While the turbelence in financial markets has caught many by surprise, Central Europe is better off than most. Still, there are lessons to be learned. An exlusive interview with Ewald Nowotny, CEO of BAWAG and former Austrian representative to the European Central Bank
The turbulence in the European economy has caught some of the largest banks in Western Europe by surprise. However, in most of central Europe and Austria it has behaved more like a cold sore – a bothersome indication of mild malady, but not threatening to the body as a whole.
The original scare was mostly for European exporters, most of whom weathered the storm by cutting costs and moving their production to non-euro countries. (See "Southern Exposure," VR September issue) But now the lack of foresight is teaching some European banks a lesson.
Since the first rapid climb, large enterprises have been affected by Europe’s surging currency – like Airbus, which earns its revenues in Dollars but pays half of its operating costs in Euros. The company has been forced to diminish costs, over €2 billion of annual cuts are planned by 2010, by selling several factories and eliminating 10, 000 jobs.
Now, the banks too have experienced a liquidity hiccup that has forced many to go into debt with central and national financial institutions.
What are the reasons for the Euro’s appreciation spinning out of control? And who is responsible?
CEO and General Director of BAWAG and former Austrian representative to the European Central Bank (ECB) Ewald Nowotny, says it was all predictable.
"There have been many warning signals," he said in an interview with The Vienna Review. The "irrational exuberance" that former US Federal Reserve Chairman Alan Greenspan first spoke of in 1996 at the beginning of the dot.com boom created a great desire for new complicated products – Asset Backed Securities (ABS) and the CBOs (Collateralized Bond Obligations), two financial instruments that played a central role in the recent crisis.
These investment instruments do make sense if they are kept in perspective. Nowotny is not worried about the ABS structures, as he believes the market will soon recover. "What has caused higher concern" he says, "is the liquidity problem – not the underlying assets."
In recent weeks as the liquidity dilemma hit European investors, the ECB under President Jean-Claude Trichet pumped billions of Euros into Europe’s money markets, which may have helped prevent a financial meltdown.
Most recently, the British bank Northern Rock triggered the country’s biggest banking crisis since 1973 when it tapped the Bank of England for emergency funding. Depositors lined up for three consecutive business days to withdraw £2 billion, or about $4 billion, until Alistair Darling, Chancellor of the Exchequer, guaranteed their savings.
It was the third time a European bank had sought a bailout since the "sub-prime" mortgage crisis in the United States drove up the cost of overnight loans. In Germany, the IKB Deutsche Industriebank of Düsseldorf and the state-owned Landesbank Sachsen Girozentrale also needed rescuing.
"It is the business of banks," says Nowotny, "to support long-term assets with short term money." The German banks did not, however, ensure this core balance and became "too highly leveraged on the liquidity side."
"There is a certain tradeoff between growth and stability," Nowotny comments. "What really happened, was that the last few years went beyond the limits. Households in the US and UK are much more in debt than continental households. But also have had much higher growth."
Despite the parallels, Jean-Claude Trichet and many others believe the economic situation in Europe is very different from that in the United States.
Former Federal Reserve Chairman, Allan Greenspan warned that the Euro was at risk of a recession as a result of the "sub-prime" mortgage crisis across the pond. In reply, Trichet was clear in stating, "The word recession is not appropriate at all for us."
"There will be consequences for the exchange rate with the USD," Nowotny says. Despite the sharp depreciation, he believes that "if there is enough cooperation between the FED and the ECB, this tendency can be brought under control." Cooperation on interest rate policy is key, if the gap between the USD and the EUR should shrink.
Nowotny also warns that although the closed character of the US economy means that the depression of the dollar has no immediate effect in the US, Oil imports are still denominated in dollars, so it could cause an increase in oil prices, or mean a switch to alternative fuels.
As we watch the obvious occur, even U.S. President George W. Bush has begun to contemplate the financial benefits of alternative energy. Supply not meeting demand means the price will grow. Nowotny calls this "the most powerful instrument [for change] we can have."
However, he doesn’t expect the slump to last long.
"If the FED adopts an aggressive policy of lowering interest rates or the ECB stays or even increases, the Dollar will go up," he said.
The Austrian and European economy in general has little to fear. BAWAG’s CEO reminds us that the Austrian Economy is becoming "less dependent on the US, and is involved with the high-growth countries of the CEE. So the counter effects will be very small."
"There is an old saying, that ‘If the US economy sneezes, Europe gets pneumonia.’ This is changing. Now we just sneeze as well," he said.
So there are lessons to be learned and a need for stricter regulatory mechanisms, meaning "stricter limitations concerning leverage, and more direct sanctions for more prudent policy with regard to the owners," Nowotny stipulates.
"It is correct to take care of the depositors, but there should be some penalties for the owners." In the case of Nothern Rock: "someone will take them over, so they will lose their independence."
Remarkable as it may seem in all this, Central Europe remains a zone of stability. Nowotny emphasizes that, "for the foreseeable future, the growth rates in the CEE and Austria will be relatively high.
"We have passed the highest point in the economic cycle, so after several very good years, we will have now only a slight moderation, about 3% (WIFO)."
He speculates that, "at the end of the day, we will have a market again" and estimates that it will resurrect itself before the year is out.
Perhaps the evolving world market needed a wake-up call.
"It’s not a black and white story," Nowotny says. "This deregulation had positive economic effects – allowed for more consumer oriented structures. But you have to know where the limits are."
Perhaps going to the extremes, he suggested, is simply "human nature."