Europe’s banks wag the dog

September 6, 2011

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.


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.


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A nation that cannot clothe and feed itself cannot survive. The European Union, just like America, has a huge trade deficit with China.

That has caused a structural weakness under the European economy, just as it has for the American economy.

Over the past 20 years, the largest corporations in Europe have lobbied European parliaments to drop trade tariffs not just for European goods, but also for all foreign made goods.

Why have the largest European corporations pushed for lower tariffs for Chinese and other non-Europe manufactured goods? Because lowering tariffs allows the corporations to take advantage of low-cost labor, and drive down the wages of their European workers. It is heartless, of course. Everyone agrees that capitalism is heartless.

The solution for Europe is simple: Re-enact their tariffs. Institute a 50% tariff on all non-European manufactured goods. This would immediately cause new European companies to sprout up like grass after a rain, hiring European workers. The tariff would also immediately generate a huge supply of cash, with which European budgest could be balanced.

Tariff’s have a proven history of good effects. Here is the Wikipedia link:

Posted by AdamSmith | Report as abusive

Global investors need next to NOTHING, in the way of a further confidence shaker, to cause them to abandon Europe’s banking sector altogether. Stated another way, full-blown investor panic directed against Europe’s banks is only days away.

Such a panic tsunami would definitely reverberate across the Atlantic to sledgehammer U.S. banks too. The bankers know this. That’s one big reason they aren’t lending, but hoarding. There you have the beginnings of the next credit crisis, which will be infinitely worse than 2007-2009, as Mr. Saft points out.

Where’s the huge sums of money going to come from to bail out financial institutions and unbind the credit lifelines this time? The sovereigns are already spent ‘blue in the face’ from handling the 2008 crisis. Get ready for the Big One.

Posted by NukerDoggie | Report as abusive

Maybe Marx was right, NukeDoggie. It does, in a way, seem like the capitalist societies have indeed sown the seeds of their own destruction.

All the un-regulated banks leveraged up, and up, and up and up, year after year, pocketing enormous profits.

Then it came crashing down. The huges losses? They pinned those, with the help of parliaments and congresses, on the backs of the average citizen.

The end result is that the wealthy are now wealthier than ever before. But the nations are bankrupt and broken. Wage rates in Europe and America are being pushed downward and downward.

Only way to dig our way out is to stop outsourcing our jobs. Re-institute import tariffs.

Posted by AdamSmith | Report as abusive

Finally someone calling into question why half of profits in a government guaranteed banking model go to a select few people and not back into making the system safer and capital cheaper for all. Fractional banking is only solvent when only a fraction of people want their money back. Capitalism is not at fault, its the troika of governments borrowing more than they can pay back, central banks printing money and expanding their balance sheets, and then both these parties supporting the banks to buy the government debt and keep the appearance of clothes on the emperor. The only winners in the long run are those skimming the profits for themselves. In the US banks can get money from the fed at 0-0.25%, then turn around and buy government treasuries at 2-3%, and this 2-3% of guaranteed profit(half goes to the bankers) is how they are slowly recapitalizing banks and allowing them to write off bad debts(mortgage, now government), this is a slow motion track wreck once the average person with money figures it out.

Posted by simpletruths | Report as abusive

The UK problem is very much to do with the gulf between property rental valuation of loan security and ‘blue sky’ market values actually used.
A practical way to at least quantify the problem would be to compel the banks and other property lenders to make public the market rental figures used (or implied) in their lending decisions.
Whether funding derives from wholesale money or bond markets, it is difficult to see how lenders/investors/issuers can be competently performing their tasks and discharging properly their duty of care to those whose money they manage – unless they can access such data.

Posted by EdMartin | Report as abusive