Nouriel Roubini's Global EconoMonitor

No Credit Crunch in the Euro Area? Part II

In January, we argued here that the Eurozone was facing similar money and credit market pressures as the U.S. The main argument against a credit crunch in the Eurozone despite tighter lending standards and wider interbank spread was that overall credit growth, and especially bank lending to non-financial corporates, remained elevated and healthy at around 15% annual growth.

The latest ECB data confirm however that the credit cycle has definitely turned in the Eurozone as well. In particular, bank lending to non-financial corporates peaked in May, and bank lending to other financial intermediaries slowed in June. Similarly, the July bank lending survey confirms that lending conditions remain tight but without worsening further.

Chart 1:


Source: ECB Monthly Bulletin, August 2008

In the money markets, interbank spreads widened again substantially since January and refuse to recede despite an (overly?) generous ECB collateral and term lending framework.

Chart 2: 3Month Euribor (orange) – 3Month EONIA Swap Rate (white) (Spread in chart below)


Source: Bloomberg

Recent research in the U.S. identifies re-intermediation pressures and writedowns of off-balance sheet asset-backed securities and structures as the main driving forces of interbank spreads. The additional stress on banks’ balance sheets results in increased counterparty risk in the form of wider CDS spreads.

As of August 25, 2008, global writedowns among financial institutions were at $504bn and new capital raised was $352 since the start of the credit turmoil. Of these, writedowns among U.S. banks were $253bn ($178bn new capital), closely followed by writedowns among European banks (incl. non-EMU) at $228bn ($153bn). Writedowns among Asian financial institutions were much smaller at $23bn ($21bn).

Chart 3:


Source: ECB Financial Stability Review, June 2008

How many more writedowns and credit losses are expected, both in the U.S. and abroad? The Federal Reserve Board published a paper this month with the title: “Foreign Exposure to Asset-Backed Securities of U.S. Origin” (by Beltran/Pounder/Thomas). An analysis of the Federal Reserve’s Flow of Funds data reveals that foreigners hold about 39% of outstanding ABS backed by U.S. assets. Therefore, foreigners will bear 39 percent of any mark-to-market markdowns associated with those securities.

Consistent with the IMF’s ultimate global financial loss estimate of $1 trillion (see Global Financial Stability Review, April 2008, Table 1.1), the authors expect foreigners’ mark-to-market losses to reach $475bn. Ultimate credit losses are expected to reach $75bn. Compared to the current $250bn writedowns taken outside the U.S., it is fair to say in the words of S&P that “we’re at best maybe half-way through this cycle.”

Charts 3 and 4 give a sense of the potential loss distribution among EMU and non-EMU banking sectors. Given current writedowns and cross-border banking flows, most of the pressure from U.S. originated assets lies on UK and Swiss banks more than on the Eurozone among whose members German, Dutch and French banks bear some exposure. This discrepancy between EMU bank losses so far and Eurozone interbank spreads might lie at the heart of the ECB’s regulatory arbitrage suspicions with respect to non-EMU banks. That said, the Eurozone has plenty of housing and economic problems of its own as the record €49bn ECB lending to Spanish banks reminds us.

Chart 4:


Source: ECB Financial Stability Review, June 2008

28 Responses to “No Credit Crunch in the Euro Area? Part II”

GuestSeptember 3rd, 2008 at 11:17 am

12:16 p.m.[GM] GMAC move to cut ResCap staff by 5,000, 60% of workforce12:15 p.m. [GM] GMAC evaluating strategic options for Home Services unit12:15 p.m. [GM] GMAC Financial to close all 200 GMAC Mortgage retail offices

GuestSeptember 3rd, 2008 at 11:20 am

Ospraie Management shuts down its largest fund due to collapsing commodity prices! Lehman was a 20% stake holder in that fund!

GuestSeptember 3rd, 2008 at 11:24 am

Tuesday, September 2, 2008 11:46 AMDavid Tice has made himself famous for successfully shorting stocks. Now the investment manager sees a bear market for the next five years, with share prices dropping 50 percent to 70 percent over the next 18 months.That would put the Dow Jones Industrial Average somewhere between 3,425 and 5,708.”We believe stocks have benefited from an unbelievable credit bubble” that is now bursting, Tice told Bloomberg TV.”Policymakers and central bankers have perpetuated a bubble like we’ve never seen before, with mortgage financing that has put government sponsored enterprises (Fannie Mae and Freddie Mac) in trouble,” he says.”The whole structure of the financing mechanism, where foreigners bought all these [mortgage] securities, has broken down. Institutions and foreigners no long trust our structure, insurance, ratings, etc.”As a result, Tice says, “We’re in big trouble.”

Miss AmericaSeptember 3rd, 2008 at 11:32 am

Nouriel, Like it or not… your loyal blog community appears confused on where to blog. The blog under your name has always taken on a life of its own, but now with the rapid fire of new topics from guest writers… blogging has become disjointed.Do what you want with your site. …but if I were asked for an opinion, I would suggest adjusting back to keep your writings (and following blog) separate from the guests or even the “RGE Lead analysts”.Miss America. – If it ain’t broke, don’t fix it. … that is, the blog! Not the economy. ;^)

GuestSeptember 3rd, 2008 at 12:50 pm

Well, well, well, looks like we are back to teh “saving the Dow at 11,400” game a gain. Thought we were done with that?

AlessandroSeptember 3rd, 2008 at 1:04 pm

Nouriel,without being asked I’ll second Miss America unrequested opinion.I see the point of promoting more RGE content to the wider audience of the flagship blog, but the new course is making the life on the comments quite a bit more messy.

GuestSeptember 3rd, 2008 at 1:06 pm


Nouriel RoubiniSeptember 3rd, 2008 at 2:19 pm

Since those who comment on my blog are often off subject i would suggest that the latest comments should always be on the latest blog item in this forum regardless of whether that item is written by me or by some other contributor.I hope this helps my community of readers and commenters.bestnouriel

GuestSeptember 3rd, 2008 at 2:27 pm

Nouriel, with the dynamic situation in the US and on a global scale, it is hard to just talk about one topic throughout the day! Thanks for the blog though-it is a rich source of expertise. You have doen well for yourself.

AfASeptember 3rd, 2008 at 2:30 pm

@ Mr. Skeptical, (from previous post)Probably Mish is correct in his analysis. However, I do not agree with the conclusion. The fact that Real interest (treasury) rates are positive does not mean there is no treasury bubble.Forget about the inflation part, the problem is one of accurate risk computation. The markets are still viewing treasuries as risk-free financial assets. Take mortgages as an example for the period between 2001 and 2006, then between 2007 and now. Mortgage rates during the bubble inflation period were mainly driven by inflation rates. Now, there is a real disconnect between mortgage rates and inflation rates (as Mish argues are down and low) and even Fed rates (supposedly irrelvent). The same story applies to CDS, risk premia …So the question to ask is what kind of risks would probably apprear in the near future (there is no such a thing as “risk free”). In order to project how short and long real interest rates will behave in the future, there are many variables we have to take into consideration, using a scenario analysis (what would impact supply of and demand for treasuries depending on each scenario, the systemic risks, liquidity, arbitrage opportunities, the attractiveness of treasuries relative to other financial instruments and of US relative to other countries … To Be Continued and expanded..)Depending how all this will play out, i.e. when sh!t hits the fan (cf. Gloomy, MA …) whether the vigilantes will wake up, whether the Fed will be forced to dramatically increase or decrease rates, whether the Fed will be forced to monetize some or all of bad debts, whether the great unwinding would accelerate …That, in my opinion what shows Treasuries are in a bubble, when will it explode or whether it will be safely deflated is anyone’s guesstimation.

GloomySeptember 3rd, 2008 at 2:43 pm

Nouriel,I agree with MA and Alessandro. I love to read all the content on RGE and appreciate your making it available to us. But the new format is too disjointed for blogging. Often the most recent post isn’t updated in a timely manner under your name on the RGE homepage-this adds greatly to the confusion.

GuestSeptember 3rd, 2008 at 3:34 pm

4:33 p.m.[AMR] American Eagle Aug. traffic slides 13.6%, traffic down 4.5%4:32 p.m. [AMR] American Air traffic falls 2.9%, capacity down 1.1% in Aug.

GuestSeptember 3rd, 2008 at 3:35 pm

Yup, yup, sure looks like housing has bottomed! LOLOLOLOL!4:32 p.m.[HOV] Hovnanian books Q3 loss of $202.5 mln vs $77.9 mln4:32 p.m.[HOV] Hovnanian Q3 revenue $716.5 mln vs $1.13 bln

ArmchairSeptember 5th, 2008 at 11:35 pm

Keep it coming! I love the onslaught of germane economic observations. It is like finally pouring disinfectant on the operating floor of the war hospital. Charts like the ones in this contribution are very insightful. Raising concern about interbank rates sounds like the correct option. It is not the type of problem that hides itself. It seems like it goes to the big decoupling debate, and a lot of other things.