Why Parex?

11. November, 2008

I didn't think it would be Parex. Of course, these are hard times for the banks, but… perhaps I was under the lingering impression of how deftly Parex had eluded the Russian crisis of 1998. Somehow I must have expected that Parex would emerge unscathed after this crisis. Oh well...

In any case, I think the whole Parex affair raises four major practical questions for those of us who go on. First, there is some learning value in understanding why exactly Parex ended up like this. Second, there is a question whether nationalization was the right thing to do. A related (third) question is what it all means for us, the taxpayers. And fourth, who’s next?

Why Parex? There is much that is not clear about what has happened. Some government officials have blamed it all on the depositors, who rushed to withdraw their money from the troubled bank. The run on Parex certainly served as a trigger for what has happened, but I don’t think this amounts to an explanation. I have three working hypotheses for what has happened. First, there is a bad luck hypothesis. Parex took a huge (more than a billion euros) syndicated loan in anticipation of great investment opportunities e.g. real estate in Latvia . As I understand, typically such loans are rather short term (for about two years) with the expectation of rolling over, i.e. extending the loan being the normal practice. But then the global liquidity crunch came, and then also the financial crisis. Liquidity became extremely scarce. Creditors refused to roll over the loan and Parex couldn’t liquidate enough of its assets. After all, who can sell real estate these days? Hypothesis number two is that Parex ended up with lots of toxic securities in the U.S. subprime. Hypothesis number three – the most interesting one – is that Parex accumulated too many of homegrown ‘subprime loans’. Of course, the Financial and Capital Market Commission (FKTK) keeps telling us that the share of ‘bad loans’ in the banking system is below one percent. Then again, just a week before the same people were trying to convince us that Latvian financial system is perfectly sound. What makes the latter explanation interesting is that it may signal about the quality of the loan portfolio that the other banks have as well.

Was nationalization the right thing to do? If the alternative was to let Parex fail, then I believe authorities did the right thing. Failure of Parex would risk triggering panic and bank runs. Resulting loss of confidence in the banking system would risk plunging this country into a deep recession – not unlike the Great Depression in the 1930s. However, there is no reason to be happy about this development. State ownership means that the government pledged the taxpayers’ money to pay for whatever mismanagement that has taken place in Parex. The ultimate cost to the taxpayer will depend on how sound the bank’s assets are.

Finally, who, if anyone, is next? The answer to this question depends on how do we read what has happened with Parex. Was it bad luck, excessive involvement in the U.S. toxic mortgages, or too many of our very own Latvian toxic mortgages? Clearly, a combination of any of these with large short-term syndicated loans is not a very good sign.

In Latvian here

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