Tuesday, April 28, 2009

Is Switzerland Headed Toward Bankruptcy?

During the boom years, a huge carry trade developed between Switzerland and Eastern Europe.

Easter European home buyers borrowed in Swiss Francs (at low rates) and converted their local currencies to make mortgage payments. Now they can no longer make their payments.

In an interview with the Swiss daily, Tagesanzeige, economist Arthur P. Schmidt warns Switzerland faces bankruptcy becasue of this (Translation from German by Edward Harrison) :

Swiss banks have given billions of credit to Eastern Europe - now the customers cannot pay back the money. Switzerland is threatened with the fate of Iceland, says economist Arthur P. Schmidt.

In countries such as Poland, Hungary and Croatia, the Swiss franc has become an important currency. Thousands of households and small firms took out loans in Swiss francs, and not in the national currency zloty, forint, or kuna because of ower interest rates. In Hungary, 31 percent of all loans are in Swiss currency. Amongst household loans, they are almost 60 percent.

Borrowers in distress.

Now, the financial crisis has ended the era of cheap credit. As a result, Eastern European currencies are falling. At the end of September, one had to pay 46 francs for 100 Polish zlotys. Today it is 30 francs. That means more and more borrowers are having problems with interest payments and repayment. So the question is what effect this has on the Swiss financial marketplace. One who sees a dark future for Switzerland is economic expert Artur P. Schmidt. He believes that the Swiss franc is in danger because of the loans in Eastern Europe.

In Poland, Hungary and Croatia, the Swiss franc has become an important foreign currency - the dollar, so to speak, of Eastern Europe. Thousands of households and businesses have franc loans.


The rapid growth in many countries of Eastern Europe was stimulated through loans in Swiss francs. Swiss banks and offshore institutions loaned the local banks francs, which passed the francs onto their customers. The loans were attractive because borrowers pay interest rates much lower than required for loans in local currency.

Now, this system has been shaken?

Yes, the system has only worked as long as the exchange rate between the franc and the currencies were reasonably stable. But that is not currently the case. For example, the Hungarian forint and Polish zloty have lost over a third of their value  against the Swiss franc in recent weeks. Because of the devaluations of the national currencies, the debt to Switzerland has increased by more than one-third. Many of the Eastern European countries have serious payment difficulties, and are virtually bankrupt.

What does this mean for Switzerland?

It is likely that a significant proportion of the total 200 billion U.S. dollars of Eastern European loans were issued in Swiss francs. According to a report by the Bank for International Settlements worldwide franc loans equivalent to around 675 billion U.S. dollars are in circulation - which was about 150 billion directly from Switzerland, 80 billion of Great Britain and about 430 billion U.S. dollars through offshore financial centres. How many of these loans have gone bad is not known. But even if the failure rate is 20 percent, the banks would lose a lot of money.

Is the federal government going to intervene now?

If the banks require a massive writedown of such loans, above a certain magnitude, the government must intervene. This is already happening via the Swiss National Bank. In Poland, it has made several billion francs available to the local central bank so that Polish banks can cover the loans. At the same time, the Swiss National Bank inquired by the European Central Bank whether it could borrow money in an emergency. This is a clear warning sign that the Swiss franc could be under huge devaluation pressures in the near future.

Rather than outright bankruptcy, I see the Swiss central bank printing the money necessary to prop up Swiss banks. Thus, the destruction of the Swiss franc as a safe haven currency against irresponsible money printing by the central banks of other countries will occur. A great currency may be no more (Which could be considered an even worse form of bankruptcy.) .


  1. The key fact, however, is that the vast majority of Swiss franc loans, as far as I can see, were NOT made by Swiss banks. On the contrary. The Swiss banks made loans to EU banks, like Raifaissen, Erste, etc.

    The western European banks owe on these loans, not the eastern European borrowers. Thus, when the default tidal wave occurs, it will hit the ECB first. They will be forced to bail out the European banks in Austria, Italy and elsewhere, or risk systemic damage.

    Bad loans do NOT "destroy" money, as is often claimed. The total number of francs will remain the same. Such events simply frighten potential lenders, who then slow down their willingness to make loans. But, Swiss banks are likely to be repaid for the bad loans, by the ECB, in Euros. This will not be franc negative. It will be Euro-negative.

    The velocity of franc circulation will be reduced, and the value of the Swiss franc will rise, not fall, as a result.

  2. It is true that bad loans will not destroy a currency. However, if a government attempts to prop up bad loans by printing money that can destroy a currency.

    If the loans have largely been made by non-Swiss banks, as you write, then there is no danger to the Swiss franc.