We have successfully transformed credit risk into solvency risk
If the goal of the rescue plan was to avert in imminent financial meltdown, it worked. Global stock market rallied yesterday, with many indices up by more than 10%, and money market rates started to come down a little, especially here in the euro area, where one-weak Euribor rates fell 26bp to 4.37%. The euro rose against the dollar to above $1.36.
Economists warn against too much enthusiasm, as financial crisis and the economic slowdown are both going to get a lot worse. There are reports of a dramatic worsening of credit card and auto debt - as our next subprime crisis is now only months away.
In the meantime, there is now a race to save the global car industry, as Germany is now considering active financial support, according Financial Times Deutschland, in response to a US package. Germany is giving up on its balanced budget goal for 2011, by the way, and while Merkel wants to support the car industry, she opposes a general stimulus.
Yesterday was the day for national action plans to save the financial sector. We are presenting the pertinent facts about the main European plans. The FT has calculated that European governments (including non euro area) have made available a total of €1873bn – which is roughly the entire annual GDP of France! – to save the banking sector. Our guess is that we may soon have a discussion about national solvency. Some commentators have already pointed this out this yesterday, see below.
Germany
Here is everything you need to know about the German plan, the biggest and most comprehensive of all eurozone countries. The German plan consists of a headline totoal €500bn, of which €400bn is not accounted for at this point. The remaining €100bn will be used immediately, €80bn of which for injecting capital in the form of equity, and €20bn in the form of lending guarantees (This is not the total of the guarantees, but the total the government expects to pay as a guarantor). Those €100bn (and any of the remaining €400bn should this become necessary), will be held off-balance sheet – which means that the deficit will not affected directly, though it is affected indirectly due to debt servicing costs. Just a ballpark: The full €500bn guarantee constitutes some 20% of German GDP. If it gets drawn, the German debt-to-GDP ratio would rise from 65% to 85%.
Here are some further details. For a good summary, see FT Deutschland today. The guarantees are in respect of issued securities with a maturity of up to 36 months. There is also an explicit guarantee of Pfandbriefe, or covered bonds.
Any bank recapitalised by the federal government has to subject itself to some stringent conditions, including €500,000 salary cap for board members, restriction on golden parachutes and dividend payments.
A really important change, for Germany, is a change in insolvency law. Germany’s almost biblical insolvency laws will now be modernised to the effect that a company medium-term viability is now taken into account if the company is deemed insolvent. Another change is a temporary abandonment of mark-to-market accounting in times of market crisis. Capital increases will from now be decided by excutive and supervisory boards alone, and do need the consent of the shareholders.
The plan was decided in the German cabinet yesterday, will be passed by the Bundestag and the Bundesrat this week, and signed into law President Köhler immediately afterwards. As ever, there is a row about burden sharing between federal and state governments. Don’t get too excited. It will be resolved.
The fund will be administered by the Bundesbank, under the supervision of the finance ministry.
France
The French plan is a lot smaller. As we reported yesterday, France will create a new public entity to forward credits to banks with a maximum duration of five years. This entity will be guaranteed up to €320bn. This entity will accept collateral, such as mortgage debt, which is not accepted by the ECB. (which means that this programme is a lot more like the US TARP than many people think). Backed by the state guarantee, the new entity will finance itself on the open market, and will then pass on the funds to the banks with a premium of 180-190 basis points. The state guarantee to this entity will expire 2009.
There is a recapitalisation component of €40bn, which will be allocated to a separate entity. As in other countries, in case of a recapitalisation, restrictions will be placed on banks. The management will be changed, caps on salaries etc.
The legislation is in Parliament today, and will be decided by the end of the week.
There are still further decision to be taken on further structural issues, such as accounting standards.
Italy
Italy’s plan is even smaller than the French plan. Giulio Tremonti announced yesterday that Italy plans no UK, or German-style fund, but decided instead on two more limited measures: to ensure liquidity to the banking system, and to prevent a drying up of credit to corporates, according to a report in Corriere della Sera.
Il Sole 24 ore reports BoI governor Mario Draghi as saying that the room for manoeuvre for further ECB repo rate cuts is constrained. The recent interest rate cuts plus the decision to provide unlimited liquidity to the market should, however, affect the inter-banking market with a short delay. Furthermore, the central bank has taken some measures to
Spain
The Spanish, which already announced a €50bn liquidity plan last week, yesterday announced additional measures. There will be lending guarantees of up to €100bn until the end of 2009 for the issue of pormissary notes and bonds, with the possibility that the government might widen the list of eligible paper. As in other cases, the maximum permitted duration is five years.
According to El Pais, the Bank of Spain will administer the scheme. The Spanish have been saying that capitalisation is not their main problem, so there is no explicit recapitalisation scheme. PM Zapatero, however, yesterday left open the door for recapitalisation in principle.
Netherlands
The Netherlands decided a credit guarantee package on similar terms as the other countries of €200bn, earmarked primarily for banks that are deemed to be healthy (which bank would that be, we wonder?), according to Het Financieele Dagblad. Many details of the plan have yet to be work by the Dutch parliament. The decisions follows last week’s setup of a €20bn to provide temporary liquidity.
Austria
In Austria the total package amounts to €100bn, including guarantees of €85bn, the remainder is earmarked for capital injections. The government also guaranteed all deposits, and declared short sales illegal. The government also said it did not in principle rule out nationalisations.
Credit cards – the next subprime
We knew that credit cards pose as much risk to the financial system as subprime mortgage, as the respective securitised products markets are roughly of equal size. More recently, the spreads on credit card securitised products widen dramatically, and this suggests that the Fat Lady about to sing in this market as well – as credit-cruched Americans have been loading up with only source of credit that has been freely available (though free is perhaps the wrong word). Naked Capitalism has an interesting entry on the latest spreads between various types of credit cards and the respective Swap/Libor rates. The spreads for credit card debt, both fixed and variable rate, and autoloans went up by 50bp in one weak, and this is unlikely to reverse as money market rates improve. Naked Capitalism remarks that the “consumer borrowing party is coming to an abrupt close”.
And now for some commentary
George Magnus writes in the Financial Times that these programmes are worthwhile, though not ideal, but that deleveraging in the financial and householders sector will continue. He draws four conclusions. First, there will be more financial stress, and failures,a . Second, the recovery in the money markets will take a long time. Secondly, there is a severe risk of an increase in government bond yields. Thirdly, the global recession is going to be worse and long; forthly, this will bring renewed credit risks, and another downward spiral.
Writing in Telos, Agnes Benassy Quere and Lionel Fontagne make some calculations about the potential costs of some of these programme, and wonder how this is financed. The calculated the deficit effect of the US plan is some 3.5 percentage points, which includes about 1pc in tax relief, on top of a projected budget deficit of 5.5%. They conclude that an inflation tax is now a very real prospect – also for the UK.
Nouriel Roubini writes that the rescue plans have saves us from an immediate collapse, but huge problems remain. He advocates a fiscal stimulus in addition to a bail-out of mortgage holders, as both are necessary to prevent a consumption slump, which is now the biggest risk, in addition to the many financial sector risks stemming from CDS, the collapse of hundreds of hedge funds, further bank failures, emerging market failures, a continued vicious cycle of deleveraging and falling asset prices, further downside risks housing (we stop here. He has got more).
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