The first quarter was hot across the Eurozone. The euro has gotten purposefully crushed by the ECB’s currency war. QE, first promised then implemented, became all the rage. And stocks surged: the Stoxx Europe 600 was up 16%; Italy’s FTSE MIB index up 22%; and Germany’s DAX also up 22%, the sharpest quarterly gain since Q2 2003. Since January 2012, in a little over three years, the DAX has nearly doubled. Only Greece couldn’t get it together.
And bonds have soared to ludicrous levels, with yields turning negative on €2.2 trillion in Eurozone government debt, according to Societe Generale. German government debt is now sporting
negative yields up to a 7.5-year maturity, while 10-year yield – at 0.14% as I’m writing this – is on its way to negative as well.
So on March 31, Hans-Jörg Vetter, CEO of Landesbank Baden-Württemberg in Germany, spoke at the bank’s annual press conference – and fired a warning shot across the bow of investors.
Publicly owned LBBW, a full-service and commercial bank, serves as the central bank for the savings banks in the states of Baden-Württemberg, Rhineland-Palatinate, und Saxony. With €266 billion in assets and over 11,000 employees, it is the largest suchLandesbank in Germany. And it too was dutifully bailed out by taxpayers during the financial crisis.
And so the press conference had the usual feel-good fare.
“Over the past few years LBBW has gained a very good position to operate successfully on a sustained basis amid a difficult environment,” Vetter said in the bank’s press release. “On this basis we are aiming for targeted and risk-conscious growth in our core business areas,” he said. There was a slight improvement in pre-tax profit to €477 million in 2014, from €473 million a year earlier. And for this year, he expected a “moderate” increase in pre-tax profit. He talked about how solid the bank was, and he talked about opening new offices…. It was that sort of press conference.
But then, maybe he got off script. That’s when the mundane bank press conference, designed for the taxpayers who own the bank but don’t care and certainly wouldn’t pay attention to it, turned into something that the major German paper FAZ decided to report.
Banks, insurance companies and all kinds of funds were taking on huge risks to get through the zero- and negative-yield environment, Vetter said. Alas….
“Risk is no longer priced in,” he said. And these investors aren’t paid for the risks they’re taking. This applies to all asset classes, he said. The stock and the bond markets, he said, are now both seeing “the mother of all bubbles.”
This can’t go on forever. Or for very long. But he couldn’t see the future either and pin down a date, which is what everyone wants to know so that they can all get out in time. “I cannot tell you when it will rumble,” he said, “but eventually it will rumble again.”
By “again” he meant the sort of thing that had taken the bank down last time, the Financial Crisis. It had been triggered by horrendous risk-taking, where risks hadn’t been priced into all kinds of securities. When those securities – mortgage-backed securities, for example, that were hiding the inherent risks under a triple-A rating – blew up, banks toppled.
Yet the bailed-out bank would not again engage in such risky transactions and would rather endure lower returns, said Vetter, who was brought in as part of the bailout in 2009 to clean up the mess and put LBBW back on its feet.
He warned that it’s hard for banks to make money by lending due to the combination of low interest rates and the effects of competition. There are too many banks in Germany and Europe, he said. They’re all going after medium-sized businesses, and prices for financings have become “critically low,” he said.
At the same time, a whole new generation was growing up without the idea of earning interest on savings in the this zero-interest-rate or negative-interest-rate environment. Without that incentive of interest, they aren’t learning to save. And banks won’t be able to play their traditional role as an intermediary to plow those savings back into the economy as loans. So he warned, “I am afraid that we will become only gradually aware of the medium- and long-term consequences of this European debt financing.”
We’ve been saying this – “the mother of all bubbles” – for a while, though we may not have used this exact technical term. And we’ve long lambasted this zero-interest-rate and negative-interest-rate environment. But he isn’t just some wayward blogger. He runs a big state-owned bank with responsibilities to taxpayers, a bank that had already taken too many risks that hadn’t been priced in, and when those risks began to exact their pound of flesh during the Financial Crisis, the bank cratered.
Central banks have re-created that environment, and similar risks are building up. With terrible consequences that we will know only afterwards. But no top banker, and certainly not a top banker at a state-owned bank, has been allowed to say it publicly. It would be heresy against current central-bank dogma.