Date: 25-11-2011
Source: The Economist: Buttonwood
Subject: Gloom descends
European banks are becoming the focus of concern
INVESTORS began 2011 with high hopes. Bob Doll of BlackRock, a fund-management group, expected double-digit gains from the American stockmarket; the strategists at Barclays Capital expected a 22% return from European shares.
Instead Wall Street is flat and European investors have suffered double-digit losses. The year is ending in a mood of unrelenting pessimism. Although a spike in oil prices and Japan’s nuclear disaster have played their part, the real problem has been Europe. The debt crisis is deeper and more widespread than almost anyone feared at the start of the year.
In a joke coined by Jim Grant, a newsletter writer, government bonds have turned from offering a risk-free return into becoming a return-free risk. Matt King, a credit strategist at Citigroup, thinks this change in attitude has been decisive. “The discovery that a credit you thought was safe, and accumulated a large exposure to, is actually rather risky, tends to lead to a wave of forced selling so strong that it can overwhelm the fundamentals.”
The proposed 50% write-off for private-sector holders of Greek government debt must have played a part in this process. Fund managers now seem to be reluctant to hold any euro-zone government debt. Even in Germany, a bond auction failed on November 23rd, with only €3.6 billion ($4.8 billion) sold of a potential €6 billion issue.
This sell-off sent ripples through the financial system because of the strange symbiosis between governments and banks. The former rescued the latter in 2008 but the banks are also big buyers of government bonds. The result is that doubts about the health of a sovereign issuer become worries about the solvency of its banking system.
Banks are finding it more difficult and expensive to borrow money. Since May, American money-market funds have cut their exposure to European banks by 42%, according to Fitch, a ratings agency. The spread between the rate at which banks pay for money and official short-term rates has widened sharply since September. Although the spread is well below the levels reached in 2008, many banks are getting by only with the help of liquidity provision from the European Central Bank. The ECB said on November 22nd that demand for funding had reached a two-year high. Some banks are having to indulge in expensive “liquidity swaps” in order to get the right kind of collateral to offer the ECB.
Other indicators of risk are also sounding the alarm. European bank shares trade at well below asset value, suggesting that investors expect their balance-sheets to suffer significant write-downs in future. The cost of insuring against European bank default is at its highest ever, according to Markit, an information provider. The yields on bank debt have also been rising and diverging sharply from the yields on non-financial debt (see chart).
There are two potential adverse consequences of this squeeze. The first is that the banks, which are being required to increase their capital ratios by the European Banking Authority, are unlikely to be able to raise new equity in such circumstances. So they may cut their lending to companies. Barclays Capital points out that, if the region’s banks improved their capital ratios purely by shrinking their balance-sheets, lending would fall by around €3 trillion, or almost a third of the region’s GDP.
The second is that concern about the banks may affect consumer confidence, as it did in 2008. Indeed, things may be worse this time round since governments may feel less able, for political or financial reasons, to bail banks out. Historians note that it was the 1931 failure of an Austrian bank, Credit Anstalt, that ushered in the worst phase of the Great Depression.
Many commentators feel that the scale of this crisis is not yet appreciated, particularly in Germany, which is why decisive action (a fiscal bail-out or the mass purchase of bonds by the ECB) has not taken place. “Germans haven’t felt the pain yet,” says David Bowers of Absolute Strategy Research, a consultancy. German industrial production was booming earlier this year; but the boom is fading fast.
Any action may come too late to stop a significant recession in Europe; already the purchasing managers’ indices are pointing to a downturn. And the rest of the global economy may not be strong enough to compensate. American GDP did grow in the third quarter, but only by an annualised 2%. In China, the vice premier for the economy, Wang Qishan, said on November 21st that “global economic conditions remain grim.” It does not look like being a very merry Christmas.
Jürgen Habermas has had enough. The philosopher is doing all he can these days to call attention to what he sees as the demise of the European ideal. He hopes he can help save it — from inept politicians and the dark forces of the market.
