James Saft

James Saft is a Reuters columnist. The opinions expressed are his own.

A sharp cut back in lending by euro zone banks in their scramble to raise capital will prove an important channel spreading pain from the vulnerable single currency area to the rest of the world.

Though the euro-induced credit crunch will be less important than the outright effects of the euro zone recession, in some areas, like trade finance, and in some regions, such as emerging Europe, the impact will be felt far more quickly.

“European banks have huge exposures outside Europe itself,” said Srinivas Thiruvadanthai, an economist at the Jerome Levy Forecasting Center.

“They are being asked to increase their capital base. You can go and raise capital or you go and get a government handout or you shed assets. Raising assets will be very, very tough.”

Euro zone banks will be cutting back on foreign exposure, either out of prudence or under pressure from their regulators.

Austria this week imposed restrictions on its leading banks, including Raiffeisen, Erste Group Bank and Bank Austria in central and eastern Europe, requiring them to make new loans of no more than to 1.1 times the deposits and wholesale funding raised locally.

Romania could see a deleveraging equal to 1.6 percent of GDP, while the Czech Republic, Hungary and Turkey all face hits of about a half a percent of annual output, according to data from Nomura International.

It won’t stop in Europe. About 20 percent of bank assets in Chile, Uruguay and Mexico are controlled by euro area banks.

Less lending by international banks will drive the overall cost of credit up, almost certainly working against official policy which will be trying to reduce rates.

In some areas, like trade finance where some European lenders are prominent, this impact may be felt rapidly, as it was in 2008 when fear of counterparty risk prompted many banks to pull out of trade financing for a time. That had a magnifying impact on the global downturn, as some exports were delayed despite their being willing buyers and sellers at a given price, simply because the letters of credit needed to facilitate the deals fell through.

This will only be intensified by European bank recapitalization proposals, which impose a tight deadline of next June for 70 euro zone banks to find about 100 billion in new capital. And remember, that amount of capital, huge as it is, may prove insufficient given the recent free fall in the value of euro zone sovereign debt, to which euro zone banks have critically high exposure.

BANKS FOR SALE

Given the difficulty in raising capital directly from investors, euro zone banks are looking to sell whatever they can that will fetch a reasonable price.

Since investors, and their peers, don’t want to buy more European exposure, that means selling off bits and pieces of financial institutions outside the euro zone.

Spanish bank Santander, seeking to boost its core capital to 10 percent by June, said this week it will sell a 7.8 percent stake in Santander Chile, worth around $1 billion dollars.

That deal sent shares of the Chilean affiliate down sharply, increasing the dampening impact on bank valuations there, and ultimately on credit availability.

While the impact in Asia, where continental European banks hold just 5.0 percent of their assets, will be less, it will still be felt, especially in areas already being hit hard, like Hong Kong property development, according to analysts at Barclays Capital.

And the great banking recapitalization of 2012 likely won’t be limited to Europe, as shown by the Federal Reserve’s newly announced stress test of US banks.

Austria‘s move to restrict lending abroad has to be viewed as a kind of economic protectionism, a sort of reverse tariff, but this time on precious bank capital. That sets an extremely risky precedent, but one it is easy to see other euro zone nations following.

If Germany fears the costs of recapitalizing its banks in the event of a euro zone break up, as well it should, a logical step would be for it to try and conserve its national banking resources via similar moves.

That same logic holds, even more chillingly, for countries outside the euro zone. Tight credit, and tight controls on credit, may end up being a leading story of 2012.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

James Saft is a Reuters columnist. The opinions expressed are his own.

It looks as if we will need to see some kind of miracle intervention from the European Central Bank — a Deus ex ECB — or the euro zone is heading for a nasty divorce.

Either the ECB comes across with a mandate-busting rescue, probably involving direct lending to Italy and rolling the currency printing presses, or the forces aligned against currency union will roll over Italy and into France.

Italian political chaos and a move by some clearing houses to demand more margin on Italian debt helped to drive 10-year yields of the troubled sovereign borrower to a euro-era record of 7.5 percent on Wednesday. The market appears to doubt that the EFSF rescue fund will be big enough and operative enough to back Italy effectively.

The sheer size of what would be required to backstop Italy, which has the world’s third-largest bond market, throws doubt in turn on support for Spain, whose bonds are also selling off, and the ability of France to maintain its AAA rating, without which Germany is left alone as the bulwark against a gigantic bank run.

The ECB has been buying Italian bonds in the secondary market but still sees itself as only providing transitional support until other European rescue initiatives can take its place.

There is no time for that, and the ECB, and the nations which ultimately govern it, must decide if they are going to stick to their stated principles or preserve the euro.

“What is needed is a clear statement from the ECB that it would act as the lender of last resort for a sovereign that meets explicit and tough conditions and can thus safely be deemed to be solvent,” Holger Schmieding, economist at Berenberg Bank wrote in a note to clients.

“We still believe that the ECB would step in to save the euro and itself in the end, and that the Bundesbank may even acquiesce to that once all other alternatives to keep the euro together have been exhausted.”

To save the euro the ECB must declare that it will act as a lender of last resort for euro zone sovereigns, wade into primary bond markets in huge size, effectively monetizing government debt by printing money to fund borrowing. To work, this has to be accompanied by believable pledges not just of economic reform, but to bring on fiscal integration and to change forever the role of the ECB.

Doesn’t sound very likely, does it, especially in the next week or two.

A SMALL MATTER OF THE LAW

Not only is this anathema to many within the ECB, it is expressly against the treaty which describe what it may and may not do. Article 101 of the European Treaty expressly forbids the ECB from lending to governments and Article 103 prohibits the euro zone from becoming liable for the debts of member states. That means that either the ECB has to in essence go rogue, violating its founding principles, or the mechanisms of structural change have to pull off a miracle in the next week to change its mandate.

The amount of debt the ECB would take on to its balance sheet might also eventually require a recapitalization of the central bank itself, no small matter.

If that all somehow comes to pass, then the rest of ailing Europe, seeing how Italy was bailed out solely because it is big, will immediately try to reopen the terms of their own bailouts. Not to mention the fact that these actions would almost certainly face enormous political and legal challenges in Germany and elsewhere.

Not only does this all seem far-fetched, it is far from clear that it is a good idea. As soon as the ECB starts printing money the euro will tumble, and the Federal Reserve will be under pressure to engage in its own round of quantitative easing to counter the drag on its own economy that a newly strong dollar represents, raising the specter of hot currency wars.

One alternative is an IMF-led bailout of Italy, perhaps supported by some cash from the EFSF. This too may be too big a task for the IMF to garner sufficient support from its own funders. Imagine the election year challenge the Obama administration would face in explaining why it provided hundreds of millions in support to Europe via the IMF.

The other choices are equally unpalatable. Simply letting Greece go, which might have worked several months ago, is now not enough. The consequences to the global banking system and economy if Italy and perhaps others left at the same time are mind-boggling.

Why equities have traded as well as they have given these risks is a mystery. Perhaps massive money printing will be good for riskier assets; a euro break-up surely will not.

One way or another, it is looking as if we are going to find out.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)

Why aren’t Americans still saving?

James Saft is a Reuters columnist. The opinions expressed are his own.

A look at the fall in the U.S. savings rate raises one crucial question: are Americans crazy, or just broke?

The answer may hold the key for whether the country is headed for another recession or a policy-engineered recovery.

The personal savings rate fell in September to 3.6 percent, the lowest since December 2007. Given that household balance sheets are still under stress from tumbling housing prices — and tiny rates of savings for much of the last decade — this makes little sense as a strategy.

If anything, the past 20 years should have taught Americans that their expectations about how fast their assets can grow, and how likely they are to be dealt a financial blow like illness or unemployment, were too rosy. Conventional wisdom in the wake of the great financial crisis was that savings were headed higher and would stay high for a long time. Many people in the U.S. were working a financial high-wire act without a net and needed to reduce risk.

Things have not turned out that way. The savings rate did claw its way higher in 2008 and 2009, ranging mostly in the 5 to 5.5 percent range, but started to head south this summer and has now been falling for three straight months.

A turning away from savings makes a certain amount of sense. After all, almost all of the policies put into place since late 2007 have been designed to transfer money out of the pockets of savers to cushion borrowers. Real negative interest rates punish those who have saved, forcing them to either live with very low returns or take on commensurately higher risks.

At the same time policies intended to aid the housing market have managed to reduce outgoings for many borrowers without actually lifting prices, which would share the benefit between borrowers and those who own their homes outright. A new round of mortgage bond buying by the Federal Reserve, something that is in the offing, might only further reduce loan costs without lifting prices.

All of this makes a depressing backdrop for savers, and some may have decided that the rewards and risks of thrift don’t add up and can’t keep up with the pleasures of spending. In its own way, this would be a triumph of monetary policy, as the Federal Reserve will have coaxed people to do something that is arguably against their own best interest in service to the, perhaps, larger goal of cushioning the blow of deleveraging.

MAYBE THEY ARE JUST BROKE

So, if households are spending because they don’t see the point in saving, score one for the Fed. There may be a simpler explanation, and a look at last week’s surprisingly strong U.S. gross domestic product figures helps to explain.

While consumer spending helped to drive GDP to a 2.5 percent annual growth rate, the stuff people were spending money on was telling. Spending on health care and utilities was the main impetus behind the consumer contribution to growth, and after all those are things it is really hard to cut back upon. And this is happening within a context where there are increasing signs that Americans are putting off or forgoing medical care for economic reasons.

Really it seems that people were not saving because they simply did not have the money. That makes it much harder to look at recent data, some of which has been reassuring, and conclude that the risk of another recession is past.

“The hallmark of the Q3 GDP report is that a massive and unsustainable gap has opened up between incomes and spending,” Gluskin Sheff strategist David Rosenberg wrote in a note to clients.

“If we don’t soon start to see personal income growth revive, then consumer budgets are going to be staring a contraction in the face.”

If that contraction does begin to emerge, then the safe bet is that the Federal Reserve will dish up more of the same kind of policy in response. Already several Fed officials have raised the possibility of another round of mortgage bond buying. While it is hard to argue that the housing market is at the center of the economic malaise, cheap financing so far does not have a good track record.

One thing is clear, at some point the savings rate will have to rise. Putting that off for a time may help ease the pains of deleveraging, but only by extending them. That is a temporizing measure rather than a solution.

Asset markets aren’t priced for the rise in savings, but some day, when the policy drugs wear off, they will be.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)