Europe is now the worlds basketcase; IMF scales back its growth projections
We mentioned six months ago that Europe was the danger of the entire financial system. It is the the fiscal basketcase of the world and is dragging down the whole system. The problem is not just the public debt, which is shameful, but not much different than the United States, the problem is the private debt, that has some of these guys levered up to 43% in Germany and in the high 30s in UK. Via Daily Markets:
Looking primarily at banks, if I had to compare Europe, Canada and US, I would be most concerned about Europe. European Commercial and Residential real estate has not experienced the magnitudes of asset price declines as they have in the US, but also because their economic recovery will likely not be as strong as it is in the US or Canada. Although sentiment is improving, European commercial real estate investment is a fraction of what it once was and is vulnerable to an anemic recovery. The residential sector will likely suffer in Spain as the residential price levels will buckle under depression level unemployment. Of course, the European regulatory environment is piecemeal. Higher leverage in Germany and UK banks give them little wiggle room for deteriorating assets. The Spanish Banks could more readily survive another black swan event, where the German and UK banks would not.
It took a while, but finally the IMF agrees, via GARP:
Europe's weakened economy is now the central threat to global recovery, as its countries struggle with heavy debt, banks face a reckoning over their lack of capital and growth is slowing, the International Monetary Fund said Wednesday in its first assessment of the world economy since a crisis over government borrowing in Greece.
While the agency estimated that growth in the United States and emerging Asian and Latin American countries remains on track, it scaled back projections for Europe and outlined a series of issues there that could -- unless controlled -- spark problems rivaling those that caused the 2008 collapse of Lehman Bros.
"Downside risks have risen sharply" in recent months, the IMF said. "The ultimate effect could be substantially lower global demand."
In updating its World Economic Outlook, the IMF slightly raised its overall forecast for global growth, to 4.6 percent for the year, compared with 4.2 percent in its April report. The improvement was based on a stronger than expected performance in the first months of the year, particularly in Asia. The IMF said it also expected the United States to grow slightly faster than earlier predicted -- about 3.3 percent this year and 2.9 percent next year, less than forecast by the U.S. Federal Reserve.
But the outlook for Europe was reduced, as the combined impact of government spending cuts, continued concern over national debt and uncertainty about the banking sector undermines an economy already lagging behind the rest of the world. The IMF projected that the 16 countries that share the euro as a currency will grow just 1 percent this year and 1.3 percent in 2011.
The report and an accompanying analysis of world economic stability emphasized how a problem that was considered limited in scope when it surfaced in Greece last fall eventually expanded to other European countries and is now one of the main issues facing the global economy. Governments across Europe are cutting spending and overhauling social programs in an effort to curb record levels of debt, and the Obama administration is studying similar U.S. measures.
"On the heels of Greece's fiscal troubles, investors are now re-pricing these risks across the region," the IMF said.
The issues of government debt and the health of the banks are related: European banks own tens of billions of dollars in Greek, Spanish and other government bonds, and the stress tests will assess how those holdings affect each company's overall financial health.
The European banking system is plagued by a "legacy of unfinished cleansing," the IMF said, which has left "pockets of vulnerability, overcapacity, and poor profitability." Banks have become hesitant to lend to each other -- much as happened during the U.S. financial crisis -- and are relying on an ultimately unhealthy mix of short-term loans from the European Central Bank to ensure they have enough cash.
"Recent global stability gains are threatened by a confluence of sovereign and banking risks in the euro area that, without continued and concerted attention, could spill over," the agency said.