Money markets remain frozen
The arbiter of whether this rescue package has worked or not is the money market, where conditions have improved marginally but not a lot. Yesterday, the US weighed in with its own “nationalisation” package, worth some $250bn, and part of the new TARP programme, and this was positively received by the market, but the big rally is over for now, as the Dow Jones lost 136 points yesterday to close at a little over 9300, and Asian stocks also declined, as the markets once again focused on the real economy and earning prospects, which are not looking good.
The ECB yesterday, in its latest refinance operation, pumped €310bn into the market, having satisfied the entire demand from the banking system. After the ECB raised the deposit facility last week, many banks are now immediately parking the new funds at the ECB at a rate of 3.25%.
3-month Euribor eased marginally to 5.225% from 5.38% last Friday, and 5.31% on Monday, but there is still effectively no volume turnover in the money market. See this article in Frankfurter Allgemeine for more details. The WSJ reports that overnight dollar Libor fell to 2.18% on Tuesday from 2.47% on Monday, but three-month Libor remained stuck at 4.6%.
Here are some more indicators, compiled by Calculated Risk. The yield on 3-month treasuries rose only marginally to 0.235%, and the TED-Spread decline to 4.30, after 4.64 on Friday. This is still huge. (0.5 is normal).
Why did they not save the money markets?
This is a question that has puzzled a couple of commentators, including Daniel Gros, who said that this is missed opportunity that should in theory be easy to fix, but in practice not. He proposed that each government should guarantee its own banks reimbursement of inter-bank loans, including cross-border loans. That means if a Spanish bank does not repay a French bank, the French government would provide insurance. The point is that this is more credible from the banks’ point of view, as they trust their own government more. One can easily see the objections of national finance ministries.
In his FT Deutschland column, Wolfgang Munchau wondered why they did not save the money markets. He was flabberghasted on Sunday night, when he learned that there was no explicit money market guarantee, but a capital issue guarantee for all banks. What happened is that the government are insurance the entire banking sector – in Germany 2003 banks alone – against failure, not just systemically important banks, of which there are only 44 in the whole of the EU. If you ensure all the banks, then there is no need for an explicit money market guarantee. Munchau thinks this is crazy, as government are issuing guarantees that might lead to their own insolvency. The British at least limited the number of banks to nationalise to eight.
The global recession is coming
We do not often report on the Baltic Dry shipping index, which many people regard as a good proxy for global and manufacturing activity. Over the last two days it dropped by some 20%, which is unusually bad even for this very volatile index. Naked Capitalism suggests that the reason is the rapid deterioration in the Chinese economy, but there are also concerns that the credit crunch has reaching shipping finance, as we reported recently.
Germany economics institutes expect a near stagnation next year, with economic growth of a mere 0.2%, according to their joint autumn report. They expressed some hope that the most recent banking rescue package would prevent the worst, but they all agreed on a crisis scenario, in which output fall by 0.8% annually, and unemployment rise by some 400,000. The probability of this crisis scenario is significantly reduced due to the rescue programme. The institutes favours a growth oriented stimulus package consisting of tax cuts, and investments in education and infrastructure.
There are increasing signs of a credit crunch as European banks are withholding credit to the private sector and companies, as they hit their capital adequacy ratios. In Germany, every fifth corporate borrower already experiences credit crunch conditions, which is fairly dramatic increase from just a few months ago, when bank lending was still flowing freely. So this crisis has taken on a new dimension.
So which are those banks?
Frankfurter Allgemeine has a very interesting article about which banks are likely to apply for government help. Some want the capital simply to bolster its capital adequacy ratios, as this is now the easiest way to obtain new share capital. But others are sceptical because they do not want to out themselves as a bank that would need to do this. (This reminds of the emergency lending facilities, or discount rate lending in the US, which banks are shunning for the same reason). The article says that several Landesbanken are considering it, as does Commerzbank, which has links to a property finance company with similar difficulties as Hypo Real Estate. Deutsche Bank refused to comment. Dresdner Bank (which will soon merge its operations with Commerzbank) said all its ratios are great, as does Hypovereinsbank. The smaller private banks generally do not want to have public money. Sal. Oppenheim said definitely no. Another reason for banks’ scepticism could be the €500,000 a year salary cap (and no bonuses).
French rescue plan adopted
Last night the French parliament adopted the draft law of Sarkozy’s rescue package that foresees the creation of two new entities, one to revive the non-collateral market, the other to recapitalize banks. The law passed with the votes of the majority and the two centre parties, while socialists decided to abstain. There was confusion about the legal nature of the first entity that is to supply financial institutions with liquidity against non-collateral assets. Les Echos quotes Lagarde saying that banks should be majority holders of this new institution, while the state would only hold a blocking minority. (A comment from us: If the entity is backed by state guarantees, ownership should not matter). Eric Woerth was quoted saying that minority holdings are not to be accounted for as public debt under the Maastricht definition.
Tough Irish budget
The Irish finance minister Brian Lenihan announced some of the toughest economic measures put forward by any government in decades yesterday, reports The Irish Independent. A 1% tax rise for workers and a 2% rise for high-income earners, higher VAT on tabac and alcohol and higher taxes on cars are part of a series of harsh measures to reign in a €15bn budget deficit. Overall government expenditures are expected to rise by 1.8%, especially in education, social welfare and housing. The main points of the budget are summarized here. Public debt is to attain €12bn or 6.5% of GDP assuming a slowdown of the economy to 1.5% growth, unemployment rate stable at 7.3% and inflation easing to 2.5%.
Fortis and Dexia could aggravate Belgian political crisis
The rescue of Fortis and Dexia, the two big banks in Belgium, is likely to aggravate the political crisis in Belgium writes Le Monde. The Belgians, stressed already from the ongoing quarrels between the Dutch and the French speaking communities, now see the essential cornerstones of their economy been overtaken by the French. While some consider the engagement of the government as a sign of the return of the Belgian state,others see it as a sign of the incapacity to act as a federal state. The paper cites Paul de Grauwe saying that the disappearance of the two financial institutions, former symbol of unity could accelerate the disintegration of the country.
And where was the European Commission?
The former German finance minister, Hans Eichel, has a comment in Frankfurter Allgemeine, in which he accuses the European Commission of inaction. He said the ECB, the eurogroup, all participated, but the Commission remained silent, which is odd given that this crisis has huge implications for competition policy, and the future of banking supervision. Eichel also said that the original Dutch proposal of a euro-level stabilisation fund is a good idea, and should be revived. A pure national approach is not going to work.
Writing in the FT, John Thornhill also asks the same question. While European governments acted, the European Commission was very notable in its silence (our view is that Barroso has been 100% occupied with his own reelection for the last couple of years, and he did not want to upset any leaders, least of all Angela Merkel)
Boeri on how to make the plan acceptable to taxpayers
Writing in the FT, Tito Boeri writes that the rescue plan will now have to be made palatable to euro area tax payers. He has three suggestions. First, increasing competition for banks, and remove national protections on bank restructuring. Second, governments should provide support to low-income families with mortgages. While the problem is not as bad as in the US, the increase in the Euribor is affecting poor families in particular. Third, cut taxes for low-wage earners.
Writing in Lavoce, Francesco Vella, also makes the point that bank bailouts should now be followed by mortgage bailouts.
Reality and illusion
It’s so ironic. Frankfurter Allgemeine has a comment the future of Germany’s “Federalism Commission”, whose goal is to make proposals to reform the competence of the federal state and the Lander. The have not been able to agree on much except one thing – to make it illegal for the state to run excessive deficits. We have always criticised this as nonsensical, and the government’s most recent largesse in the form of a €500bn plan just to bail out the banking sector is a good example of the difference between reality and rhetoric.
What if this had been the Czech EU presidency?
Jean Quatremer asks a question that occupies an increasing number of EU officials and observers. What if this crisis had occurred under the Czech EU presidency, which is due to take over in January? How would Europhobic Klaus and Topolanek have handled this crisis, who last week denounced state intervention in banking as a return to financial communism?
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