A fine mess
The House of Representatives rejected the €700bn rescue package in a surprises vote of 228 to 205, sending equity markets into a tailspin, and US politicians and commentators into despair. Even more important than the 9% fall in the S&P has been the ensuing stress in the money and capital markets. As Naked Capitalism reports, the Fed immediately swamped the financial sector with massive amounts of new funds, added $300bn to its Term Auction Facility, which is in addition to a $330bn increase in currency swaps arrangements. Naked Capitalism also makes the point that the next TAF auction is not for another week, so no immediate relief is likely. Furthermore, there were signs of significant stress in the US repo market, with spreads now of 1.25%, the highest level since the Bear Stearns rescue. Earlier yesterday, the market for covered bonds, or Pfandbriefe, effectively collapsed follow the German bailout of Hypo Real Estate.
After the shock in Congress, Hank Paulson said he wants to hammer out a new plan. Meanwhile the House may put the failed plan for a second vote next week, after the expected passage of the bill in the Senate. So this stinker of a rescue is not quite dead yet.
The most fitting description came on the front cover of the latest New Yorker, with Humpty Dumpty about to fall off the edge of the NY stock exchange.
The commentariat was almost speechless. Paul Krugman talked about a banana republic, and opined that the decision to allow Lehman to fail delivered the White House to Obama. Many others were too shocked to say anything. There will be more tomorrow, no doubt.
Willem Buiter on what happens now
The one commentator who was not speechless this morning was Willem Buiter, who was a little bit on the gloomy side. He says the following will happen, unless Congress reconsiders: Stock markets crash (already happened), CDS crash, money market crash, fire sale of bank assets, no more credit to households, banks fall like dominoes, other financial institutions collapse like dominoes, household revert to financial autarky, consumer demand collapses, indefinite suspension of trading in financial stocks, all banks nationalised; the Great Depression of 2010 begins.
It could not happen in Europe…
… is what we used to say. Now each day brings a new bank failure. Yesterday it was the turn of Dexia, which announced that it was assessing the international situation, which is bankers’ short-speak for: we are bankrupt. Belgian authorities were meeting last night to hammer out a bailout package for Belgium’s second largest bank. Le Soir reports that the discussions focused on a ballpark of €6-7bn last night, and that the regional governments were last night giving the green light for the rescue of Dexia. The idea was to have a bailout ready by this morning. And if you read newspapers from Ireland, Italy and other euro area countries, there are concerns about the liquidity of many European financial institutions.
The Fortis Rescue
Willem Buiter is rubbing his eyes in the light of the Fortis rescue, saying that it showed how wonderful the euro area works. Everybody was involved, including Trichet and Juncker. It was a great day for the euro area, not so great a day for Benelux banking.
Daniel Gros and Stefano Micossi argued in the FT that the Fortis rescue, rather than showing that the euro area’s bailout mechanisms are working, is showing just the opposite. They argue in the FT that the eurozone does not have the defence to resolve a euro-area wide solvency crisis, as the rescue of any single cross-border bank exceeds the capacity of their home government to bail it out. They are proposing, first, a European statute for EU-chartered banks, a contingency fund for organising rescue operations at EU level, preferable at the European Investment Bank, all large too-big-to-fail banks should recapitalise to reduce the leverage ratio to below 20.
Jean Quatremer writes in his blog that the bailout of Fortis by the Benelux governments proves that it is indeed possible in Europe to coordinate their efforts as fast as the US. But if this concerted action serves as a blueprint of what a “government economique” could look like, it is still lacking an institutional setup. Why Europe has so far failed to coordinate its efforts when it comes to a common banking supervisor? Is it reasonable to limit the EU budget to 1% while systemic risks ignore frontiers? If member states want to give themselves the opportunity to act they need another step towards a federal structure.
Le Monde editorial asks what would have happened if the participating countries could not reach an agreement or what would have been the authority of Jean Claude Trichet if the bank has one leg inside and another outside the euro area? The EU would be incapable to decide on a package comparable to the Paulson plan. The large countries are not ready to pass over their authority to an EU system and London would never consider the ECB to have a say with respect to the city.
The Hypo Rescue
FT Deutschland has everything you ever wanted to know about the German bailout of Hypo Real Estate –over eight pages or so. We are not going to summerise, but would like to point to a couple of articles regarding Depfa, the Hypo subsidiary which failed to adhere to the golden rule of banking – not to finance long-term liabilities with short-term liquidity.
Why did Hypo have to be rescued?
Frankfurter Allgemeine said in a comment that Hypo was hardly known outside banking circles, and has no private investors who would stand to lose any money. So why was the bailout necessary. The answer is that Hypo is a key institution in the German Pfandbrief – or covered bond - market, which is one of the backbones of Germany’s financial system. The market has already dried up, but the death of Hypo could have finished it off for good.
Ban on short selling last straw for hedge funds
The hedge fund industry is already in dire straight, because its investment model no longer works when there are no bubbles. Now the worldwide ban on short-selling is turning a bad situation worse, according to the FT. The industry is now facing massive withdrawals from investors. Given the high fees that hedge funds, plus the fees for the funds of funds, there is no way that the hedge fund business model could work in a bear market.
Irish market crash
The Irish stock market yesterday crashed even before the dramatic events in Congress. The SE index was down 12.7%, and there is almost certainly more to come today. Look at FT Alphaville for a chart. One of the reasons is Allied Irish Bank. These European banks are now falling like dominos.
Guaino for a new Bretton Woods
Arnaud Leparmetier in Le Monde writes that the financial crisis gives a new platform to Henri Guaino, Sarkozy’s gifted speechwriter, who made himself known in Europe for his anti European instincts and the ECB bashing. Now Guaino has apparently learned his lessons and is up to something bigger: the construction of a new Bretton Woods. The discussions started according to the following lines: the financial crisis will reach Europe, requiring a guarantee for French savings; no unrealistic European proposals as long as France holds the EU presidency (one remark from us: this is a bad timing for a French presidency. They will find it hard to convince others of any substantial proposal); no stimulation package like in 1974 or 1981 but postponing deficit cutting until after the downturn.
Robert Shiller on what happens now
This is probably the most level-headed comment this week, it is by Robert Shiller in the Washington Post, in which he argues that this is not the end of capitalism, merely a crisis that leads into a new, and better direction. He says any new system would have the following components. It needs to handle moral hazard better. It is better risk management, and better derivatives. Markets should matter more, Wall Street titans should matter less. Trust in new ideas.
Greek banks are to prepare for the crisis
Kathemerini writes that the Greek central bank is to press local banks to clean up their loan books by making more provisions for non-performing loans and to proceed with higher write-offs even if this means they will have to boost their capital. So far the international credit crisis has been felt by Greek banks only in the form of higher funding costs. However, higher lending rates, along with a slower-growing domestic economy, higher risks in neighboring southeast European countries and the central bank are bound to force them to take a closer look at their credit asset quality. The likely deterioration may spell trouble for their future earnings and even capital adequacy ratios in some cases.
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