The euro fell against the dollar yesterday - by the largest amount registered in any single day since the introduction of the single currency in 1999. The drop was effectively a response to the growing signs of strain in Europe's banking sector. Activity in support of banks was widespread throught the day, and across the whole system. The euro fell 2.5 percent to $1.4077 by mid morning in New York, down from $1.4434 on Monday. Early this morning in Europe it was trading in the $1.41 range.
This current pressure on the euro is more the result of signs of liquidity problems in the banking sector than it is a response to the growing weaknesses in the eurozone real economies, which, as we saw at the end of last week, are really pretty substantial in their own right. What follows is simply a summary of some of the highlights of the European banking crisis as it has emerged in recent days. As such it is more a narrative - obtained by scouring the financial press - than an analysis. On the other hand I do think we can already identify some clear trends, since we can see that in those European countries which had substantial housing booms - the UK, Ireland, Spain and Denmark - the bank exposure is to the drop in the value of the underlying assets (the houses, or the land, or the malls, or the office blocks) and to the defaults in payments which have their origin in the consequences of the mortgage seize-up for the real economy (rising unemployment, declining bonus payments etc), whereas in non-housing boom countries (lead by Germany, Italy, Sweden and Austria) the exposure is to lending which was made to banks in the boom countries - first and foremost in the United States, but also in the UK and Ireland (see Germany's Hypo and it's Irish subsidiary Depfa) and, of course (and the large slice of this is yet to come) in Eastern Europe (lead by banks in Sweden, Austria and Italy).
The other key thread is whether or not the institution in question lent against deposits, or depended on the wholesale money markets for funding. The banks - lead in this case by the Spanish armada - who were most dependent on external borrowing are now evidently those who have (or are about to have) the biggest problems.
And again, before we proceed, I would stress again that I am a macroeconomist, and not a banking sector analyst. What follows is simply a summary of what I have been able to find out simply reading round the press. As far as I am concerned, getting a measure of what is happening in the banking and financial sector is a necssary preliminary for starting to reach any macroeconomic serious evaluation of what the consequences will be for the real economy. Needless to say, all the 2009 numbers just went down, and they went down considerably. How considerably depends of course on what gets to happen next.
Irish Deposit Support Move
Europe has been restless all week, but yesterday it was really the turn of the Irish banks to occupy centre stage, with the Irish government unveiling a wide-ranging guarantee scheme to safeguard deposits and debts at six leading financial institutions. The scheme, which guarantees an estimated €400bn (£315bn, $567bn) of liabilities, covers retail, commercial and inter-bank deposits as well as covered bonds, senior debt and dated subordinated debt.
Most Irish depositors were already covered by an existing deposit insurance scheme for up to €100,000, and the move was essentially aimed at easing short-term funding problem. The scheme offers guarantees for the deposits in Allied Irish Banks, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, Irish Nationwide Building Society and the Educational Building Society.
Irish finance minister Brian Lenihan, stated that the government's intention was to make it easier for Irish banks to access funds, and he admitted that "since the collapse of several institutions in the US, it has been very difficult to access funds on international markets for Irish banks.......This will present real problems for the Irish economy if it is not addressed.”
The move followed the biggest one-day fall in bank share prices in two decades. Anglo Irish Bank plunged 45 per cent while Irish Life and Permanent, the Republic’s largest mortgage provider, fell 34 per cent. Allied Irish Banks were down nearly 16 per cent and Bank of Ireland lost 15 per cent.
The Irish economy - like it's Spanish counterpart - had enjoyed pretty spectacular growth since the creation of the eurzone, and was widely know as "the Celtic tiger", even being hailed as a model for the accession states of the European Union to follow (watch out Slovenia). But now the model itself, as well as the advisability of having long periods of ECB serviced negative interest rates, is being hastily re-examined - as construction and property markets seize up in the wake of the global credit crunch. Indeed Ireland last week became the first among the 15 eurozone members to declare it was officially in recession. It may have been the first, but I am sure it won't be the last. The q-o-q GDP data from Ireland has long been volatile
(even when seasonally adjusted) but the y-o-y chart below makes things pretty clear, I think. Not only did the economy contract q-o-q over two consecutive quarters, the contraction also took place vis a vis the equivalent quarters a year earlier. Ouch!
Belgium and France Rescue Dexia
French banks are widely regarded as being the most stable in the current crisis, due to the importance of their retail banking business, and the extent of their deposit base. Nonetheless some French financial entities have been facing difficulties, and on Monday the Belgian and French governments - in a joint initiative - threw a 6.4 billion-euro ($9.2 billion) lifeline to leading local government lender Dexia (which is in effect a transnational entity, based both in Brussels and Paris).
According to the details of the deal reached, the Belgian federal and regional governments and shareholders will invest a combined 3 billion euros into Dexia. The French government will invest 1 billion euros and Caisse des Depots et Consignations, France's state-owned bank, will put in 2 billion euros. The Luxembourg government will buy 376 million euros of notes convertible into shares of Dexia's unit in the country.
Dexia, which employs about 35,000 people in more than 30 countries, generates about half its profit from arranging loans for municipalities from Mexico to Japan, funding infrastructure projects and insuring U.S. municipal bonds. The company also provides financing to half of the France's local governments, according to French Finance Minister Christine Lagarde.
The French Caisse des Depots et Consignations, which is based in Paris, will now become Dexia's largest shareholder with 19.3 percent of the equity, up from 11.9 percent previously. The French government, the Belgian federal government and the Belgian regions will each own a 5.7 percent stake.
Dexia came under pressure following its bailout of Financial Security Assurance, its New York-based bond insurance unit. Dexia agreed in August to provide $300 million to FSA after provisions tied to the subprime crisis led to a loss. The bank had previously pledged a $5 billion credit line to FSA in June, and injected $500 million into the unit in February.
Dexia also took responsibility in August for the $17.3 billion in invested assets at FSA's financial products unit, which includes $7.6 billion of subprime mortgage-backed securities. Dexia's tier 1 capital ratio, which is a measure of it's ability to absorb losses, seems set to rise to something above 14 percent following the capital increase. The ratio currently stands at about 10.5 percent, after suffering 350 million euros in losses related to Lehman's bankruptcy in the third quarter, according to Chief Financial Officer Xavier de Walque.
Fortis, which is in fact Belgiaum's largest financial-services company, received an 11.2 billion-euro ($16.3 billion) rescue from the Belgian, Dutch and Luxembourg governments (also on Monday) after investor confidence in the bank simply seemed to evaporate last week. Fortis shares had previously dropped 35 percent in Brussels trading on concern the company would struggle to replenish capital depleted by the 24.2 billion-euro takeover of ABN Amro Holding NV units and credit writedowns. Belgium will buy 49 percent of Fortis's Belgian banking unit for 4.7 billion euros, while the Netherlands will pay 4 billion euros for a similar stake in the Dutch banking business. Luxembourg will provide a 2.5 billion-euro loan convertible into 49 percent of Fortis's Luxembourg banking division.
Fortis is the largest European firm to be bailed out so far. Fortis has said it plans to sell its stake in ABN Amro's consumer banking unit, although a buyer has yet to be identified. Fortis joined Royal Bank of Scotland Group and Spain's Banco Santander last year to buy Amsterdam-based ABN Amro for 72 billion euros, just as the U.S. subprime mortgage market collapsed.
Fortis, which was formed in 1990 following the merger of the Dutch insurance company NV Amev, Belgian insurer AG Group and the Dutch bank VSB, has seen its shares fall 71 percent so far this year in Brussels, lowering the market cap to 12.2 billion euros. The company is estimated to have about 3 billion euros of bonds maturing this year and needs to refinance an additional 7 billion euros next year.
Fortis reported a 49 percent decline in second-quarter profit on credit-related writedowns on Aug. 4. The banking business's core Tier I capital ratio, an indicator of a bank's ability to absorb losses, was 7.4 percent at the end of June, compared with Fortis's own target of 6 percent. The company's structured credit portfolio, which includes collateralized debt obligations and U.S. mortgage-backed securities, amounted to 41.7 billion euros at the end of June. Fortis said Aug. 4 the pretax impact of the credit market turmoil on its earnings was 918 million euros in the first half.
And Then There Is Hypo Real Estate
Hypo Real Estate Holding, Germany's second-biggest commercial-property lender, is going to receive a 35 billion-euro ($50 billion) guarantee from the German government and private banks. The bank's rescuers will provide an emergency credit line in two allotments, of about 14 billion euros and 21 billion euros. Private banks will pay 60 percent of the first transfer and the Berlin-based federal government will put up the entire second payment.
Hypo Real Estate said it needs the loan to shield itself from the financial-market turmoil after its Dublin-based Depfa Bank unit ran into problems getting short-term funding. Hypo Real Estate fell as much as 76 percent to 3.30 euros in Frankfurt trading on Monday. At the same time Commerzbank, owner of Germany's biggest commercial-property lender Europhypo, dropped as much as 27 percent.
``Refinancing of all subsidiaries including Eurohypo is centrally organized and secured over the long term,'' according to Reiner Rossmann, a spokesman for Commerzbank, Germany's second-biggest bank by assets. ``Refinancing needs for 2008 are already covered'' and the bank's deposits provide a ``stable'' refinancing source, he added.
Commerzbank AG, Germany's second-biggest bank, slumped for a third day on Tuesday, as Cheuvreux reduced its recommendation on the stock to ``underperform'' from ``outperform.'' Deutsche Bank AG, the country's largest lender, also declined. Commerzbank fell 3.6 percent to 10.56 euros, bringing the three-day drop to 32 percent. Deutsche Bank lost 3.6 percent to 48.84 euros.
And Bradford and Bingley
Bradford and Bingley, which is the U.K.'s biggest lender to buy-to-rent landlords, was seized by the British government after the credit crisis shut off funding and competitors refused to buy mortgage loans that customers are struggling to repay. Banco Santander SA, Spain's biggest lender, has agreed to pay 612 million pounds ($1.1 billion) for the building society's 197 branches and 20 billion pounds of deposits.
Bradford and Bingley thus became the second British bank to be nationalised this year - following the rescue of Northern Rock earlier this year.
The U.K. Treasury will take over Bradford and Bingley's 41 billion pounds in mortgage loans. In return, the British government obtains rights to any gains as the bank sells off assets, including personal loans and its Bingley headquarters. UK compensation rules mean other financial entities will have to cover the 14 billion-pound insurance policy the former building society had to protect depositors. A short-term loan from the Bank of England will initially cover the amount falling on the banks.
Santander will pay the additional 4 billion pounds to protect deposits over the 35,000 pound maximum amount covered by the U.K. regulator's compensation plan.
Bradford and Bingley's shares were cancelled in London before the market opened on Monday. The credit crunch had made it impossible to fund Bradford & Bingley's lending. Deposits at the bank were obviously totally insufficent, and amounted to only slightly more than half of loans outstanding. This situation had forced B&B to depend on the now-frozen wholesale capital markets.
``In a nationalization, shareholders get wiped out,'' .........``That's just the risk investors take.''
Bradford and Bingley was the smallest of the four British building societies that transformed themselves from customer-owned lenders to publicly traded mortgage specialists during Britain's housing market boom. It was created in the 1964 merger of the Bradford Equitable Building Society and the Bingley Building Society, both established in 1851. The combined company started to sell shares on the London Stock Exchange in December 2000 and had a market value of 3.2 billion pounds as recently as March 2006. Shares plunged 93 percent this year, to reach 20 pence on Sept. 26, reducing Bradford and Bingley's market value to a mere 289 million pounds, even following the raising of 400 million pounds in its third attempt to replenish capital.
Basically the UK's falling home prices and rising unemployment took their toll, and pushed up late mortgage payments to more than 2 percent of B&B's loans. That compares with the U.K. average of 0.5 percent, according to the UK Council of Mortgage Lenders. Almost half of B & B's 42 billion pounds in loans went to landlords, bringing its share of the U.K. buy-to-let market to 19 percent. Arrears on loans to buyers who rent out their properties rose from 0.73 percent at the end of 2007 to 1.1 percent by June 30, according to the council.
About 17 percent of the bank's loans went to customers whose incomes weren't verified, and obviously such lending typically has a higher level of default than loans to standard borrowers. B & B's bad debts in the first half jumped to 74.6 million pounds from 5.3 million pounds last year.
U.K. government and BoE officials had tried for most of the year to prevent B & B from becoming the second Northern Rock, and had earlier borrowed about 24 billion pounds in emergency funds from the Bank of England.
Northern Rock was nationalized in February and got an additional 3.4 billion pounds from the government last month after late loan payments rose to 1.2 percent amid the U.K.'s steepest decline in house prices since 1992. The U.K. has so far managed to avoid nationalization of HBOS, the UK's biggest mortgage lender. It waived antitrust restrictions on Sept. 18 to allow Lloyds TSB Group, the U.K.'s largest provider of checking accounts, to enter into negotiations to buy HBOS in a stock swap valued at about 12 billion pounds. But this deal has yet to be cobcluded, and yesterday shares in HBOS fell as much as 20 percent amid market chatter that Lloyds could reduce its offer by a quarter.
Lloyds shares were up 3.9 percent in mid afternoon yesterday, giving its bid a value of 187.4 pence under the recommended offer which will see HBOS investors get 0.83 Lloyds shares for every HBOS share they own. By contrast HBOS shares were down 10 percent at 127.8 pence, making them the biggest faller in the FTSE 100 share index and putting them at a 31 percent discount to Lloyds' offer price. The stock had earlier fallen as low as 113 pence. Rumourology had it that on nthe back of the change in relative values Lloyds could revise its offer to 0.6 of a TSB shares for each HBOS share.
HBOS, is another bank which is dependent on wholesale borrowing for its mortgage funding, a gets almost half of its funding from this source. HBOS has seen its share price fall 86 percent since the onset of the credit crunch in September last year. HBOS' loans are estimated to have 52 percent cover from customer deposits, against 61percent for Lloyds and 55 percent for the combined group.
If the deal goes through it will create a lender with a 28 percent share of the UK mortgage market and the new entity will control a quarter of the country's current or checking accounts.
UniCredit SpA, Italy's biggest bank and owner of Germany's HVB Group, fell more than 10 percent for the second day running in Milan trading yesterday as the feeling grew amon analysts that the company may need to raise money to strengthen its finances. UniCredit fell a record 38 cents, or 13 percent, to 2.60 euros, giving the bank a market value of about 34 billion euros ($48 billion). The stock, which is now at its lowest since Dec. 4, 1997, has fallen 55 percent this year. Concern that UniCredit may help in the bailout of Germany's Hypo Real Estate Holding, a development which could have negative consequences for Unicredit's capital position seems to be behind the fall. Hypo Real Estate was in fact spun off from HVB Group in 2003.
Chief Executive Officer Alessandro Profumo denied on Monday that Unicredit would need to inject additional funds, and a company official reiterated the comments after the shares were temporarily suspended for the second time today.
``We're absolutely confident about our position, even in this hectic market
scenario,'' Profumo wrote in a letter to employees.
Asked yesterday if Unicredit expectations for the year would be changed, Alessandro Profumo replied: "I can't possibly say given the way the market is going and the widening of spreads."
UniCredit has forecast earnings per share of 52-56 euro cents this year and a stretching Core Tier 1 ratio (this is a measure of capital held against risky assets) of 6.2 percent based on Basel II requirements, up from 5.7 percent at the end of June. In fact this is not the first time this year Profumo has had to roll-back on targets, and the pressure on shares seems to be due to market questioning of how he is going to reach the Core Tier 1 target without a further capital increase, despite repeated denials of any recourse to investors for funds. As I say, this would not be the first time Profumo has had to change course, since back in March he dropped an earnings target of 66 euro cents per share, citing market volatility.
In terms of lending against deposits, Unicredit's current ratio is 97 percent for 2008, below Intesa Sanpaolo's 104 percent. Both the Italian majors have LtD ratios below the European bank average which is estimated to stand at about 129 percent. Five-year senior credit default swaps on UniCredit were up 14 basis points at about 121 basis points yesterday, according to Markit data.
Europe Wide Response?
So what now? Well, as much of the press seems to be noting, all that "NINJA mortgage ha ha ha" stuff from the EU politicians is now starting to look pretty silly (Peer Steinbrueck may well have been the worst case scenario here - being actively seen to gloat with his "ninja loans" quip - short for "no income, no job, (and no) assets." - but I think before anyone laughs too loudly we should just wait and see what happens to the German economy if the run on the Russian financial system continues). Europe's leaders have really been extremely foolhardy in giving the impression to their electorates that the European economy was completely sound and that Europe's banks would avoid any fallout from the global housing bust. If a whole generation of new financial products are suddenly withdrawn from the market (rather like all that "tainted" Chinese milk) it should be obvious that property prices and the construction industry everywhere will feel something, and those banks who didn't have a local property boom to fund, well they simply got involved in buying securities issued by others who did, via the so called "global wholesale money markets".To take just one simple example - of the estimated $591 billion in losses and writedowns so far recorded by global banks since the start of 2007, 39 percent have been accounted for by European institutions.
Yet despite all of this, some European politicians are still at it. Italian Prime Minister Silvio Berlusconi was busying himself yesterday trying to vaunt it over the United States for just this sort of reason. While Italy's financial stability panel, which met for the third time in 10 days yesterday, discretely limited itself to saying what it was supposed to say - namely that the impact of the global financial crisis on Italy's banking and insurance system remains limited and Italian banks had enough liquidity - Berlusconi was busy proclaiming that Italy was far better placed to handle its problems than the United States was: "I am not pessimistic about the future ..." he is quoted as saying "because our financial situation is less fragile than that of the United States,". This, I think remains to be seen, and such bravado in making comparisons hardly befits a Prime Minister whose country has just enetered its fourth recession in eight years and which looks set to contract across whole year 2008.
And the President of Spain's government, José Luis Rodriguez Zapatero, doesn't seem to be much better, since he seized the opportunity provided by his recent United States trip to tell a group of businessmen that the Spanish financial system, unlike its US counterpart, was in extremely good health. Not satisfied with simply making himself look ridiculous, he went further, stating that the extent of Spain's growth had depressed Silvio Berlusconi (his traditional "enemy"), and even suggested that Spain would overtake France in terms of per capita income within three or four years. If someone else hadn't used the phrase already this week, I would have said that what we had here was a clear case of "whom the gods would destroy they first make mad", as it is I will simply have to limit myself to saying that the condition of the patient with Artemio Cruz Syndrome is evidently detiorating.
What Can The EU Do?
However, recognising that we will need some sort of concerted intervention to address the developing problem is one thing, and deciding what that intervention should be is quite another (as we can see from what is happening in the United States right now, getting consensus on any sort of major intervention is far from easy). In theory, the 27-nation EU structure should offer a ready means of coordinating policy. But while the EU has unified laws on areas like trade and labour standards (and in the near future on immigration) more broad-reaching policy harmonisation (such as fiscal coordination) has long been resisted, and the recent sorry attempts to introduce a basic constitution provide clear evidence of the difficulties which lie ahead. The EU has no institutional equivalent of the US Treasury, which is why all the initiatives which we have seen to date - for all the European "feel" about them - have been either ad hoc bi- or tri- lateral arrangements. US NBER head Marty Feldstein has long been on record as pointing out that the greatest weakness in the eurosystem architecture from the start has been the absence of a common fiscal system, and the inability to correct the problems caused by deficits in one country drawing on surpluses in another. Feldstein was thinking about asymetric recessionary processes, and I doubt was thinking about a problem of the severity of the one we now face at the time, but in the longer run he has been proved right, this sort of problem was always going to arise at some point or another.
And we also need to think about the budget deficits issue. If certain of the national governments move back on the commitment to balance the budgets by 2011 then we will only start to shift from banking instition downgrades to soverign rating ones.
At the present time the European Commission seems to be limiting itself to talking about regulatory issues for the future, and new legislation proposals are expected later this week aimed at strengthening bank monitoring across borders, but such moves will hardly serve to resolve the present issue. Up to now European governments seem to have only agreed to a concerted supervision framework which is set to come into effect in 2012, pledging themselves to cooperate as required in managing any crisis, but they have most meticulously resisted devising any kind of formula for splitting the bill in the event that a cross-border bailout should become necessary, or that the problems of one country (and Spain immediately comes to mind here) should become to great for any single member to handle alone.
Daniel Gros, director of the Centre for European Policy Studies in Brussels, in particular has come out and stated that European governments ultimately will have to put capital into their banks, which he calculates are more leveraged than their U.S. rivals.
``These are highly leveraged institutions which need to have support from the
public purse,'' according to Gros.
Daniel Gros also suggested that EU governments assign the European Investment Bank, the EU's financial arm, the job of infusing 250 billion euros to support the region's banks, in return for an equity stake. The quantity he mentions seems rather small by my calculations (I think more than this will be needed in Spain alone), but he is undoubtedly scratching around in the right area.