Banking Crash Hits Europe

Banking Crash Hits Europe As ECB Loses Traction

By Ambrose Evans-Pritchard | 30 September 2008

The global credit crisis has slammed into Europe with stunning violence over the last two days, triggering five major bank rescues and a near total shut-down of the region's credit markets. The Dutch-Belgian bank Fortis, Britain's Bradford and Bingley, and Iceland's Glitnir, were all partially or fully nationalized after failing to roll-over debts in the short-term money markets, while the French state pledged support for the Franco-Belgian lender Dexia after the share price collapsed on reports of a capital shortage. "The European financial sector is on trial: we have to support our banks." said French President Nicolas Sarkozy. He has reportedly ordered the state investment arm Caisse Des Depots to shore up Dexia, even though the bank is based in Belgium.

Germany's Hypo Real Estate, a commercial property lender, was rescued with a €35bn lifeline from a consortium of local banks. The lender has $560bn in liabilities, almost as much as Lehman Brothers. Hypo Real's share price crashed 74pc, setting off a masse exodus from financial stocks in Frankfurt. Commerzbank fell 23% and Aareal Bank was off 43%. Anglo Irish Bank was down 44% in Dublin on wholesale funding fears.

Europe's credit markets have come close to seizing up as three-month Euribor jumped to a record 5.22% and OIS spreads rocketed to 113 basis points. "The interbank market has collapsed," said Hans Redeker, currency chief at BNP Paribas. "We're now seeing a domino effect as the credit multiplier goes into reverse and forces banks to cut back lending to clients," he said. Mr Redeker said the latest alarming twist is a move by banks to deposit €28bn in funds at the European Central Bank in a panic flight to safety. This has jammed the mechanism used by the authorities to shore up the financial system in a crisis.

"The ECB is no longer able to inject liquidity because the money is just coming back to them again. This is extremely serious. If monetary policy is no longer working, there is a risk that the whole system will blow up in days," he said. The euro plunged on Monday as the wave of bank failures hit the newswires, dropping 2% to $1.43 against the dollar. It recovered slightly as the US Federal Reserve flooded the markets with $630bn of dollar funding with fellow central banks in the biggest liquidity blitz in history.

Analysts say German finance minister Peer Steinbrueck may have spoken too soon when he crowed last week that the US would lose its status as a superpower as a result of this crisis. He told Der Spiegel yesterday that we are "all staring into the abyss". Germany— over-leveraged to Asian demand for machine tools, and Mid-East and Russian demand for luxury cars— is perhaps in equally deep trouble, though of a different kind. The combined crises at both Fortis and Dexia have sent tremors through Belgium, which is already traumatized by political civil war between the Flemings and Walloons. Fortis is Belgium's biggest private employer.

It is unclear whether the country has the resources to bail out two banks with liabilities that dwarf the economy if the crisis deepens, although a joint intervention by The Netherlands and Luxembourg to rescue Fortis has helped Belgium share the risk. Together the three states put €11.2bn to buy Fortis stock. This tripartite model is unlikely to work so well in others parts of Europe, since Benelux already operates as a closely linked team. The EU lacks a single treasury to take charge in a fast-moving crisis, leaving a patchwork of regulators and conflicting agendas.

Carsten Brzenski, chief economist at ING in Brussels, said the global crisis was now engulfing Europe with devastating speed. "We are at imminent risk of a credit crunch. Key markets are not functioning properly. The Europeans thought the sub-prime crisis was just American rubbish that the US should clean up itself, but now they are finding out that it is their rubbish too," he said.

Data from the IMF shows that European banks hold 75% as much exposure to toxic US housing debt as US banks themselves. Moreover they have mounting bad debts from the British, Spanish, French, Dutch, Scandinavian, and East European housing markets, where property bubbles reached even more extreme levels than in the US. The interest spread between Italian 10-year bonds and German Bunds have ballooned to 92 basis points, the highest since the launch of the euro. Bond traders warn that the spreads are starting to reflect a serious risk of EMU break-up and could spiral out of control in a self-feeding effect.

As the eurozone slides into recession, the ECB is coming under intense criticism for keeping monetary policy too tight. The decision to raise rates into the teeth of the crisis in July has been slammed as overkill by the political leaders in France, Spain, and Italy. Mr Sarkozy has called an emergency meeting of the EU's big five powers next week to fashion a response to the crisis. Half of the ECB's shadow council have called for a rate cut this week, insisting that the German-led bloc of ECB governors have overstated the inflation risk caused by the oil spike earlier this year.

Jacques Cailloux, Europe economist at RBS, said the hawks had won a Pyrrhic victory by imposing their hardline monetary edicts on Europe. "They have won a battle but lost the war. The July decision will hardly go down in history books as a great policy decision," he said.


Financial Crisis: Ireland’s Banks Are Rescued
Ireland Has Launched A Full-Scale Rescue Of Its Financial System, Issuing A State Guarantee Worth €400bn (£316bn) To Cover The Key Liabilities Of Its Biggest Banks And Mortgage Lenders.

By Ambrose Evans-Pritchard | 30 September 2008

Irish package for banks may prove one Guinness too many for the EU Commission. It is the most dramatic and comprehensive bank bail-out in Europe since the Scandinavian rescues of the early 1990s and may serve as a model for Britain and other countries that so far have been muddling through from one mishap to another with a mish-mash of ad hoc policies. The state guarantee exceeds 200% of Irish GDP, marking a new phase in the escalation of the crisis.

The move came as Standard & Poor's cut Iceland's sovereign credit rating from AA— to A+ following its nationalisation of Glitnir Bank. It is a warning that the cascade of bank bail-outs on both sides of the Atlantic could start to undermine the credit-worthiness of Western states. S&P warned that the tiny Nordic island is now saddled with liabilities that dwarf its economy.

The euro suffered the sharpest drop since the launch of the currency, dropping almost 3% at one stage to $1.40 against the dollar in a day of high drama across Europe. Belgium, France, and Luxembourg stepped in to rescue Dexia, the world's biggest lender to local authorities. The trio agreed to inject €6.4bn in fresh capital after the share priced crashed on Monday. Dexia's top management stepped down.

"We must have total confidence in the safety of the French banking system: there is absolutely no reason to panic," said Christian Noyer, head of the Banque de France. "The credit crisis is working its way up the food chain," said Chris Whalen, head of Institutional Risk Analytics. "Now states that sponsored the idiocy of the credit bubble are being challenged themselves. Unfortunately this could lead to global debt deflation. We are seeing a shrinkage of bank capital and this will cause a depression unless we stop it," he said.

The Irish measures amounts to a state rescue of Allied Irish Bank, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, and Irish Nationwide, which all suffered a frightening share slide on Monday. "We can't bail out a particular bank: that wouldn't be right," said Brian Lenihan, the Irish finance minister. "What we have decided to do is give a general guarantee that the banks can lend in security and safety", he said. RBC Capital Markets said it was unclear whether wholesale support for Irish banks is legal under EU state aid rules.

"This may be one Guinness too many for the EU Commission. The action may affect trade between EU member states and raise the ire of other governments," it said. The EU Competition watchdog said it was in "urgent" consultations with Dublin. The Irish banks have been bleeding money as the property bust sets off a chain of defaults. House prices have fallen for eighteen months, and are now down 13% from their peak. Construction reached 21% of gross domestic product at the height of the bubble.

Under EMU membership the Irish authorities have been unable to cut interest rates to cushion the hard-landing. The European Central Bank raised rates in July to 4.25%. With Euribor now at record levels, the borrowing cost for Irish homeowners on floating rates (55% of the total) has risen by 1.5 percentage points since the credit crunch began. Ireland is now the first eurozone state in official recession. Unemployment has risen from 5% to 6.1% since January.

Moritz Kraemer, head of European sovereign ratings at S&P, said there is no immediate threat to Ireland's AAA rating. The country has tiny national debt (25% of GDP) and may not have to commit state funds for the rescue plan to restore confidence. "If it all goes terrible wrong in the property market, there could be significant losses for the treasury given the size of the Irish banking system. This could hit the sovereign rating," he said. It is another matter for Iceland where the three biggest banks have ammassed liabilities equal to 800% of the country's GDP in a breackneck expansion across Europe.

S&P said the Glitnir nationalisation had alone cost 5.9% of GDP, but the taxpayer burden could reach well beyond that figure. "The Icelandic banks are super-sized compared to the Icelandic budget. If there is a systemic crisis it could be very hard for the authorities to stop it. Moreover, the banks have used aggressive leverage, so their funding base is volatile," he said.

The euro suffered the sharpest drop since the launch of the currency, dropping almost 3% at one stage to $1.40 against the dollar in a day of high drama across Europe. Mr Whalen who advises the Icelandic authorities, said the country would muddle through. "Iceland has an open economy, so it has been easy for the hedge funds to come in and rape the currency. But the country is really like a giant private equity fund. Its banks buy real things so its liabilities are matched by assets. I am not really worried," he said.

Normxxx    
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