Euro zone medicine not working on banks
Fear of lending to banks is rising again in Europe, as even a 750 billion euro zone rescue package proves not enough to stem fears that the banking system will prove the weak link when southern European nations can’t meet their obligations.
Strikingly many European and British banks are now being forced to pay more to borrow money in the interbank markets than before the joint European Union, International Monetary Fund and European Central Bank package was announced two weekends ago.
That deal, which should insulate highly indebted countries such as Greece, Spain and Portugal from funding pressure for the next two years or so, was effective in driving down the extra interest those countries had to pay to borrow as compared to Germany. Tellingly, it was less effective, even counter-productive, in restoring calm to the markets in which banks fund their short-term borrowing needs.
While the mutual distrust is still far less than the utter panic during the crisis following the collapse of Lehman Brothers in 2008, it is very significant that the bailout of the weak links in the euro zone is having far less of a multiplying effect than earlier infusions of cash and liquidity into solvency shortfalls.
It may be simply a passing tremor. It may be a result of structural weakness in the euro zone, as investors bet that when push comes to shove a politically fractured Europe will find it impossible to agree on how to underwrite and fund the rescue of banks facing losses if Greece and its peers default.
It might, even more interestingly, be a sign that the medicine of government rescue packages works less well the higher and higher you go up the world’s capital structure. After all, the banks two years ago were rescued by governments, which were bigger. Small governments are now being rescued by bigger governments. Will Mars or Saturn have cash to contribute when it is Britain, or, whisper it, the United States, which needs help?
WILL BANKS BE LEFT HOLDING THE BAG?
The three-month dollar London interbank offered rate (LIBOR), a compilation of the costs banks report they must pay to borrow, rose to 0.46 percent on Monday, having risen steadily since concern over Greece became acute, its highest level since last summer. Also rising markedly is the spread between LIBOR and an overnight indexed swap (OIS), a measure of unwillingness to lend that, because it strips out interest rate fluctuations, is considered a more pure indicator of bank solvency fear. It now stands at about 24 basis points, about double the rate in February but far below its crisis peaks.
“The liquidity crisis that has taken hold of the markets is once again driven not by a shortage of liquidity but by the collective desire for capital preservation of each financial institution in the market,” according to Lena Komileva, head of G7 market economics at Tullett Prebon in London.
“Furthermore, the negative effects for banks’ collateral quality, liquidity and capital stemming from deteriorating euro sovereign credit risk and fears about the euro’s collapse, have transmitted the contagion across every capital market and asset class around the world.”
Looking at those figures, it seems as if investors have concluded that, though the countries themselves have been given a couple of years to sort themselves out, the risks to the banks holding their debt has risen, even in the very short term. It may well be that Greece is forced to restructure its debts. In the medium term that seems quite likely. That it would happen some time in the next three months actually seems far-fetched.
It may well be that money market funds, which supply a tremendous amount of money to the banking system, learned their lesson from the Lehman affair, and have decided that reaching for a few extra basis points when something big may be brewing is too risky. So called Prime Money Funds hold more than $850 billion in bank-related paper, according to Barclays Capital, and are under increasing regulatory scrutiny. A manager at a money market fund who remembers when the Reserve Fund broke the buck, or fell below the key $1.00 per share value, could be forgiven for sitting this particular crisis out.
That is perhaps the most benign explanation. More troubling is the idea that the interbank market is realizing that if the euro rescue fails, or even if it only partly succeeds, it may be banks which are left holding the bag.
If a euro zone sovereign default happens, after all, there will be a huge political mismatch between those doing the defaulting and those nations whose banks are hurt.
(Editing by James Dalgleish)
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)