26th March 2012 by Shaun Richards
The evolution of the Euro zone crisis has had many twists and turns over the past three years. However as the travails of the Euro zone had developed there has also been consequences from its problems for nations outside of it as well as those in it. At the moment the focus of such collateral damage is on the slow down apparent in several Euro member countries and the implications for their trading partners. But well before this countries in Eastern Europe were affected by another consequence of the Euro crisis which was the rise and rise of the Swiss Franc.
The Carry Trade
Back in the middle part of the previous decade borrowers in Eastern Europe found that they could borrow much more cheaply in currencies such as the Euro and the Swiss Franc than they could in their own currency. As this was a time of what was then considered to be dynamic innovation by banks we saw many banks in Europe rush to provide such mortgages. What could go wrong?
The Swiss Franc
At the time the value of the Swiss Franc was depressed by the all the borrowing which took place in it, which has an equivalent effect to selling the currency. So we saw something very dangerous which was that not only due to low Swiss interest-rates was borrowing cheaper in Swiss Francs than in say Hungarian Forint or Polish Zloty’s but it appeared that capital gains could be made too. For a while the capital gains were genuine but just typing this sends a shiver down my spine as I imagine the army of bank salesmen and women that will have invaded these countries and the subsequent promises they must have made to what were mostly unwary customers.
One of the effects of the credit crunch was a demand for what were considered to be safe haven assets and one of these was the Swiss Franc. Then the crisis in the Euro saw investors there also look to the perceived safety of the Swiss Franc. So a falling currency became a rising one and we also saw investors looking to reverse the borrowing above if they could. So the Swiss Franc surged from 1.67 versus the Euro in the autumn of 2007 a to 1.05 four years later.
There were many casualties from this, for example think of the Swiss economy (which ironically has found itself to be something of a side issue in the affairs of its own currency!). However today I was to concentrate on the impact on mortgage borrowers in Hungary as an example and they mostly borrowed in Swiss Francs.
Not only did these mortgage borrowers see the capital value of their mortgage rise by 37% their monthly payments rose by the same amount. So a genuine financial crisis emerged particularly if we consider that many Hungarian businesses had borrowed in Swiss Francs too. This created a problem for the banks too as if you borrowers are in trouble so is the bank. Those who have seen the myriad of problems in the Austrian banking system will be aware that its root lies here too. Another Austro -Hungarian empire falling? Not yet but give it time…
The Swiss intervene
The solution of these times is virtually always central bank intervention and the Swiss National Bank tried ahead to resist the rise in the Swiss Franc. After defeat after defeat it fixed a 1.20 ceiling for the Swiss Franc versus the Euro which has for now stabilised the situation. Eastern European borrowers will be grateful for this although as it hovers nearby at 1.2054 it is a problem which may yet return.
The impact on Hungary’s housing market
Price falls have so far been less than you might have expected as according to the Royal Institute of Chartered Surveyors prices have fallen by 15% between the end of 2007 and 2011. If we add inflation to this we see real house price falls of about 30% over this time.
The reason for the lack of heavier falls is government intervention. Governments usually hate falls in house prices and the Hungarian government has been no exception. It has allowed mortgage holders to end their mortgages at favourable exchange rates at the banks expense and made it difficult for banks to repossess properties. Even so according to the Hungarian central bank 4% of properties have been repossessed as of the end of 2011 and a further 13% of mortgages are non-performing.
The problem with intervention: yet another false market
On the face of it such governmental intervention seems sensible. But there is a catch and that is that if you create what are false prices you end up with a false market and the impact of this ricochets around your economy. One measure of this is the number of house transactions or sales which dropped to 90,000 in 2011 which is a third of the peak of 2003. Another issue is that house-builders usually do not want to build in such a situation and in Hungary we are seeing this. According to the RICS 21,000 house were built in 2010 which was 52% of the 2004 peak and then 2011 saw a 38% reduction in its first nine months compared to even the previous year’s depressed level. As the number of permits to build fell by 62% the outlook for 2012 looks even worse and the fall of 1.5% in January in construction output is not a good portent either.
The Hungarian economy
In spite of the problems discussed above the Hungarian economy managed some economic growth in 2011 as in the fourth quarter it grew by 1.4% versus a year before. This was due to agricultural and industrial exports presumably boosted by the fall in the Forint’s exchange rate. Unfortunately for that scenario the Forint has strengthened in 2012 from 320 versus the Euro to 295.
If we look at her “misery index” we see unemployment of 11.1% combined with inflation of 5.5% leaving a high reading and an uncomfortable mix. Her government has a fiscal deficit although in a move since repeated by Portugal and the UK the numbers in 2011 were flattered by this.
From the wealth of private pension funds – except for real returns and additional membership fees – HUF 2677.7 billion, and related to this HUF 39.0 billion of other revenues were accounted in the system of national accounts as the revenues of the general government sector.
Easy to turn a deficit of 1180 billion Forint to a surplus of 1537 billion like this is it not? Shame about the liabilities from this which of course are ignored! Financial alchemy combined with misrepresentation I think. The prospects going forwards had a rather ominous ring to them from this section.
besides a significant decline of personal income tax revenues corporate tax revenues decreased as well.
So far the performance of Hungary’s economy has been quite good once you allow for the cataclysm which has taken place in her mortgage and housing markets. The problem is that government intervention has second and third order effects which will weaken any further recovery. Added to this in a year which is likely to be weak for Euro nations she may find that having 76.7% (as of January 2012) of your exports going there will make it a awkward year.
Domestic demand is not going to be helped by mortgage and loan rates which are around 12% for Forint denominated borrowing and of course there we find ourselves where we came in! Could the carousel start again? Foreign-currency borrowing was banned but some is now permitted again…. In terms of bond yields Hungary has to pay a high price for its borrowing as its ten-year bond yield is now 8.93%.
What about Austria?
Here we find problems abounding for Austria via her banks. We are back to a rather familiar loop of bank problems leading to banks being guaranteed leading to problems for the sovereign nation. As we stand we find little evidence of this in her bond yields as compared to Hungary she is in a fortunate position of only having a ten-year bond yield of 2.81%.
Yet if we look at the impact of the crisis described above on her banks such as Erste bank Bawag,Hypo Alpe, Oesterreichische Volksbanken AG and RZB we see that there are genuine problems which look set to continue. It was only recently that the nationalised KA Finanz AG revealed heavy losses on its activities in Greek credit default swaps.
For me that seems quite a lot of banks in trouble for such a small nation and if any further problems appear that ten-year bond yield is in danger of looking awfully thin. So via the impact of the recent activities of the European Central Bank we find yet another false market.