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Monday, October 06, 2008

European Banking Soap Opera

It went on all weekend and I followed it in the foreign press all weekend. Major drama, still escalating. I expect further moves for the next few days.

The background: Recently the Irish guaranteed deposits in some of their largest institutions. This caused great angst, because of course this gave those banks (some of which had branches in the UK) an advantage versus other banks. It also spawned complaints to the EU on the grounds that it was unfair competition. Of course Ireland had no choice.

Last week, Greece followed suit and guaranteed all their deposits, which caused the ECB to ask for "unity".

On Saturday, the prime ministers of the UK, France, Germany and Italy, along with Barroso, Trichet and Juncker (head of Eurogroup) met in Paris. The result was a carefully nuanced statement that the individual nations would act on their own to bail out their domestic banking operations, but would act "cooperatively". Best article here, but it's in German and I am too lazy to translate. If you read Spanish, check out the comments to a similar article in La Vanguardia.

Sunday Merkel of Germany announced that Germany would guarantee personal deposits (not company funds). The guarantee is to German citizens only but covers all deposits with no limit. One would guess that this would cause German citizens to move money back within the country, wouldn't one?

Early today Denmark said it would guarantee bank deposits.

In the background to all this, both the Fortis and Hypo rescues broke down and were restructured. The Netherlands is basically nationalizing most of its domestic Fortis ops, and the German government had to step in and up the ante for the Hypo rescue.

The implications of all this are tremendous. Many of the big European banks have branches all over the place. Guaranteeing your own domestic deposits limits your liability, but does obviously produce competition for deposits. If it's a little bank solely within one country, that's one thing. I don't see how this will in practice work for the larger multi-national banks. It's as if NY were guaranteeing deposits of Citibank and Bank of America, and Virgina was not. Since the cost is related to institutional stability....

Bank supervision in Europe is done by individual countries. Thus, a country may be supervising a bank that has operations all over the world, although most of the countries individually supervise domestic branches of foreign ops, or retain the right to do so. The standards aren't really uniform, and the potential for conflicts of interest and tensions between different countries is massive.

Eventually some sort of scheme for EU-wide bank supervision is needed, but the EU does not move quickly on these matters.

Currently, the UK is under tremendous pressure to guarantee its own bank deposits, which may or may not interfere with the speculations about a further UK banking bailout. Tomorrow the UK coverage will be raised to 50,000 pounds, more than doubling the insured limit.

The government of Spain will have to do something more about its banks, and La Vanguardia suggests that something is in the works this morning. This article claims that the Spanish government may buy loans or securities, and I am sure that Spain will have to raise its guarantees for at least the savings banks (funcas). A lot of the Spanish mortgages were variable, and much of this assets were issued as bonds, and foreign investors did buy them. Therefore the Spanish government cannot easily fix the situation. If the ECB cuts rates, this might lower Euribor and help the mortgage payers, but the banks don't retain most of the rights to fix the loans on their own.

In the meantime, this India Times article correctly observes that worldwide bailout efforts are now up to around 2 trillion with no end in sight. The US has about half of that.

Over the weekend the meme that the US bailout was the result of unreasonable panic started to grow. That's false. It is hard for people to grasp how pervasive this crisis truly is. The Russian financial system is collapsing, the Australian mortgage market locked up so tightly that the Australian government is buying 4 billion worth of RMBS, and China is moving to shore up its banks and equities.

This week Unicredit (Italy) is under pressure, I'm not sure of the real status of Dexia, and in India, the derivatives losses are beginning to be "settled", meaning that banks are going to have to write loans to keep some of these companies alive rather than write off the losses. The companies are refusing to pay up, AFAICS. The ball just keeps rolling, and with the rupee still falling and those oil bonds simmering grimly in the banking coffers, I have developed extreme doubts, partly because of the divestments that are beginning. The crash of the Indian equity market has reduced some private fortunes to an incredible extent.

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