Stefano Giantin | Portfolio

"Yeah, man, crisis" (cartoonist: Gatis Šļūka)

“Eastern Europe is now the biggest problem in the global crisis”, says Edward Hugh, a macroeconomist who became popular among Internet users explaining the crisis from the pages of several economics-specialized blogs. Hugh goes straight to the point, describing a ‘tsunami’ that is likely going to storm the Old Continent. It won’t be a natural disaster, but a financial and economic one, that will first crash the banking system and then the real economy. The epicentre will be somewhere in Eastern Europe, and the fault igniting the earthquake will be a major European bank, for instance the Italian bank UniCredit.

Europe is frightened by the crisis, but still largely unaware of the real dimensions of the looming economic catastrophe. Media and politicians keep trying to underestimate the emergency while European economies spiral down. “I understand the point of denying the situation”, explains Hugh, “if the people come to the conclusion that their leaders have absolutely failed, it’s going to be a complete collapse”.

UniCredit’s exposure

During the last decade, major Western European banks have lent billion of euros to individuals and firms in Eastern Europe. Foreign currency loans became widespread among the majority of Eastern European countries because of their lower interest rates. UniCredit, the second biggest Italian bank, has an enormous exposure in the former-Socialist block, up to 21% of the total assets at the end of 2008.

With the ongoing devaluation of Eastern European currencies and with a mounting crisis in the manufacturing sector, there is a genuine risk for banks like UniCredit to lose what they have lent, as people and firms stops to pay back their loans.

“I can’t put you hard evidence on the table that UniCredit will be in troubles in the next weeks, but there are warning signs”, explains Hugh. One of the indications that the banks is in trouble comes from a statement of Alessandro Profumo, UniCredit’s CEO. He said the bank is considering “state support as insurance against unpredictable events”.  UniCredit planned to ask money in Italy, Austria and Poland to survive the looming financial crash.

Part of Eastern Europe is “bound to collapse”

“In Ukraine there is a risk of 60% of mortgages and corporate loans defaulting”, says the macroeconomist Hugh. UniCredit – together with Raiffeisen, Intesa San Paolo, Erste Group Bank, Societe Generale and KBC Groep NV – is one of those banks, which are going to suffer the most from the credit crunch. “There is a high risk of UniCredit needing a bailout in 2009, let’s say 80% chances”, explains Łukasz Goczek, professor of economic sciences in Warsaw. “Some countries in the region are bound to collapse. Especially Latvia, Ukraine, perhaps Hungary, Bulgaria and even Russia. This looks pretty grim for UniCredit with a lot of exposure to some pretty unrecoverable deals in the region”.

The situation is bleak for Eastern European citizens and governments as well. With the crisis approaching its peak, one will likely see not only the local branches of the international banks bankrupting, but also a lot of foreign-based and local industries closing down. European cars will likely not be anymore produced in Poland, Czech Republic or Serbia, textile industries and shoes factories will be shut down in Romania and Bulgaria. How will the young democracies in Eastern Europe cope with the social problems arising from such a large crisis?

A monetary Stalingrad
The counteroffensive by the European governments that are more exposed to the crisis of the banking sector appears to be ineffective. The Austrian government managed to allocate up to 150 billion euros for a rescue plan for its banks exposed in the former-Soviet block. Austrian banks have lent € 230 billion in Eastern Europe and only Erste bank’s exposure is “much larger than Austria’s economy. No one can save it if it has problems”, says professor Goczek. The European Bank for Reconstruction and Development estimates the losses caused by ‘bad debts’ for Austria to be around 20% of its GDP. Austrian media assess that the Bank Austria, together with its owner, UniCredit, are facing a “monetary Stalingrad”.

It will be perhaps look more a monetary Waterloo, as the Italian government will continue to be unable to cope with the mounting problems in the banking sector. Berlusconi’s administration needs to find quickly the liquidity for a rescue plan similar to the Austrian one if UniCredit needs a bailout. “Italy did not manage to save € 20 billion, this is another big sign of weakness”, explains Hugh. “It was just obvious that either Italy took seriously back in 2006 things like pension reforms and the control of public finances or the next time there was a downturn it was all going to go bad. Here we are, Italy didn’t do anything”, adds the macroeconomist from Barcelona.

Are EU bonds the last hope?

If Italy doesn’t have the liquidity to save its banks, it will be forced to find quickly investors willing to buy new Italian national bonds and to bring fresh cash into the empty state accounts. Unfortunately, the international investors are loosing trust in the capacities of Italy and of other countries, like Greece, to pay back the loans.

Maybe for this reason the Italian financial minister Giulio Tremonti, not exactly a supporter of European integration, since weeks is pushing for a ‘revolutionary’ solution, the creation of EU bonds that will substitute the discredited national bonds of some countries like Italy or Greece. “It’s a good idea”, says Prof. Goczek, “and a major step for the European Central Bank to have more fiscal powers and regulatory powers over the banking sector”. The EU bonds, which will get a triple-A rating – the best possible – as they will be guaranteed by the whole European Union, will help countries in trouble to find the money to save the banks and to avoid a free fall towards bankruptcy without emitting national bonds.

Europe in stand-by

It remains to be seen if the European Union would able to emit the EU bonds before it is too late.  It does not look like this will happen. The German economy is contracting together with its export rate, UK is busy nationalizing its banks and France is entering a recession. All circumstances are against a common European action for saving the banks and those EU countries in trouble. “Other European countries saying ‘we don’t want to help Italy or Greece or Hungary’, they just don’t know what they are talking about. They will just cut off their own nose”, explains Hugh. “EU already issued € 12 billion bonds for Hungary without consulting anybody”, he adds, “and at this point I am in favour of all of this, I am a democratic, but I don’t mind technicians doing this, because it needs to be done.”

If Western European countries cannot save themselves, how to deal with the looming crisis in Eastern Europe, in the Balkans, Russia and Ukraine? “We are on a Titanic”, answers Hugh, “and there are not enough lifeboats. If we don’t save first the EU, we will not be able to save anybody else”.