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2010

But the problems with Ireland and Portugal might not generate the same kind of upset seen when Greece reached a tipping point. During the first half of the year, global financial markets convulsed as the Greek debt crisis raised doubts about the ability of overextended nations (BANKS in Germany, France, etc) in Europe to meet their obligations to investors, who lent them hundreds of billions of dollars by buying their bonds. The measure triggered a wave of government cutbacks from Greece to Spain, sparking a number of protests, with the most violent demonstrations on the streets of Athens.

The European Union has since established a $1 trillion bailout fund for countries in fiscal crisis, though just how willing other European nations will be to offer up those funds remains in question.

Table of Contents:

European Banking

Central Bank weakness:

The trouble with the ECB is that they only focus on inflation, and not on economic growth or unemployment. Read more here...

Regulation weakness:

According to the FT.com, there are "many shortcomings of Europe's system of financial regulation. It is a forceful reminder that when it comes to bailing out failing banks, it is national governments that hold the purse strings, and they are mainly interested in shoring up domestic operations. That is in stark contrast with the US, where the federal government and the central bank have assumed hundreds of billions of dollars in liabilities in an effort to shore up the financial system....Ever since the introduction of the single currency, European commissioners have been pushing for cross-border consolidation to create large, pan-European banks."

Cross-border concern:

Will deposits in foreign banks be protected? If there is a crisis in European banks, will foreign banks be protected / saved? This is in sharp contrast with the US, where there is little doubt that a North Carolina bank will be saved. But, in Europe, if a Spanish bank fails, will deposits in Netherlands be protected?

Impact of the Credit Crisis:

One interesting twist is that the Paulson plan for bailing out the banks not only includes the US banks, but also any foreign banks with operations in the US. This means that US tax payer money would be used to buy up bad "toxic" debt off the balance sheets of many European banks, or at least the biggest ones with US based operations. So, if the Paulson plan gets rejected, and if there is no bailout plan, then European banks get hurt along with the US based ones.

But, the Paulson plan would do nothing for smaller regional banks in Europe that do not have US operations. So, in response to this fact, we have seen a recent trend whereby investors have been punishing the stock prices of these smaller banks (such as the recent bank failures in Iceland, Ireland, Benelux,etc). The trouble is that all banks suffer equally from a liquidity freeze, but only the larger international banks benefit from exposure to the US based bailout. If, however, the Paulson plan gets rejected, then all banks suffer…and the impact is significant on both sides of the Atlantic.

Differences with USA:

Many investors are also betting that Europe will suffer more from this crisis than the US will. This is because the US government is much more proactive than the European government can be. Europe is in a structurally more difficult position to deal with this crisis. Unlike the US (where there is both a Central Bank and a Treasury), Europe only has a central bank (ECB), but they do not have a pan-European treasury to help deal with the financial crisis. In addition, there is no pan-European way to raise taxes to pay for a bail-out package.

Here in the US, if a bank in Arizona were to fail, there would be no issue about using tax payer money from Washington to bail it out. But, if a bank in Spain were to fail, its difficult to see taxpayers in Germany running to the rescue. A pan European banking system has never been fully tested in this way. (this explains why President Angela Merkel of Germany recently begged the US government to please pass this Paulson bill, knowing full well the impact that a failure to act would have on her country)

Also, in Europe, if a bank from one country has deposits in another country, would those deposits be guaranteed and protected if the foreign bank were to fail? Would tax payers in France foot the bill if a foreign Italian bank were to fail in France? Im not an expert, but I remember reading in the Economist that international banks might not be fully protected in the event of a crisis (unless their government decides as Paulson & co. decided that foreign banks should be saved as well). In the end, its difficult to say that HSBC is less of an American bank than is CITI bank, but its nice to know that on the US side of the Atlantic that definition is already established (they will both be protected), but will that same lesson hold true on the other side of the Atlantic? (and readers want to comment?)

Finally, its important to point out that Britain and Spain both are suffering from real estate downturns similar to the USA. This means that local pressures in Europe are as real as they are here in the US. But, on the European side, they also suffer from additional strains placed on the union by financial crisis's on the Eastern front. Many Eastern European countries are suffering from very high rates of inflation and other macroeconomic nightmares.

Add that to a "flight to quality" where you see investors running to invest in US treasuries, and you can begin to understand the complex factors effecting the Euro-Dollar exchange rate.

Banks in Europe:

UK

Bank name Total Assets '08 (euros)

RBS 2.1 trillion

HSBC 1.5 t

Barclays 1.5 t

HBOS .8 t

Lloyds TSB .4t

Standard .2t

Alliance & Leicester .1t

Bradford & Bingley .07t

Germany

Bank name Total Assets '08 (euros)

Deutsche Bank 1.9 t

Commerzbank .6 t

Hypo Real estate .4t

Deutsche Postbank .2t

Italy

Bank name Total Assets '08 (euros)

Unicredit 1.1 t

Intesa Sanpaolo .6t

MPS .2t

Banca Popolare .13 t

UBI banca .12 t

BPM .04 t

Mediobanca .04t

Credem .03t

Creval .02t

Switzerland

Bank name Total Assets '08 (euros)

UBS 1.4t

Credit Suisse .8t

Spain

Bank name Total Assets '08 (euros)

Santander .9 trillion

BBVA .5t see Banco Bilbao Vizcaya Argentaria SA

Benesto .1t

Popular .1t

Sabadell .08t

Baniker .05t

Trouble at BBVA: BBVA is slowing lending growth and building up reserves against loan defaults as the global recession hits Spain, the U.S. and Mexico, markets that account for four-fifths of the company’s earnings. The bank will take a charge of about 300 million euros on losses from the $50 billion Ponzi scheme allegedly run by Bernard Madoff and as Latin American currencies weaken.