Last year I wrote that Viktor Orbán’s economic high-wire act just might work. Well, it seems it hasn’t. The financial markets are about to give up on him, and the forint is starting to head south.
When you mix populist rhetoric with financial incompetence you get a truly potent recipe for a financial meltdown. And that is exactly where Hungary is at this very moment.
Even Orbán’s confident finance minister, György Matolcsy, thinks that a downgrade is inevitable.
Orbán rolled in with bombastic promises of one million jobs and a chicken in every pot. He soon realized that the debt is Hungary’s main headache. Significant portions of the state debt, the municipal debt, the corporate debt and of course the consumer debt are Swiss franc denominated. His government has astutely noticed that the most dangerous of these is the mortgage debt.
As a man of action, Orbán immediately started to fix the problems and made two terrible mistakes. Government meddling with the economy is always dangerous. The Nobel-prize winning economist Milton Friedman, another Hungarian, wrote that “the government solution to a problem is usually as bad as the problem.”
The first mistake Viktor Orbán made was how he implemented his foreign denominated mortgage ban. The Swiss franc ban made some sense, but the euro denominated mortgage ban didn’t. If I correctly recall, even Sándor Csányi, the quiet OTP oligarch, was in disbelief. The drastic foreign denominated mortgage ban reduced originations, real estate turnover dropped, and new construction disappeared. It literally choked the market and started a deflationary spiral. Real estate prices continued to drop.
The second mistake was just as deadly. The unusually long (more than one year) foreclosure moratorium produced a poisonous side effect resulting in 200,000 defunct mortgages. Orbán theatrically pronounced that no Hungarian can end up homeless in the streets because of “greedy banks.” Hungarians got the message; they stopped paying their mortgages.
Bank books are loaded with Non Performing Loans (NPLs), and when you have 200,000 of them in a tiny country like Hungary, the banks are really in big trouble. If banks foreclose on the mortgages, what do they do with the real estate? Whom do they sell it to? If they let the defaulted real estate hit the market, it will create a huge deflationary shock, driving NPLs even higher.
And herein lies the problem. Some of Hungary’s banks have eurozone parents who will pick up the tab, pulling their subsidiaries out from the rubble. They may increase capital to the regulatory limit, but they won’t lend. This will badly hurt the economy in the future.
More than a quarter of the Hungarian banking market is owned by OTP, a "Hungarian owned" bank, that has no foreign partner. OTP expanded into dead-end banking ventures from the Ukraine to Bulgaria, and all of her subsidiaries are doing badly. The big puzzle is how bad is OTP’s balance sheet? I wouldn’t trust the published numbers. There is a time lag in reporting that distorts them. I also suspect that OTP is in much worse shape than reported. I’m especially suspicious of their municipal loan portfolio. They expected NPLs to top out at 15%; under 20% they are still OK, but above 20% OTP will need cash or must be nationalized. (This is the point when we might have a Hungarian Anglo-Irish Bank case.)
Viktor Orbán recognizes that OTP is in a tough spot. He has stated that the government is firmly behind the bank. Now the question is where will he get the money? A partial takeover of OTP will include a piece of MOL because of the cross-ownership structure, and MOL is already partially nationalized. Orbán’s direction is clear; he is envisioning more and more state ownership.
The government is also talking about beefing up the state owned bank system to help borrowers. Great idea! But where will the money come from? They were also talking about buying out the expensive PPP financing solutions and providing public employment for 300,000 low skilled workers. Where do they plan to get the money for all these ideas?
Orbán knows that he’ll need to execute drastic budget cuts next year, and that could lead to social explosion. The demonstrations have already started, although they are not yet as vicious as in Athens.
The real danger is that the inexperienced young Hungarian leadership will start to panic and experiment with irrational financial solutions. Orbán’s past Chavez-style tirades against the IMF were not helpful; and his pronouncement that the West is dead, or at least on the verge of collapse, doesn't increase his credibility. He calls the communist Chinese leadership Hungary’s allies and sees a “beautiful future” with Saudi Arabia. His apparent delusion or desperation is not a good sign.
The government senses danger, but they still fail to address the fact that Hungary is close to a financial meltdown with its runaway inflation, bank runs and even higher unemployment. To paraphrase Bette Davis from “All About Eve” – Fasten your seat belts, it's going to be a bumpy year! I wouldn’t be surprised if Viktor Orbán’s government doesn’t survive it.