Business as usual for European finance ministers
The final agreement reached on the Ecofin meeting yesterday fell substantially short of the EU’s aim of setting common standards for deposit protection schemes writes the FT. Finance ministers agreed to raise the deposit guarantee protection for individuals for an amount of at least €50,000. The initial proposal to lift the ceiling to €100,000 did not find consensus. Le Monde reports that Eastern European countries, as well as Denmark and Finland feared that such a high ceiling is too much of a burden. Meanwhile Greece, Spain, the Netherlands, Belgium and also Austria announced to raise the ceiling to €100,000.
The Irish Independent considers the agreement as meaningless and concludes that everybody is going its own way. They also reported that the ECB said that Ireland should have ''properly'' informed the EU before announcing the bank- guarantee plan.
FT Deutschland is more upbeat, saying that the major agreement was that finance ministers agreed to save all important banks whose failure could endanger the financial system. They quote French finance minister Christine Lagarde as saying that the EU would not accept a European version of Lehman Brothers. There is no common master plan but national efforts will be coordinated. Angela Merkel announced that the government is working on criteria to distinguish between systemically relevant and non relevant institutions.
Meanwhile, several countries speed up their efforts to limit or condition the remuneration of the management. Le Soir writes that Belgium will legislate against golden parachutes of companies in difficulties in which the state is taking a stake. In France, the government still counts on self regulation but the pressure is high to reinstall confidence in the system writes Le Monde. The French Senate thus is to propose end of October that the management is not to receive stock options without proposing a system that benefits employees in line with the company’s performance.
It was another bad day on financial markets, as the 3-month hit another record level, and as global stocks continued to retreat with the S&P now under 1000, and the DJIA at below 9500. The euro stabilised.
IMF says euro area is decoupling after all
Now this is interesting. In its latest world economic outlook (see an excellent discussion by Menzie Chinn), the IMF says the impact of financial stress will be a lot worse in the US than in the euro area. “The US economic downturn may well become more severe and could evolve into a recession. The evidence for the euro area is more consistent with the pattern for a slowdown than a recession, and the dynamics also appear to be evolving with some lag.”
IMF revises estimate of subprime crisis upward
Another $100bn, or so, the numbers almost don’t matter any more. The IMF now estimates that the total losses on securitised debt instrument will be in the order of $1.4bn, which means that the worst of the crisis is still ahead of us. It estimates that the banking system will need another $675bn in new capital, according to FT Deutschland, reporting on the IMF’s latest World Economic Outlook. Interestingly also, the IMF says that in times of disturbances of money and capital markets, the role of central bank interest rates as policy transmitters is correspondingly reduced.
US considers another rate cut
Ben Bernanke effectively pre-announced a rate cut yesterday, saying that the risks to the economy have grown significantly in recent weeks, and that the Fed would now be reconsidering its policy stance. The message was pretty clear, and grim. There was no upside. So a rate cut will come. Look at Calculated Risk for a good summary of extracts of his speech.
Spain’s crisis programme
El Pais has details of the latest Spanish emergency programme to help the financial sector. The Spanish government has now raised the deposit insurance ceiling to E100,000, to pledge up to E50bn in support of the financial sector. In a worst case scenario, this would raise the country’s debt-to-GDP ratio from 37% to 42%. These funds are not intended as a capital increase, but as pure liquidity injections only.
Tremonti calls domestic summit
Corriere della Sera reports in its print edition that Giulio Tremonti, Italian finance minister, believes the worst of this crisis has yet to come, and he urged social partners to prepare for stage two of the crisis. He called a crisis meeting with the Bank of Italy, the Italian Banking Association, the employers organisation Confidustria and Mediobanca for today to discuss the crisis, which has hit Italy at a time when the economy was already stagnating.
Martin Wolf has changed his mind
Martin Wolf offers three priorities for western policy makers ahead of their meetings in Washington. He says time for a country-by-country approach is over. The three priorities are, for Europe, to offer time-limited guarantees to the systemtically important parts of the banking sector, which should reignite the money markets. The second priority is recapitalisation, but Wolf is opposed to a shrinkage of the core financial system, and the third measures is to buy up toxic assets, as in the TARP programme. He also makes two further points. The first is that in terms of sovereign risk the ratio that matters is recapitalisation (not gross liabilities) to GDP. In the UK, a 4% recapitalisation in respect of the banking sectors’ assets would translate into an increase in the debt-to-GDP ratio of 20 percentage points, which would make debt-to-equity swaps unavoidable. The other point is that in his view UK interest rates should fall by a full percentage point.
Iceland pegs kronar to euro
As part as its emergency package to prevent a macroeconomic collapse, Iceland has pegged the kronar to the euro at 131, after nationalising Landesbanki, the country’s second largest bank, following the purchase of Glitnir last week. S&P yesterday cut the country’s sovereign rating further, to BBB, according to FT Deutschland. The net external debt of the banking sector was 2.2 times GDP in 2007, (2.6 for the country as a whole), while Fitch estimates that the latter figure will go up to 3.4 this year. One of the problems are the high short-term interest rates in Iceland (15%), which have forced banks to borrow outside.
Jean Quatremer makes the point that the European Commission considers the accession of Iceland to the EU as possible.
From debt crisis to sovereign crisis
P O Neill in A Fistful of Euros makes the point that we are on the verge of turning from a credit crisis into a sovereign crisis, as countries take on banking sector liabilities onto their own balance sheet. Iceland is a frightening case, which had to resort to some extreme measures, including a bailout from Russia, and a hugely overvalued peg. He says that Iceland’s situation might have reverberations in other parts of non-eurozone eastern Europe.
Buiter on Iceland
Willem Buiter argues that Iceland should have pulled the plug on its banking sector, instead of transforming private risk into public risk. “Rather than hammering its tax payers and the beneficiaries of its public spending programmes, rather than squeezing the living standards of its households through a sustained masstive real exchange rate depreciation and terms of trade deterioration, and rather than creating a massive domestic recession/depression to try and keep its banks afloat, it should now let Glitnir, Landsbanki and Kaupthing float or swim on their own. The interests of domestic tax payers and workers should weigh more heavily than the interests of the creditors of these banks.”
Why the ECB needs to cut rates now
Dieter Wermuth, in Herdentrieb, has an excellent analysis about refinancing costs for banks, and argues that the main reason for a sizeable interest rate cut in Europe is to allow the banking system to play the yield curve – to earn money by refinancing at low short-term interest rates to lend at higher rates. The problem for banks at the moment is a fall in the value of their assets combined with an increase in refinancing costs – the 3-month euribor hit another record yesterday, 3-month dollar libor is also more than two full percentage points above the Fed funds rate. The banks are now in such a dire straight that they have to raise capital or sell assets, both of which is not possible right now. This is why government make deposit insurance guarantee, but a rate cut is also necessary to allow banks to ride the yield curve, which is what happened in Japan, where post-crisis interest rates fell to almost zero percent.
The German government is panicking
Wolfgang Munchau, in his column in the FT Deutschland, has only one explanation for the extraordinary convulsions in the German government, that complancency has given way to panic. Angela Merkel announces that the government guarantee all financial sector liabilities, yet curiously she plans no legislation. Steinbruck is very opaque about the government’s participation of the Hypo Real Estate rescue package, which is actually larger than admitted. And the latest confusion about a comprehensive rescue is another example that the government makes big preannouncements, with no backup. This is likely to lead to even more uncertainty among savers. If there is one reasons to favour an EU-wide solution, it is to get rid of these bunch of incompetents.
The importance of risk sensitivity
Avinash Persaud, writing in Vox, asks when subprime mortgages account for less than 1% of the world’s debt stock, how could they cause the greatest financial crisis in modern times? “Risk sensitivity” is his answer. Regulators gave bankers incentives to combine bad loans with good ones and securitise the package in complex structures. The inseparability of the suspect parts meant problems with one package questioned the value of all packages. The least liquid banks failed, triggering a vicious cycle of fear and failure.
A new Bretton Woods
In Le Monde Christian de Boissieu and Jean Herve Lorenzi call for a new Bretton Wood conference that is to renew the foundations of the international banking and finance system. Such an international conference could by reuniting the world’s players send a strong signal to the markets of rupture with the past. The conference should be called in as soon as possible with the following two main objectives: the first is to get coherent set of recommendations about the role of rating agencies, prudential regulation, how to adjust norms in international accounts, rules for sovereign funds and supervision of financial institutions. The second is to redefine the role of the IMF. In its new role it should be endorsed with some regulatory power in the financial world, e.g. with respect to rating agencies or sovereign funds.
Belgium under strike
Large parts of Belgium were paralysed on Monday by a strike of the three main trade unions, which protested in favour of more purchasing power and in defense of their wage indexation system, reports Le Monde. It is a Belgian anachronism that adjusts the salaries automatically once inflation reaches a certain limit. The three trade unions also called for a cut of VAT on energy and a tax reform that benefits low income earners. Their punch line was to say look the government has no millions of euros for the employees but is willing to spend billions on banks instead.
Eurointelligence wishes to thank the Collegio Carlo Alberto for their support to help us maintain eurointelligence.com a free public service.