We have been asserting for many moons that despite having lower incidence of US style, “another quarter, another writedown” behavior, European banks are actually in weaker condition than their US counterparts. That’s based on the view of a buddy who has top level regulatory connections here and in Europe, and it seems plausible given the fact that European regulators let their bank operate with lower equity levels than US banks can.
Not only have events started confirming this view, but, with a banking crisis starting to take hold in the EU, the stakes are high. The EU lacks a mechanism for rescuing banks; the responsibility falls to national central banks. The rescue over last weekend of Fortis demonstrated that several central banks, shepherded by the EU, can make a coordinated rescue. But will this prove to be a one-off or a model? The biggest banks in Europe, starting with Deutschebank and UBS, are similarly too big for their home country central bank to salvage in case of a meltdown.
Ambrose Evans-Pritchard, who admittedly has an appetite for drama, contends that the survival of the monetary union itself is in play.
From the Telegraph:
It took a weekend to shatter the complacency of German finance minister Peer Steinbrück. Last Thursday he told us that the financial crisis was an “American problem”, the fruit of Anglo-Saxon greed and inept regulation that would cost the United States its “superpower status”. Pleas from US Treasury Secretary Hank Paulson for a joint US-European rescue plan to halt the downward spiral were rebuffed as unnecessary.
By Monday, Mr Steinbrück was having to orchestrate Germany’s biggest bank bail-out, putting together a €35 billion loan package to save Hypo Real Estate. By then Europe was “staring into the abyss,” he admitted. Belgium faced worse. It had to nationalise Fortis (with Dutch help), a 300-year-old bastion of Flemish finance, followed a day later by a bail-out for Dexia (with French help).
Within hours they were all trumped by Dublin. The Irish government issued a blanket guarantee of the deposits and debts of its six largest lenders in the most radical bank bail-out since the Scandinavian rescues in the early 1990s. Then France upped the ante with a €300 billion pan-European lifeboat for the banks. The drama has exposed Europe’s dark secret for all to see. EU banks took on even more debt leverage than their US counterparts, despite the tirades against ”le capitalisme sauvage” of the Anglo-Saxons.
We now know that it was French finance minister Christine Lagarde who begged Mr Paulson to save the US insurer AIG last week. AIG had written $300 billion in credit protection for European banks, admitting that it was for “regulatory capital relief rather than risk mitigation”. In other words, it was underpinning a disguised extension of credit leverage. Its collapse would have set off a lending crunch across Europe as banking capital sank below water level.
It turns out that European regulators have allowed even greater use of “off-books” chicanery than the Americans. Mr Paulson may have saved Europe.
Most eyes are still on Washington, but the core danger is shifting across the Atlantic. Germany and Italy have been contracting since the spring, with France close behind. They are sliding into a deeper downturn than the US.
The interest spreads on Italian 10-year bonds have jumped to 92 points above German Bunds, a post-EMU high. These spreads are the most closely watched stress barometer for Europe’s monetary union. Traders are starting to “price in” an appreciable risk that EMU will break apart.
The European Commission’s top economists warned the politicians in the 1990s that the euro might not survive a crisis, at least in its current form. There is no EU treasury or debt union to back it up. The one-size-fits-all regime of interest rates caters badly to the different needs of Club Med and the German bloc.
The euro fathers did not dispute this. But they saw EMU as an instrument to force the pace of political union. They welcomed the idea of a “beneficial crisis”. As ex-Commission chief Romano Prodi remarked, it would allow Brussels to break taboos and accelerate the move to a full-fledged EU economic government.
As events now unfold with vertiginous speed, we may find that it destroys the European Union instead. Spain is on the cusp of depression (I use the word to mean a systemic rupture). Unemployment has risen from 8.3 to 11.3 per cent in a year as the property market implodes. Yet the cost of borrowing (Euribor) is going up. You can imagine how the Spanish felt when German-led hawks pushed the European Central Bank into raising interest rates in July.
This may go down as the greatest monetary error of the post-war era. The ECB responded to the external shock of an oil and food spike with anti-inflation overkill, compounding the onset of an accelerating debt deflation that poses a greater danger. Has it committed the classic mistake of central banks, fighting the last war (1970s) instead of the last war but one (1930s)?
After years of acquiescence, the markets have started to ask whether the euro zone has the machinery to launch a Paulson-style rescue in a fast-moving crisis. Who has the authority to take charge? The ECB is not allowed to bail out countries under EU treaty law. The Stability Pact bans the sort of fiscal blitz that has kept America afloat. Yes, treaties can be ignored. But as we are learning, a banking system can implode in less time than it would take for EU ministers to congregate from the far corners of euroland.France’s Christine Lagarde called yesterday for an EU emergency fund. “What happens if a smaller EU country faces the threat of a bank going bankrupt? Perhaps the country doesn’t have the means to save the institution. The question of a European safety net arises,” she said.
The storyline is evolving much as eurosceptics predicted, yet the final chapter could end either way as the recriminations fly. Germany has already shot down the French idea. The nationalists are digging in their heels in Berlin and Madrid. We are fast approaching the moment when events decide whether Europe will bind together to save monetary union, or fracture into angry camps. Will the Teutons bail out Club Med? If not, check those serial numbers on your euro notes for the country of issue. It may start to matter.
31 comments
Comments are closed.
One of the speakers at the Princton panel debate a few days ago (http://www.youtube.com/watch?v=Wj_JNwNbETA) made the point that people pay too much attention to leverage ratios not enough attention the “maturity mismatch” between long-term assets and short-term liabilities.
While European banks are leveraged much higher than American banks that doesn’t necessarily mean they are in worse shape.
Not necessarily, but it the eu leaders are already planning for an emergency fund. So they apparently know more than we do. What happened in Belgium can happen in any country I guess.
Maturity mismatch and leverage are in a way linked: if you assume a bank has 300bn outstanding bonds and about 50bn are maturing every year, then you get average losses of 1-1.5 bn (assuming spread of 200-300bps). Be aware that this is an extremely conservative calculation and is a strucural problem of banks most people are not aware of.
@Yves: Any discussion about EMU breakdown is complete bullshit (maybe a minimal probability for Italy). It is mainly a political thing and the political elite learnt their lesson from the 2 bloodiest wars in human history.
Matt Dubuque-
I agree with the comment here that Trichet’s recent interest rate rise was a case of anti-inflation overkill. Why Trichet seems to have been treated with kid gloves in this crisis is unclear to me.
Trichet still seems to be fighting the wrong war. Not good.
On another note, I recall Milton Friedman stating 3 years ago that the Euro would be extinct within 10 years. Will he be proven correct?
Friedman was referring to the political tensions among the various nations at the time making a coherent monetary policy impossible over time.
Indeed, when you look at the plight of the PIGS nations (Portugal, Italy, Greece and Spain) within the EU, you can see his point.
On another note, I wanted to mention that yesterday’s proposed tougher ECB banking capital requirements needs to be ratified by the European parliament before becoming effective.
That could easily take 9 months, in my view, and is likely to be amended.
Matt Dubuque
mdubuque@yahoo.com
I understand that the stress within the monetary union is less manifest in yield differentials because so much of the activity is basket oriented. The Boiler Maker Pension fund says: “Buy me $20m 5-year euro bonds.” This index-hugging is obscuring country risk.
However, the country risk is becoming apparent in the credit default spreads. This is a long way from my world and I don’t have these on my screen. But if anyone can dig these up, pls share.
The one lesson here is that we will not be able to hide in someone else’s paper currency.
It is very difficoult to imagine Italian banks to go down they way is happening in the Anglosaxon world.
To apply for a loan is Italy is a very tough task, with the banking asking you any possible guarantee, and with very few possibilities to cheat.
Morgtgages are rarely superior to 75%, most are at 50-60%.
In Italy the stigma associated with bankrupcy is very high.
Italian families do not have personal loans and are among the highest savers in the world.
Bank will have their share of risk mostly linked to loans to real estate developers, overleveraged private equity transactions, and investments in US assets.
But paradoxically, given the strenght of their deposits, Italian banks may come out as aggregator.
Also, remember when you look at italian statistica that there are two Italys: North of Italy GDP per capita is 140% of EU average.
“Any discussion about EMU breakdown is complete bullshit (maybe a minimal probability for Italy). It is mainly a political thing and the political elite learnt their lesson from the 2 bloodiest wars in human history.”
Last I checked, peace is not dependent on a league of countries being in monetary union.
Hardly the end of the EU. I’d say this article qualifies for the usual euro-phobia from the UK, with Pritchard et al by now probably in secret regretting not having joined the currency.
this article is a few days old but I just saw it today. I was amazed at how large the european bank are versus the GDP of their home country.
If a Bank like UBS gets into major trouble who is going to bail them out? The U.S.? Certainly can’t be the Swiss with UBS assets being 484% of GDP.
Are European Banks to big to Fail?
Everybody who reads Ambrose Evans-Pritchard, knows that is anti-EU rethoric is beyond the drama level… So the “grain of salt” needed to swallow is view, can be as big as a house…
I think this crisis will force Europe to develop a working solution to the crisis, since even the biggest economy is not able to save its own banks – i suppose Deutsche Bank is too big to save, if Germany would try it alone.
The problem i see is that France floated these ideas in the public, instead of working through the system, until a prelminary agreement is reached. Now politics raise their ugly head and stay in the way of the technocrats working out a sensible solution. ;-)
Ambrose is always spouting out “foaming at the mouth” Europhobe piece, but he might be prescient here, but in reverse. The crisis might force the UK into the Euro. See Willem Buiter’s (ex Bank of England Monetary Policy Committee) piece in the FT.
“This may go down as the greatest monetary error of the post-war era. The ECB responded to the external shock of an oil and food spike with anti-inflation overkill, compounding the onset of an accelerating debt deflation that poses a greater danger. Has it committed the classic mistake of central banks, fighting the last war (1970s) instead of the last war but one (1930s)?”
Reading this passage confirms that Ambrose Evans-Pritchard cannot be take serious. As the American model showed lowering interest rates did nothing to stop the current debt deflation. We are faced with a systemic crisis where reinflation is not effective. In fact only the ECB had the right approach from the beginning by rather providing a liquidity backstop for banks than lowering interest rates. The Fed eventually acknowledged that this approach was correct.
The author is a known anglophile and has still to comprehend that the Anglo-Saxon approach to capital markets is fatally flawed.
Economic stress can obviously take down economic and political arrangements. But the United States had no trouble maintaining its currency union even when states were relatively independent and the federal government relatively weak, prior to the US Civil War. That included going through the collapse of two central US banks, and a massive depression, similar in intensity to the Great Depression, which resulted from the second failure.
It may be that the other nations will no longer trust states like Italy to issue Euros. The response to that, I think, will be for Euro issuance to be delegated to a central bank, just as in the US. Faced with the choice of being kicked from the EMU and facing all the hassle of currency exchanges I think any EMU nation would accede to this. If not, perhaps a few will leave and the rest hang together. Even this wouldn’t be a problem for the EU politically. It’s not like the UK is readying carrier strikes on Paris since they have different currencies.
Viewed from the US, Europe seems to have done a pretty good job of forging a set of philosophical shared values with strong contrasts to those of the US, Russia, the Muslim states, or China and I think this provides quite enough of a sense of “us” to make the EU hang together. The memory of the World Wars will also be around for a long, long time inciting Europeans towards mutual peace and cooperation. The Wars of the Reformation have been over for 300 years but the lessons of religious tolerance branded into the Western soul by those horrors are still with us and indeed stronger than ever.
There is always a lot of hate coming from the UK against the euro (envy?). See also the traditional negative comments about the lack of rate cuts of the ECB, while they should know that the single mandate the ECB has is safe guarding price stability, and not like in the US/UK stimulating the economy. Now you can debate about if this is a good thing, but why blame the ECB for sticking to its job description?
Actually, Italian and Spanish banks are well seasoned pros when it comes to crisis management.
They worked under high inflation environment before euro just fine and working under euro must be much much easier without constant fear of foreigners dumping lira or pesetas.
@ faireconomist:
>>the United States had no trouble maintaining its currency union even when states were relatively independent and the federal government relatively weak, prior to the US Civil War. That included going through the collapse of two central US banks, and a massive depression, similar in intensity to the Great Depression, which resulted from the second failure.
Yes, but that's when the dollar was backed by gold. You simply cannot compare a gold-backed dollar to a dollar (or euro) back by, well, nothing.
“The memory of the World Wars will also be around for a long, long time inciting Europeans towards mutual peace and cooperation.”
This is some of the bullsh*t from Europeans I don’t understand. They think that if the EU or the euro disappeared, they’d all go back to killing each other. South Korea and Japan don’t have the same currencies or any kind of political union, but they’re not letting the memory of Tojo from 1945 bring them back to killing one another are they? Dear God, get a grip on reality.
This is actually a very good take on the fear mongering out there:
http://www.youtube.com/watch?v=5_dsFEw3-Y0
Yves,
With all due respect, are you getting addicted to bad news, or what?
You diminish your normally excellent blog to the level of demagoguery by posting Evans-Pritchard’s lowest common denominator drivel. The French bailout proposal to the EU, not being a hard intitiative but a trial balloon, is most likely an attempt to deal with political issues that would arise in advance, rather than find themselves in the hideously stupid legislative situation of the U.S. in the past week. To locate that item in a paragraph of hard news is one tiny notch under outright lying. Fact by contagion.
We’re still waiting for Evans-Pritchard to deal with British banks tapping the ECB through EMU subsidiaries. But that will never happen. His father is rolling in his grave for having begat the cretin.
The interest spreads on Italian 10-year bonds have jumped to 92 points above German Bunds, a post-EMU high. These spreads are the most closely watched stress barometer for Europe’s monetary union. Traders are starting to “price in” an appreciable risk that EMU will break apart.
I believe that this is merely market forces at work. The credit worthiness of the Italian government is inferior when compared to the German government.
Italy, Spain, and Greece benefited greatly from joining the Euro zone by getting access to low interest rate credit. There is no way back, their economies will suffer greatly if they return to a regime of the higher rates of the past.
@slimcarlos: the dollar was backed by gold, but for Italy, Spain, and Greece, the euro is backed by access to low interest rates loans. It is not only the people, but their governments can’t afford to leave that currency regime.
–pe
Deutsche Bank is not too big to be rescued by the German gov’t. Otherwise the Eurozone as a whole is as well, because there are other rescues (like Fortis, Daxia,…) and so even when no central action is persued, every gov’t gets it share of problems.
I think it is very disingenious to cite USB as a European bank, when you talk about the Eurozone. The UBS is at least as much a US bank as a Eurozone bank. I live in Germany in the state next to Switzerland. I have never seen a UBS branch office here.
Of course he misstates Steinbrueck, but who cares. But this of course can only understand, who understands, that leverage is not at all at the heart of the problem, but intransparency.
A E-P is a nice fellow … However when it comes to EC and specifically the Euro, Ambrose is litteraly grasping the problem with anything but fair judgment. His prejudices are deeply ingrained.
The latin attitude to household debt has evolved with time. Not in the right direction. But we are comparing apples and oranges here.
Yes both are fruits. So what? Getting into the details for credit activity in France itself.
PICTURE IN FRANCE IS NOT VERY DIFFERENT FROM THE ONE IN ITALY
“It is very difficult to imagine French banks to go down they way is happening in the Anglosaxon world. To apply for a loan is France is a tough task with very few possibilities to cheat.
Nothing like non-recourse stuff.
In France as well the stigma associated with bankrupcy is very high. It is even very difficult to apply for.
French families have limited personal loans and are among the highest savers in the world.
Bank will have their share of risk mostly linked to loans to overleveraged private equity transactions, and investments in US assets.”
On a larger basis, Yes we are all nervous here. Certainly not because of French credit by French households but on the following:
– what has SocGen outside the country and specifically in the US (CDS exposure ?)?
– same issue for AXA ?
– what is the picture of BNP bancwest exposure to mortgages?
– what are Calyon liabilities.
The rest is peanuts, so to speak.
URGENT: At 3:20PM today Thursday October 2, 2008.
The http://marketwarnings.blogspot.com has called for a bottom. Fireworks start tomorrow!
Deatils of the call are at:
http://marketwarnings.blogspot.com/2008/10/stock-market-trading-call-urgent.html
Who in the European Union actually produces anything? If you can name one then that one is carrying the load and is not to happy about it. (and I wouldn’t rely on tourist income, it could dry up any second now)
The best way that we can get our economy quickly moving again is not by bailing out the big bad banks with 750 billion dollars but by giving that money to the homeless. It is estimated that there are three million homeless people in the United States that are costing the government billions each year to feed and shelter them. A grant of 250 thousand dollars to each person that can prove that they have been homeless for over a year would cost less money then the amount that the government is ready to waste on bailing out the banks. The results would produce the greatest spending spree in American history and jump start our economy. An added benefit would be that many of the homeless would purchase homes that have been foreclosed and bring added life to the housing market. Some Americans would be envious of the new found wealth of our most unfortunate citizens, but instead they should welcome their large contribution to our economy.
That’s pretty funny to read such views from a well known eurosceptic. Reality is, the UK is about to enter its worst recession in 40 years. Amazing household debt, debt culture, no savings, no industry, no agriculture, ailing nuclear facilities, ailing sewers facilities, ailing public transport, ailing healthcare… The national spécialité -finance- is near death (how incredible it is the ECB discount windows that pours lifeblood into UK financials veins…)
Well in a word the whole UK picture is bleak. And what we have is a paper about fragile EU banks from a brithis fellow ? Pathetic.
The crisis we are in will be felt from berlin to London sure, but the UK is likely to get back to its worst social ills, and maybe M. Gordon will have to beg for an admission in Eurozone, exactly like his 79s counterparts begged for entering the EEC…
French banks are not innocent, but somehow avoided loading up on the drivel some US dominated investment banks (I include UBS here) loaded up on. BancWest is about 9% of BNP activities and seems to be doing quite well for a bank from California. Credit Agricole and SocGen were just dabling in CDO’s when compared to UBS (NY desks?) – they can lose a few billion and tell the tale… as SocGen proved at the beginning of this year, Citi and Merrill … who had 40+ bn of super senior CDO positions from mezzanine (i.e. first risk, wiped out) subprime securitisations… and Merrill, Citi and UBS managed to add huge Alt-A and whole loan positions to that. SocGen and CredAgricole were a bit smarter than that.
As for Deutsche Bank which is deemed too big to save… probably most of it is repo-based lending. And last but not least: the leverage ratio did not save WaMu or Wachovia… and was barely adequate for Citi… whose credit-card and direct subprime pain is still to come.
Well, somebody said that Deutsche Bank could be saved by the German government – now, I’m not that deeply into the business, but let’s assume that their counterparties in CDS would go bust, and it would have to get to levels of leverage from 50 to 10 – in other words it would have to be recapitalised to the tune of 150bn €. That would be about 50% of federal budget, or some 7-8% of gdp – I wonder if this would be managable.
Owe,
7-8% of GDP is similar to the 700 bn$ bail out in the US + the AIG rescue.
The US obviously can not only afford that, but a F&F bail out, a BS bail out and guarantees for the money market on top of that, despite, the both public and private debt levels in the US are higher than in Germany.
Note: The debt levels given for EU countries as public debt include all state and municipal debt. Even when you don't count the social security trust fund as debt, you still end up with slightly higher public debt in the US, by taking the full count.
Excellent and informative feedback on that thread.
Thank you to everyone that participated into it.