Last night, we posted a VoxEU article on the unraveling of Iceland that (among other things) said that the problem was that the financial sector had gotten so large that the government could not possibly rescue it. The author made a comment in passing that indicated he thought this was not a problem shared by other European countries; several alert readers said that both Switzerland and Germany have disproportionately large financial sectors.
And the numbers needed for rescues just keep getting bigger and bigger. The latest estimate comes via Reuters. And this is just for a US rescue. This does not count the cost of bank salvage operations in other countries, nor does it allow for the cost to the US of lending assistance (unlimited dollar swap lines, rescuing AIG, which has among other things, provided guarantees to European banks that allowed them to circumvent minimum capital requirements):
The U.S. government’s $700 billion bailout fund is unlikely to be enough, with the financial system needing more than $1 trillion to get through the crisis, two of Wall Street’s top dealmakers said on Wednesday.
The global crisis appears to have passed its most intense phase, seen around the time of the collapse of Lehman Brothers Holdings Inc in September, but financial institutions still face losses in the fourth quarter and early next year as the economy and credit quality deteriorate, said Gary Parr, deputy chairman of investment bank Lazard Ltd.
Parr was speaking on a panel along with H. Rodgin Cohen, chairman of law firm Sullivan & Cromwell, at The Deal’s M&A Outlook 2009 conference in New York.
“You saw the problems of the financial services industry start to play over into the broader economy,” Cohen said. “Now, we are going to see the reverse trend, with the broader problems in the broader economy moving back into the financial services industry.”
Parr said the financial system had run out of a cushion to deal with further losses.
“The government’s $700 (billion) is not enough. It’s going to be over a trillion,” he said. “It has to come from somewhere. And indeed in the last three months around the world, the primary source of capital for the financial services industry was the government.”
Cohen added that private equity could be another potential source of capital — although relatively smaller — for the sector, but an unwillingness to change the approach to letting that happen had held buyout shops back…
Cohen said that among the developments of the last few months, the failure of Lehman was “of all the events, probably the single most significant.”
“This was the first time all creditors were going to be at risk in any financial services company,” Cohen said….
Over the coming months, the priority of financial institutions should be to start working through some issues, such as finding ways of funding, recapitalization and strengthening balance sheets, Parr said.
“I frankly don’t think strategic positioning is the priority for major financial institutions,” Parr said. “The priority of the next 12-18 months is to live to fight another day.”
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Somehow I don’t get think I’ll get that usual warm, fuzzy feeling this year that I normally get every Christmas when I watch “It’s a Wonderful Life.”
Yves said: “several alert readers said that both Switzerland and Germany have disproportionately large financial sectors.”
Are you sure about Germany? The data I know shows that the financial sector in Germany contributes less to GDP than in the UK, the US etc. According to the BIS Quarterly Review from September 2008 German Banks are net creditors. They have a big exposure in emerging economies. So the risk level is high and we are talking about a lot of money. But Germany also has a huge industrial base and a positive savings rate for decades. So we are not talking about hot money that will leave Germany any moment. Any comparison to Iceland (or Ireland) strikes me as odd.
So I wonder why you would call it “disproportionately large”. Is there anything I have overlooked?
Just to be precise: There are troubled banks in Germany and some have gambled stunning sums of money. But the question is, if the burden compared to GDP is disproportionately large. Did I mention that there is no housing, HELOC or credit card debt bubble in Germany?
gregor,
I have read several places (don’t recall where) that the German government could not rescue Deutshcebank.
I’d put Ireland over Germany. Hell, I’d put the U.S. over Germany. The U.S. doesn’t have another 1 trillion. It’s broke. The policymakers and the economists already had us spend 1 trillion – sending good money after bad. We’ve wasted our reserves.
http://www.reuters.com/article/Finance08/idUSTRE4AB7HT20081112
“I think it would be worse than the depression,” Whitehead said. “We’re talking about reducing the credit of the United States of America, which is the backbone of the economic system.”
Does anyone know more about Whitehead? Is he a Volcker-kind of guy? Wasn’t he the one who said that finance types were making too much money?
No problem — we’ll steal it from future generations, per SOP.
‘We will steal it from future generations’…Only if some fool is willing to lend against future generations!
This administration is kicking the can down the road.
We have seen how quickly and glibly Paulson can change gears. One moment it is imperative that the US cover the bad mortgage paper sitting in the vaults of major banks. The next moment that problem is apparently insoluable and the new imperative is to save auto/credit card/student loans.
I fully expect that shortly before leaving office Paulson will announce that operations by the treasury and fed have been successful and ‘it’s been a pleasure to rape…er, serve the people. See you later.’
Few seem to realize that we, the people, have a deranged administration. This bunch runs the gamut from sociopaths to downright idealogues with sucidal tendencies. They are perfectly willing to destroy the country in order to achieve their ends.
America would be better off to pay the bastards to leave the country before they destroy it entirely.
The hole in their game plan is believing that they can get away with it. Watch the Dems haul them away to prison, one by one.
Germany does not have much of a problem compared to other countries:
http://www.marketoracle.co.uk/Article7241.html
Bank lending to emerging markets as a percentage of GDP shows:
Austria 83%
Swtzerland 50%
Sweden 25%
Seriously, how long will the U.S. maintain a AAA rating?
“Seriously, how long will the U.S. maintain a AAA rating?”
Right after I posted that, I saw this (at Calculated Risk); it really supports what I just said:
The economy faces a slump deeper than the Great Depression and a growing deficit threatens the credit of the United States itself, former Goldman Sachs chairman John Whitehead …
“I think it would be worse than the depression,” Whitehead said. “We’re talking about reducing the credit of the United States of America, which is the backbone of the economic system. … I see nothing but large increases in the deficit, all of which are serving to decrease the credit standing of America. … I just want to get people thinking about this, and to realize this is a road to disaster. I’ve always been a positive person and optimistic, but I don’t see a solution here.”
http://calculatedrisk.blogspot.com/2008/11/whitehead-worse-than-depression.html
Hey, remember when Congress voted down the 3 page Bush Bailout Bill, because they said there wasn’t enough oversight written into it?
Turns out the “oversight” in the modified bill is in name only, which explains why Paulson is burning through that money without anyone slowing him down:
http://www.washingtonpost.com/wp-dyn/content/article/2008/11/12/AR2008111202846.html
This is just disgusting; petty party politics while the economy burns down around us all.
Anonymous said: “that the German government could not rescue Deutshcebank”
Deutsche Bank is an interesting story. They are highly leveraged (slowly coming down from 50:1) and everybody is expecting big trouble.
But so far they are refusing to get any government money. They don’t want to be rescued, because they say they don’t need to be rescued. And — to their credit — the losses are not alarmingly high. Either they will blow up big time or Deutsche Bank is able to weather the storm. We will see. But as today Deutsche Bank looks rather stable.
Deutsche Bank clearly fits into the “too big to fail” category. Germany and he EU have promised to stabilize the systemic important banks. I am not aware of any proof that Deutsche Bank could not be stabilized.
This is the policy question that ultimatley needs to be faced….Iceland is the example.
Wat happens when the home country cant save it? So should banks always be limited in size by home governments? Is the stability that would create a worthwhile benefit to receive for the increased cost and ineffeciency that is ultimatley the result.
I have to say from the way things look today it is. Banks are national trasures. Coming from Canada it is clear that stable ones yield positive externalities, but the Banks are able to produce these from protection, national charters and properly functioning home economies that fund them.
Roads are generally built and maintained by governments but the payments and settlements system is built and maintained by private institutions based on the underlying laws, courts and trust that a country generates. Very symbiotic.
I am trying to be rational about all of this, but when I get to thinking about how this was allowed to happen, including numerous ridiculous management decisions, is it true Fuld had two offers to buy them and rejected both?, you have to wonder if there shoudl be metaphorical heads on metaphorical pikes?
But we can worry about the rivet makers in Belfast later, we still seem to be scooping survivors and bodies from the waters of the North Atlantic right now.
Yves — why is everyone still quoting that $700-Billion number like it ever had any meaning.
The Fed as admitted it was a made-up number, they just wanted something “sufficiently large.”
We ALL know that far more than that will end up trotting out the door, but it is an illegitimate number on its face.