A TARP for Europe or How not to solve a financial crisis
It looks as though the rotten TARP package is coming to Europe. Les Echos writes that the French government is ready to bring in such a proposal even if it will divide the Europeans. In an interview in yesterday’s Handelsblatt Christine Lagarde suggested the setup of a warning system and an EU emergency fund for bank failures. Reuters reported about a €300bn bailout fund, which was categorically denied by Lagarde later that day. The German government, meanwhile, fond strong words to condemn the idea of an emergency fund (see Peer Steinbruck’s response below), while Deutsche Bank chief Joseph Ackerman is all in favour (we wonder why). The French initiative also finds advocates on the international scene such as OECD’s secretary general Angel Gurria and IMF chief Dominique Strauss Kahn.
Steinbruck rejects the French initiative
In an interview with the Wall Street Journal, German finance minister Peer Steinbruck rejected a European rescue plan as unnecessary. Here is the quote in full: “I don’t think the American package, which Congress will hopefully approve this week, can or should be applied to Europe. I don’t see any need for Germany to put 3 or 4% of its GDP in such a package without knowing what this German money which actually achieve and whether we’ll solve concrete problems with it. The individual banking cases in Europe can have very different causes. In some cases we are dealing with a bank that has a solvency problem. In other cases like with Hypo RE we’re dealing with a liquidity problem. Such a supranational umbrella might not be helpful in these specific cases. To put it mildly, Germany is highly cautious about such grand designs for Europe.”
When tragedy turns into farce
The Senate last night passed the bailout bill by a wide bi-partisan margin, unsurprisingly of course. The new bill includes an incresae in the ceiling for deposit insurance from $100K to $250K. There is one unsuspected element in the bill, which none of us would have dreamed about. Apparently, in Section 503. (it’s gotten a bit longer after Paulson original three page draft) it has the following provision: “EXEMPTION FROM EXCISE TAX FOR CERTAIN WOODEN ARROWS DESIGNED FOR USE BY CHILDREN” This raises the all important question which wooden arrows are exempted, and which are not.
Is the bailout bill worsen the liquidity crunch
Yves Smith and correspondents on the Naked Capitalism blog are probably onto something. A debate is raging there whether the bailout bill may actually make matters worse for the money market. So far we have only argued that it is the wrong approach, a waste of time, but not resulting in an actual deterioration. The argument is that the bailout plan is a Ponzi scheme, which works as follows.
The Fed ends up as the only lender (which is already the case); bailout is needed to prevent the Fed from going broke; Treasury will need to issue more treasury bills to fund the bailout; panic encourages the buyers of treasuries; bailout recipients, i.e. banks, will hoard cash to buy the treasuries bill; “rinse and repeat”; the result is a drying up of lending to corporation and a crowding out of private capital. Interesting.
How useful is deposit insurance?
Deposit insurance is a big subject this morning. Willem Buiter has a very long discussion about it. So does the Spanish newspaper El Pais, which makes the point the deposit insurance is totally useless if there is a systemic collapse of the banking system, or even when one very large bank goes bust, as it is simply unaffordable.
The Irish bailout plan
In response to turmoil in financial markets, the Irish Government introduced a wide-ranging guarantee arrangement to safeguard the deposits and debts at six financial institutions on Tuesday (see FT). The scheme covers deposits in Allied Irish Banks, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, Irish Nationwide Building Society and the Educational Building Society. It guarantees an estimated €400bn of liabilities and covers retail, commercial and inter-bank deposits as well as covered bonds, senior debt and dated subordinated debt. Legislation was pushed through parliament and senate last night. The scheme received mixed responses at home and abroad (see below).
The Irish Independent reports that bank charges are set to spiral as a result of the state guarantee for the four domestic banks and two building societies. The news provoked a furious response from consumers last night. The move means taxpayers could end up paying for the state insurance scheme for banks on the double -- through providing both a guarantee and higher bank costs.
Ireland’s folly
A Fistful of Euros has an interesting item about how competitive devaluations make depressions worse. A modern version is Ireland’s total bank sector bailout guarantee. The Irish government has guaranteed all liabilities of all Irish-headquartered banks. This is not just deposit insurance, but every debt, including to bondholders. The blog asks the sensible question: Would we all be better off if everybody did this? The answer is of course not. Such a blanket guarantee would wreck the public sector if it was applied by everybody.
Moody’s cuts Iceland’s credit rating
This is a very good example of the rating agencies’ duplicity. While all of them tell us the US bailout has no effect on the US government sovereign rating whatsoever, they seem to be treating smaller countries with a different measure. Yesterday, Moody’s an Fitch cut Iceland’s rating to A-, and both agencies threatened further downgrades. Nothing has really changed in Iceland in recent months, except of course for the bailout of Glitnir, the country’s third largest bank.
Panic among Germany’s Landesbanken
If you thought that this crisis of Anglo-Saxon capitalism would be a unique opportunity for Germany’s Landesbanken to defend their business model, you could not be more wrong. The German state-owned banking sector is at least in as much trouble as the private sector. Financial Times Deutschland has the wonderful story that one of them, LBBW from Stuttgart, asked a law firm for a report about what would happen if any of the other Landesbanken went bankrupt. Under the rules, the Landesbanken are supposed to cover for each other’s depositors in such an emergency. In Germany, even the system of desposit insurance is highly decentralised, and depends on the type of institutions. It is no surprise that the other Landesbanken were not particularly pleased to hear about LBBW’s now public report.
EU solves credit crisis…
It is an example of regulation trying to solve yesterday’s crisis. Frankfurter Allgemeine reports that the EU internal market commissioner Charly McCreevy yesterday announce a new regulation to force banks to hold at 5% of the risk of a securitised product. With this rule, he essentially caved in to demands from the industry. A further part of the regulation is a limit on any single unsecured credit to 25% of the bank’s capital or €150m, whichever is the highest – a rule that effectively allows small banks to be completely reckless. FT Deutschland reports that this is actually counterproductive during a period of acute liquidity crisis, as it placed restrictions on an already defunct money market. McCreevy said he would welcome if the European Parliament or national legislatures impose stricter rules, such as Germany, whose finance minister has recently talked about a 20% risk share. The problem with any such number, as we have recently pointed out, is that it would depend on the type of securitisation whether this is a lot, or not enough. In any case, the next, or next but one, regulatory problem in this sector is probably somewhere else.
Code of conduct for golden parachutes
Le Monde has the story that ECOFIN is to adopt a code of conduct for golden parachutes next Tuesday, October 7. In the document, obtained by Le Monde it says that the performance shall be correctly and exhaustively reflected, providing the right incentives by aligning salaries and bonuses with long term profitability. National authorities are to assure remunerations control by share holders. In the talks ahead of the meeting special attention is given to mergers and acquisitions payoffs as well as remunerations in the finance sector that are considered to be biased towards the short term. The proposal comes timely as many countries have ongoing discussions about golden parachutes. Amid growing concern about the golden parachute of €3,7m for the former head of the troubled Dexia bank, Belgian politicians declared to be in favour of abolishing golden parachutes altogether. In France, the government is pressing Patricia Russo, former chief of Alcatel Lucent to renounce her parachute of €6m
An open letter by European economists
When economists who usually disagree with each other draft a common letter to politicians, then we know that things have gotten serious. Here we have Alberto Alesina, Richard Baldwin, Tito Boeri, Willem Buiter, Francesco Giavazzi, Daniel Gros, Stefano Micossi, Guido Tabellini, Charles Wyplosz and Klaus Zimmermann writing a call for action to European leaders, publish in Vox and Lavoce. Warning about an acute threat of financial sector collapse and depression, this is what they propose. Here are the pertinent abstracts:
“The US authorities learned last week that saving one bank at a time won’t work; a systemic crisis demands a systemic response. In Europe, saving one bank at a time means either a rescue effort mounted by one nation, despite important spillovers to neighbouring countries, or last-minute improvised coordination and agreement about fiscal burden sharing. The national responses and ad-hoc cooperative efforts to date have been useful. Yet interdependence among European banks is too deep and too wide-spread for national responses or case-by-case coordination to be enough. Each national policy intervention and each cooperative intervention by a small number of countries can have unpredictable implications for other European nations. It is critical that national authorities sit together and coordinate their responses, developing Europe-wide solutions where appropriate…
“…In Europe, the key problem is high leverage among the internationally active large banks. Hence the EU contribution must be centred on a recapitalisation of the banking sector, through the injection of public equity or through mandatory debt-to-equity conversions. This has to be done at the EU level (e.g. through the EIB). The current approach of rescuing one institution after another with national funds will lead to a Balkanisation of the European banking sector. Agreeing a harmonised level for deposit insurance would also be important. To prevent future crises of this nature, regulation of the European financial markets and institutions at the European level will also be required.
“The problem is not a lack of understanding of how to stop financial crises. The problem is a lack of political will. Unless European leaders immediately unite to address this crisis before it spirals out of control, they may find themselves fighting over how best to salvage the aftermath.”
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