche Bank AG said it
substantially reduced its "net exposure" to Italy, both by selling
bonds and buying default protection.
Policy
makers' moves this fall may have exacerbated cross-border disinvestment.
The
European Banking Authority, or EBA, had subjected banks in July to "stress
tests" to see how well they could weather trouble.
But by
early October, the regulators were eager to send a signal they had a handle on
the crisis and to force weaker banks to bolster their capital. One option was
to re-crunch the stress-test numbers, in a way that reflected the possibility
-- not considered before -- of losses on euro-zone government debt.
For such
an exercise, banks would have to value these bonds not at their expected
long-term values but at the current depressed market values.
The banks
lobbied against such a step, fearing it would expose big holes in their balance
sheets. A top executive at France's BNP Paribas SA warned regulators that
"the moment you change the rules, we have to sell" bonds from
peripheral Europe, said a person familiar with the matter.
When the
board of the EBA met in the first week of October, the routinely scheduled
gathering, held in the EBA's offices with panoramic views of central London,
took on an emergency tenor.
EBA
officials acknowledged a strong risk that banks would dump government bonds in
response to toughened stress tests, said people familiar with their thinking.
But they felt in a bind, because critics had derided the initial July stress
tests as too weak. Tougher ones might help restore shaken confidence in banks.
The board
members also were under the impression that EU leaders in Brussels were poised
to unveil a comprehensive plan to stabilize the Continent's financial system,
said those familiar with their thinking.
As a
result, the regulators hoped, sovereign-bond prices would come back somewhat
and banks wouldn't face pressure to sell.
The EBA
plowed ahead. On Oct. 26, it announced it was recalculating banks' capital
needs.
Bank
reactions were swift. The Association of German Banks wrote to EBA Chairman
Andrea Enria of Italy, saying regulators' policy risked "a fundamental
change in the perception of sovereign exposures."
Across
Europe, banks started selling bonds issued by Italy, Spain and other heavily
indebted euro-zone governments, regulatory filings show. The stampede was
partly an attempt to reduce the amount of capital banks needed to reserve
against possible losses on such bonds, as well as an effort to avoid the wrath
of risk-averse investors, executives say.
BNP
Paribas rid itself of more than 8 billion euros of Italian debt from June
through October. Belgian lender KBC Groupe SA cut its portfolio of Southern
European bonds by about half.
Even some
Italian banks, which long had been dutiful buyers in Italian treasury auctions,
moved to the sidelines. Regulatory filings show banks in Italy, Germany and
Spain cut their holdings of French, Belgian and Luxembourg government bonds by
half or more.
Heading
back to its home market, Spain's No. 2 bank, Banco Bilbao Vizcaya Argentaria
SA, virtually eliminated its 504 million euro portfolio of Finnish government
debt.
In some
cases, such as KBC's, executives said they racked up tens of millions of euros
of losses by selling in a hurry at cut-rate prices.
Despite
the fire sales, the regulators found that Europe's biggest banks still faced a
substantial capital shortfall.
The July
stress tests had showed them in need of just 2.5 billion euros in additional
capital; results of the new exam, revealed this month, raised this to about 115
billion euros.
What would
it take to get Europe's big investors buying the peripheral euro-zone
countries' debt again? Investors haven't been convinced by European leaders'
efforts at last week's summit to play down the likelihood that bondholders
would face losses on future country bailouts.
The
Transport Industry Pension Fund of the Netherlands sold Greek bonds last year,
followed by Spanish bonds and then short-maturity bonds of Italy, according to
its chief investment officer, Patrick Groenendijk. It still owns some
longer-term Italian bonds.
Asked when
it might invest new money in the Italian market, Mr. Groenendijk was blunt.
"If you want an honest answer, when they have their own currency," he
said.
No comments:
Post a Comment