East Europe – Ready for Round 2 Financial Crisis

If anything that could be the time-bomb to my optimism to market, it will be the unfolding drama from the Eastern Europe. I have written at least two articles related to this region, and I believe this debacle is big enough to shatter the fragile banking systems of Western Europe and potentially to set off round 2 of our financial crisis.

Last week, Austria’s finance minister Josef Proll made frantic efforts to put together E150 billion rescue for the ex-Soviet bloc, as his banks have lent some E230 billion to the region, equal to 70% of Austria’s GDP. The Vienna press said Bank Austria and its Italian owner Unicredit face a ‘monetary Stalingrad’ in the East, but the interestingly part of this episode is that Germany’s Peer Steinbruck said this is not our problem and we will see about that.

Some statistics suggest that Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities and it must roll-over some $400 billion this year, and that equal to a third of the region’s GDP. We know jolly well that the credit window has slammed shut. Not even Russia can easily cover the $500 billion debts of its oligarchs while oil remains near $33 a barrel. Russia has bled some 36% of its foreign reserves since August defending the rouble. This is the longest run on a currency in history.

In Poland, 60% of mortgages are in Swiss Francs. Hungary, the Balkans, the Baltics and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America’s sub-prime. And the crucial difference, however, European banks are on hook for both.

They are five times more exposed to this latest bust than American or Japanese banks, and they are 50% more leverage, according to statistics from the IMF.

Whether it takes months, or just weeks, the world is going to discover that Europe’s financial system is sunk, and there is no EU Federal Reserve yet ready to act as a lender of last resort – a German-Dutch veto – and the Maastricht Treaty.

Under a “Taylor Rule’, the ECB already needs to cut rates to zero and to make matter worse, banks are pulling back, undercutting subsidiaries in East Europe. The sums needed are beyond the limits of the IMF, which already has bailed out Hungary, Ukraine, Latvia, Belarus, Iceland and Pakistan – Turkey could the next candidate and is fast exhausting its own $200 billion reserve. It wouldn’t surprise me if the IMF has to resort to printing money for the world, using arcane powers to issue SDRs.

If Deustche Bank is correct, the economy will have shrunk by nearly 9% before the end of this year. This is the sort of level that stokes popular revolt and the implications are obvious, as the lethal brush fires move closer. Are the firemen ready?