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Why Europe Should Be Wary of Populists

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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The latest developments in the sad story of a small Austrian lender that an ultranationalist politician allowed to swell out of proportion are a preview of what may happen to more European banks, and their creditors, in the years ahead. Above all, the case of Hypo Alpe-Adria-Bank International warns investors not to be naive about financial guarantees from governments. They may look solid, but they are sometimes the flimsiest of reasons to part with one's money.

On March 1, the Austrian government decided to stop supporting Heta Asset Resolution, the "bad bank" formed after Hypo Alpe was nationalized in 2009. It is now in a resolution procedure under last year's EU Bank Recovery and Resolution Directive, a key part of the budding European banking union, which entails a 15-month moratorium on debt payments and ultimately a "bail-in" -- a haircut for the creditors. 

This almost immediately caused a downgrade of Carinthia, the Austrian province that originally owned the bank, by Moody's Investors Service. Carinthia guarantees 10.2 billion euros of Heta's senior debt, and, as Moody's points out, that's nearly five times the region's operating revenue.

Those guarantees are a legacy of Joerg Haider, the most popular governor that Carinthia, a sleepy, touristy lake region in the south of Austria, ever had. He was first elected to the governorship in 1989, then forced to resign two years later after praising Adolf Hitler's employment policy, then re-elected triumphantly in 1999. Haider was fond of the grand gesture (he built a too-big soccer stadium and a six-star hotel that's now all but empty); generous with subsidies while tough on "freeloading" immigrants; and contemptuous of the European Union. He was the darling of the local press, and voters mourned him when he died in a car crash in 2008 ("King of Carinthia," read one of the signs put up in the regional capital, Klagenfurt, for Haider's funeral).

Haider was close friends with Hypo Alpe chief executive Wolfgang Kulterer, whom the German magazine Der Spiegel has called Haider's "house banker". Whenever the governor needed money for one of his grandiose schemes, he called Kulterer. Kulterer was ever ready with the cash, and in return, Haider was generous with provincial government guarantees that helped fund the bank's rapid expansion into the Balkans in the early 2000s. 

Austrian banks, among the most sophisticated in Europe but constrained by a tiny domestic market, rushed headlong into eastern Europe when companies and individuals there were hungry for loans. Lenders such as Raiffeisenbank, Bank Austria (which is part of Italy's Unicredit) and Erste Bank were eventually saddled with dwindling revenues and moldering assets in the region, particularly in Russia and Ukraine, forcing them to scale back their presence.

Hypo Alpe, however, ran into problems for somewhat different reasons: It was criminally careless, bribing politicians and funding white elephant projects, at one point even issuing a loan to a Croatian hotel operator to buy land from Serbia that actually belonged to Croatia. (Kulterer is now in prison, serving a six-and-a-half-year sentence for embezzlement and fraud.)

Haider and Kulterer almost managed to pass all of Hypo Alpe's risks to the neighboring German state of Bavaria, by selling the Austrian bank to BayernLB, a bank owned by that state, in 2007. But that deal fell apart in 2009 when the German bank, bailed out by its own government, took billions in losses by selling Hypo Alpe Adria to the Austrian government for a symbolic sum. 

Austria only agreed to take over the insolvent bank because of Carinthia's 21 billion euros in guarantees. Vienna didn't want the region to go bankrupt and it thought it had a chance of avoiding paying out on the guarantees. It took Austria six years and 5.5 billion euros to realize that it would probably end up paying the entire amount unless it gave up. In the process, Austria complicated the situation by letting the "bad bank," Heta, issue subordinated debt guaranteed by the central government. Now those subordinated debt holders, paradoxically, appear to have a better chance of being repaid than senior debt holders with their Haider-issued guarantees.

This is a classic situation in which everyone involved is at fault to some degree. Haider should never have been able to issue the guarantees (in fact, the practice has since been outlawed by the EU as unfair state aid). Crooked banker Kulterer should have been stopped by regulators before he bankrupted Hypo Alpe. The bank's creditors, for their part, should have realized that Carinthia did not have the money to honor the guarantees. It should not have mattered that the Austrian region, along with Austria itself, had stellar credit ratings, allowing creditors to book their investments as virtually risk-free. The reason bankers have heads and not just rating scanners is that they have a responsibility to think twice about trusting a far-right populist on an ego trip.

The Austrian government's negotiations with the creditors -- who include big, litigious German banks and some investment firms that have fought the Argentine debt restructuring in the courts -- will be tough. Yet new EU rules, in place since last year, put an emphasis on creditor responsibility and protect taxpayers from having to take over banks' losses. Eventually, the holders of Heta's 15.8 billion euros in debt will probably take a haircut, sending a minor financial shockwave through central Europe. It won't be the last one, either. Throughout the EU, banks have been too loosely regulated for too long, and, according to the results of the European Banking Authority's stress test of 123 big banks, they have just under 900 billion euros in non-performing loans (and that doesn't include loans made by smaller banks). As the new resolution rules gain acceptance throughout the EU -- Austria has been in the front rank, apparently because of the Heta problem -- financial blood will continue to flow.

The point of the Hypo Alpe lesson, though, is that government guarantees are probably riskier than any other kind. Politicians can't be counted on to always be responsible, especially since, when they act like Haider, voters often reward them. (His successor as leader of the far-right Freedom Party, Heinz-Christian Strache, has led the group to 20.5 percent of the vote in the 2013 national election.) With radical parties on the rise throughout Europe, parsing their promises and their countries' true financial capabilities will be an increasingly important task. Caveat emptor.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net