Europe’s banks wag the dog
James Saft is a Reuters columnist. The opinions expressed are his own.
HUNTSVILLE, Ala. — With European banks facing mounting funding problems, it is time once again for the tail to try to wag the dog.
Democracy or not, procedure or not, principles or not, a funding crisis could soon put euro zone policy makers in a position where they either take radical steps to resolve their debt crisis, or face having their decisions made for them by events which would overwhelm their banking systems.
That, at least, is the impression given by recent comments from leading bankers. I’d love to tell you they are bluffing, but I am not so sure.
First, chief executive of state-owned ABN Amro Group, Gerrit Zalm, a former Dutch finance minister, warned on Sunday both that funding markets were becoming difficult and of the catastrophic consequences of a break up of the euro zone.
“We will have a recession which makes the 1930s look like nothing,” he told Dutch television. “The whole of Europe will crumble.”
The connection between bank funding and euro zone breakup risks is clear. Many euro zone banks are not solvent if true market prices on their holdings of euro zone government debts are taken into account, and investors will only fund banks to the extent that they believe that those debts will never be marked to market, as they would be immediately for banks if their countries spun out of the euro.
“It’s stating the obvious that many European banks would not survive having to revalue sovereign debt held on the banking book at market levels,” Deutsche Bank Chief Executive Josef Ackermann said at a meeting of banking executives.
And yet, almost in the next breath, Ackermann scorned a call from IMF head Christine Lagarde for mandatory recapitalization of banks, saying that it would “threaten to send the signal that politics has lost faith in the ability of existing measures to succeed.”
Really what Ackermann is implying, and he is right, is that almost no amount of bank capital is enough to overcome a loss of faith in the sovereign states on which all banks in a fiat money system, by definition, rely. You can dilute the equity stakes of existing shareholders as much as you want, but banks will still fail if the sovereign fails, and that is exactly what is at risk if the euro zone disintegrates.
HANG TOGETHER OR HANG SEPARATELY?
The Ackermann-led bank lobby group, the Institute of International Finance said in a statement: “In a pattern echoing that of the 2007-09 financial crisis, there is a growing risk of the real economy and financial conditions being locked into a mutually-reinforcing downward spiral,” citing, in part, the impact on bank health of unsustainable levels of debt in some European countries.
“The situation for banks is more dramatic than it was in 2008,” said Ulrich Schroeder, head of German government-backed KFW, speaking at the same conference.
“In 2008, governments were still able to support their banks. Now this is simply no longer possible.”
The distinction here is between individual states supporting their banks, which for Italy or Greece would clearly not be possible in a euro exit, and of the euro zone as a whole supporting its members and thereby, hopefully, avoiding the whole nasty issue of bank capital.
Really though, this analysis only gets half of the story right. While it is true that many banks would be vaporized by a euro breakup, it is not therefore true that if you deal with the sovereign debt problem you needn’t bother with bank capital levels. The key is to do both at the same time, rather than pretending that doing one will mean you don’t need to do the other.
European banks need more capital not simply because they happen to be holding a lot of dubious paper issued by euro zone countries. They need more capital because they have been operating at levels where they cannot absorb even moderate losses and survive without implied and real government aid.
Even worse, euro zone banks, and those in the U.S. for that matter, continue to pretend that profits gained by government license have been created by existing employees and executives in a competitive market. Much of that money flying out the door as compensation should be retained to build up capital, thereby reducing dependence on the public purse. Euro zone reform, banking recapitalization and further regulation should come as a package.
We should be afraid that the euro zone will break up – that is both increasingly possible and would be a disaster. But we should not conflate keeping the euro zone intact with maintaining an unfair and debilitating status quo in its banking system.