A euro area action plan
The first ever euro area summit produced a plan last night, and the initial market reaction to the sum total of global action plans is mildly positive. Asian stock markets stabilised, posting moderate gains of around 3%. And the euro also gained against the dollar.
The eurozone summit did not pledge any concrete sums, but only provided a framework. Member states will announce their individual plans today. The UK will nationalise some banks this morning.
The euro area agreement consists of three main components: state guarantees of new debt issuance by banks, recapitalisation of banks, and new temporary accounting rules. We think there are no explicit provisions for the non-collateralised inter-banking market, but the deal appears to cover the commercial paper market. The agreement is much more specific than Friday’s G7 communique.
This is our edited version of the euro area summit’s agreement’s three main points. For the full text, see here.
1. Guarantees of New Debt Issuance
… Governments would make available for an interim period and on appropriate commercial terms, directly or indirectly, a Government guarantee, insurance, or other similar arrangements of new medium term (up to 5 years) bank senior debt issuance. Depending on domestic market conditions in each country, actions could be targeted at some specific and relevant types of debt issuance.
…all the financial institutions incorporated and operating in our countries and subsidiary of foreign institutions with substantial operations will be eligible, provided they meet the regulatory capital requirements and other non discriminatory objective criteria ; - Governments may impose further conditions for the beneficiaries of these arrangements, including conditions to ensure an adequate support to real economy; - the scheme will be limited in amount, temporary and will be applied under close scrutiny of financial authorities, until December 31 2009.
2. Recapitalisation
…each Member State will make available to financial institutions Tier 1 capital, e.g. by acquiring preferred shares or other instruments including non dilutive ones. Price conditions shall take into account the market situation of each involved institution. Governments commit themselves to provide capital when needed in appropriate volume while favouring by all available means the raising of private capital. Financial institutions should be obliged to accept additional restrictions, notably to preclude possible abuse of such arrangements at the expense of non beneficiaries….
Governments remain committed to support the financial system and therefore to avoid the failure of relevant financial institutions, through appropriate means including recapitalization. In doing so, we will be watchful regarding the interest of taxpayers and ensure that existing shareholders and management bear the due consequences of the intervention. Emergency recapitalisation of a given institution shall be followed by an appropriate restructuring plan.
3. Accounting Rules
… Under the current exceptional circumstances, financial and non-financial institutions should be allowed as necessary to value their assets consistently with risk of default assumptions rather than immediate market value which, in illiquid markets may no longer be appropriate.
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The eurogroup commitment is backed up by national strategies, some of which were already in the pipeline ahead of the eurogroup meeting. More details are expected today. Inspired by Gordon Brown’s rescue package, here are some first information bites from Le Monde and other newspapers:
Germany prepares a €400bn package with a €250bn guarantee for interbank transactions, according to the Handelsblatt. Direct recapitalization will be assured through a special fund, available to private banks, Landesbanken and insurances. The state will be prepared to become shareholder in private banks, for Landesbanken the state goes in by buying up deposits; in return those institutes will have a legal obligation to reform their business model and their bonus payments. The blueprint for this is Gordon Brown’s rescue package. The Bild Zeitung has an interview with Peer Steinbrueck saying that under these circumstances he is ready to give up the 2011 target for a balanced budget.
France is preparing its emergency package to pass parliament by the end of the week. To recapitalize the banks, a new Société de prises de participation de l'Etat (SPPE) will assure medium term credits in exchange for shares. The budget will be of several tens of billons euros. But the novelty writes Les Echos - different from the UK plan- is a legal structure to ensure banks better access to the money market (instead of a state guarantee for the interbank market). The idea is that this entity shall take those collaterals not allowed in the central bank operations. Backed on a state guarantee, this entity will seek financing on the market to pass on to the bank, on condition of a promise to increase credits to households and SMEs. To pass parliament, the bill needs some upper limit - of several hundreds of billons euros. These will not show up in the deficit, assures Philippe Marini from the Budget committee in the Senate. It could be just another society 100% ownership of the state.
Portugal announced on Sunday to guarantee finance operations up to €20bn for banks located in the country, writes Liberation.
UK will announce today a rescue package of £500bn (€636bn), including the nationalization of the two large banks RBS and HBOS. Other measures include a guarantee for interbank credits up to £250bn and liquidity injections of £200bn. FT reports that the UK will implement part of its plan this morning with the de facto nationalisation of Royal Bank of Scotland an HBOS, and large capital injections into other British banks. The government was preparing to pump about £39bn as new capital. Executives from RBS, HBOS, Lloyds TSB and Barclays were last night negotiating with the British government to reach deal by this morning. RBS is likely to raise as much as £20bn in fresh capital, most of it in the form of ordinary shares.
Ireland has drawn up contingency plans beyond the €400bn bailout guarantee with the Central Bank and the Financial Regulator, including nationalising the banks and buying up equity in the troubled sector, writes the Irish Independent. Liquidity injections of €12bn and €16bn are ready if needed and it is now likely that one of the ‘big six’ banks will be nationalized this week. The government could suspend the National Pension Reserve Fund and use those funds, believed to be worth between €16bn and €17bn, to buy equity in the banks. The newspaper also reports that Brussels was successful in watering down the €400bn guarantee scheme, yet to be finalised by the government.
The Netherlands had announced on Friday a € 20bn emergency fund for Dutch banks and insurers, reports Nisnews. It is raised via state bond issue. The troubled institution can have access to it in exchange for company shares.
An okay deal…
Wolfgang Munchau writes in his FT column that this is an okay deal that will do the job of calming the financial markets. He raises the question to which extent disparate national schemes are being dressed up as European. He also wonders whether these arrangement deal with the various cross-border issues. For example, guaranteeing the money market can only be done at euro area level. So this is not an optimal policy response, but it is start. It won’t solve the crisis though.
Positively surprised…
Paul Krugman has been saying for a while that policy makers need to surprise. This agreement, which he refers to as a “worthwhile British initiative” is the first time in this crisis that this is happening.
… but the credit crunch will come anyway
Thomas Mayer of Deutsche Bank, writing in Frankfurter Allgemeine, says that even a deal among European finance minister (he wrote before the agreement) would not prevent a credit crunch and a recession, as the banks are not willing or able to restart the supply of credit to the economy. What is now needed is a stimulus package. The new US administration is likely to pass such a package, but this will only become effective in mid-2009. The Europeans, as ever, are going to be more cautious.
Spain will not need to recapitalise
El Pais quotes finance minister Pedro Solbes as saying that Spanish banks do not need to recapitalise as their capital ratios are sufficient. The problem with Spanish banks is of a different kind: a mismatch between very long term lending, and short-term finance. The Spanish government approved a plan last week to deal specifically with this issue, including the provision of liquidity against mortgage collateral.
Oh, and by the way, Iceland may join the EU
FT Deutschland reports that Icelandic diplomats in Brussels have held talks with senior EU officials about the possibility of financial aid, and future EU membership. The biggest obstacle to the latter is domestic politics, as the party of Iceland’s prime minister Geir Haarde was previously opposed, though the country’s near bankruptcy has probably changed the political map. The paper reports that Iceland could assume full EU membership as early as 2010 and 2011, since as a member of the European Economic Area it already fulfils most of the conditions. The perspective of EU membership also serves to reduce Russia’s political influence over the island.
Richard Portes on Iceland
Writing in the FT, Richard Portes says that Iceland’s banks were victims of uncertainty that followed the collapse of Lehman Brothers, and sheer incompetence by Iceland central bank government. He said all three of Iceland’s banks were solvent. The central bank overreacted to a temporary liquidity squeeze through full-scale nationalisation on punitive terms, which triggered a debt downgrade, and a further fall in the krona. The central bank then committed two further mistakes, an unsustainable e/r peg, and a premature announcement of loan negotiations with Russia. He said Iceland is now facing limited options, an IMF rescue with conditionality, or EU membership among them.
The Lehman CDS shock (or not)
Naked Capitalism has a couple of articles (here and here, both with further references) on the likely exposure of large financial institutions who wrote credit insurance on Lehman Brothers debt. On Friday, the auction for Lehman Brothers’ outstanding bonds produced a value of under 10 cents per dollar in Lehman bonds. This means the CDS insurance would have to compensate buyers for over 90 cents, for a total of some $400bn gross. But the net exposure is estimated to be only $6bn, which is good news, as a lot of protection writers appeared to have hedged their positions. There is another Lehman Brothers auction today
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