Watch Latvia Carefully

From the Guardian (UK)

Latvia threatens foreign banks with huge losses
Ian Traynor in Riga, Wednesday 7 October 2009 19.35 BST

Crisis-hit Baltic state proposes emergency law to slash mortgage holders' liabilities to lenders

The Latvian government was struggling to avert a financial meltdown today as ministers convened emergency talks with Scandinavian banks to discuss a bold and controversial plan to slash mortgage-holders' liabilities to lenders.
The scheme could mean billions in losses for the big Swedish banks most exposed by the small Baltic state's financial and economic crisis.
Valdis Dombrovskis, the embattled Latvian prime minister, said he was confident he could get his proposal through the parliament in Riga, but was still examining the legal implications of the scheme. But the powerful Latvian central bank delivered an unusually blunt attack on the prime minister, saying that his budget and bank policies were feeding a fresh "wave of distrust" towards the small and highly vulnerable state.
Banking sources in Riga warned that the radical proposal on mortgages, which could see borrowers repaying only a fraction of their loan, would backfire, deterring foreign investment, bringing already low bank lending to a complete standstill and wrecking international confidence in Latvia.
Dombrovskis said the foreign banks, which hold controlling stakes over 90% of the Latvian banking sector, shared the blame for the crisis and would also have to share the costs. "Some balance has to be found between the interests of borrowers and the interests of lenders," the prime minister told the Guardian. "The real incomes of people are diminishing and it is getting more difficult to repay loans."
Dombrovskis's surprise proposal came amid growing international concern about Latvia after he revealed plans to cut public spending next year by only half the level agreed with international creditors earlier this year as part of a €7.5bn (£6.9bn) rescue package put together by the EU, the IMF and the Nordic countries. Sweden, currently chairing the EU, reacted by threatening to withhold more than €1bn in credit scheduled for next year.
In a further sign of rock-bottom confidence, the government in Riga received no bids for one of its three auctions for debt securities.
"We have limited room for manoeuvre," Dombrovkis said in an interview. "We're on track to reach our budget targets. We're now discussing with our international loan providers how to get there."
A financial collapse in Latvia would reverberate through the other Baltic states, Lithuania and Estonia, which are both struggling with recessions of their own. It would also have implications for the EU and thwart Riga's ambitions to join the eurozone in 2014.
Latvia's spending spree came to an abrupt halt last year when one of the world's biggest property bubbles, relative the size of the economy, burst. House prices have collapsed by up to two-thirds. Almost all mortgages are in euros, most supplied by the big Swedish banks, which own half the Latvian banking sector outright and hold €80bn of assets in the three Baltic states.
Dombrovskis has proposed new laws limiting liability in the case of mortgage default to the current market value of the property – meaning colossal potential losses for the banks, since most property borrowers are in negative equity.


We need to watch the events unfolding in Latvia. The politicians are desperate to find a way to repair the damage done to their economy due to high leverage and borrowing in foreign currency (the Euro). A bond auction failure has occurred recently and poverty is rising quickly.
If the proposal goes through, foreign banks could be writing down loans by up to 70% and quickly destroy their weak TCE levels. We remind our readers that European banks are in at least a much difficulty as American banks with leverage levels commonly ranging from 30 to 50:1. A small decline in TCE will wipe out equity in these banks.
This could be the source of Credit Crunch part 2 that we have been concerned is developing since the collapse of Lehman's and the Big Bank Bailout that did nothing to address underlying issue of high leverage.


  1. PW, do you believe that Latvia's collapse will cause the credit markets to freeze up all over the world like what happened with Lehman's collapse last year? Why or Why not?

  2. Anonymous askes a good question.
    Will a Latvian failure cause credit refreeze? It is difficult to say with any amount of certainty what the impact would be. The issue is, banks do not provide GAAP financial statements and they carry extreme leverage. Therefore knowing the true health of banks is next to impossible. What is apparent, is the determination of many banks to remain opaque. It is also apparent that in the US at least, government & the Fed are the enablers of banks allowing them to remain opaque by lending money at near zero interest rates, suspending mark to market accounting, and bailing out those that were near failure last fall. My suspicion is that most major US banks are underwater right now. I also suspect that European banks are in the same position. A serious blow to the balance sheet of a major European bank could cause a cascading domino effect that would turn banks into zombies at best or force governments to nationalize.
    Is a Latvian default large enough to cause this. I estimate it is not a large enough hit to cause paralysis, but I worry that I'm wrong.


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