Hypo Bank Rescue Fails, Threatening Lehman Scale Bankruptcy, Future of Euro

Hypo Real Estate, Germany’s second largest real estate lender, teeters on the verge of collapse. The bank has a €400 billion balance sheet, which would make for a failure of a similar scale to Lehman’s (Hypo’s footings are roughly $550 billion, while Lehman’s were $660 billion as of its last balance sheet date).

Even though Hypo it technically a bank, it is not a depositary institution, so rescuing it poses similar difficulties (procedural and political) to the authorities as Bear and Lehman did in the US. The financial system cannot take another body blow of this magnitude. The authorities had better patch this one up over the weekend, or we face even more credit market panic on Monday.

And if that weren’t an ugly enough picture, the failure to salvage Hypo has even broader ramifications. From Marshall Auerbach, independent global strategist who does consultancy for a number of funds, and sometimes financial commentator, via e-mail:

The euro is in serious trouble with this Hypo Real Estate collapse. Germans remain completely in denial. The French get it, largely because their clever finance minister, Christine LaGarde, was educated at the University of Chicago and consequently understands something about markets. Sarkozy, to his credit, appears to be listening to her. The Germans are about to destroy EMU with their pigheadedness, and this will be the stuff of revolution, given that the German people were never consulted on abandoning the DM (if there had been a referendum, the euro would have never been accepted in Germany) and were forced to get rid of arguably the most successful post-war monetary institution, the Bundesbank.

The sop thrown their way was the stupid Stability and Growth Pact, designed by former German Finance Minister, Theo Waigel. So he has hoisted the Germans and the euro zone on a German petard. And that’s made things worse! No EU wide guarantee of deposits, no EU-wide prospect of a major fiscal stimulus and bye bye euro.

Ed Harrison of Credit Writedowns provided a translation from Der Spiegel. Key sections:

HRE spokesman Obermeier did not want to comment Spiegel Online as to reports that the liquidity Gap of the bank could reach 70 to 100 billion euros by the end of 2009. He could only confirm that the consortium’s original aid pledge had been withdrawn. “Why, we do not know,” Obermeier said. He said there were clear signals from the shareholders and Government, that they wanted to cooperate to find a solution to the problem….

Sources close to [Finance] Minister Steinbrueck said that the Finance Ministry had not been informed of the changed situation in advance by either Hypo Real Estate or the consortium of banks. The government was informed only through ad hoc communication with HRE that the rescue package had collapsed. “We will now try to pick up the pieces on Sunday,” the Ministry of Finance said. The aid plan, agreed to one week ago, foresaw a short-term loan of 15 billion euros and a long-term refinancing of up to 35 billion euros in the second half of 2009.

“Die Welt am Sonntag” had previously reported that Deutsche Bank had found in a study that HRE already clearly needed more money in the short-term. According to the Deutsche Bank report, the company would lack up to 50 billion euros by the end of the year and even as high as 70 to 100 billion euros by the end of 2009….

“If there is no solution when stock markets open on Monday morning, the company won’t make it two more days,” said a banker.

This week, the Bundesbank and the BaFin had labeled the rescue operation which is now collapsing as vital to avoid “severe disruptions to the financial markets”. In a letter from the Bundesbank and BaFin to Finance Minister Peer Steinbrueck it was said that otherwise the German financial and economic system would be threatened by “similar unforeseeable consequences” as after the collapse of the U.S. financial group Lehman Brothers.

Bloomberg reports more clearly than Der Spiegel did that the bailout package may have been inadequate even over the coming weeks:

Hypo Real Estate’s financing needs exceeded the bailout plan guarantee, Germany’s Die Welt reported yesterday, citing unnamed people in the finance industry. It will need 20 billion euros by the end of next week and 50 billion euros by the end of the year, according to the newspaper. As much as 100 billion euros may be needed to shore up the bank’s finances by the end of 2009, Die Welt said. Obermeier declined to comment.

The European Central Bank and the Bundesbank planned to contribute jointly 20 billion euros, and a group of unidentified banks another 15 billion euros. The plan called for Hypo Real Estate to use 42 billion euros in assets, mostly debt owed by government borrowers, as collateral.

Further detail from Reuters:

Property lender Hypo Real Estate fought for its life on Saturday after German banks and insurers pulled out of a state-led 35 billion euro ($48.5 billion) rescue program stitched together only days ago.

The news is a fresh blow for the global financial system struggling to master an unprecedented crisis of confidence and poses a political challenge for the Berlin government, which has been fighting efforts to arrange a pan-European bank bailout.

“The 35 billion euro rescue package promised to the Hypo Real Estate Group and extending into 2009 announced last week is currently withdrawn,” the Munich-based real estate and public-sector lender said in a brief statement.

“The intended rescue package involved a liquidity line to be provided by a consortium of several financial institutions. The consortium has now declined to provide the line.”

And Times Online:

The breakdown of the rescue of Hypo Real Estate will send fresh alarm through the markets that a raft of emergency measures enacted by European governments as well as the approval of the historic $700 billion (£396 billion) bailout by the American government in the last week have done little to keep the crisis from deepening.

Under the Hypo deal, which had been brokered by Berlin last week, a consortium of German banks had agreed to put up about €8.5 billion of a €35 billion emergency credit injection to keep the company afloat. The German taxpayer would have footed the rest of the bill.

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79 comments

  1. River

    Bank runs next?

    ‘The next step of this panic could be the mother of all bank runs, i.e. a run on the trillion dollar-plus of the cross-border short-term interbank liabilities of the U.S. banking and financial system, as foreign banks start to worry about the safety of their liquid exposures to U.S. financial institutions. A silent cross-border bank run has already started, as foreign banks are worried about the solvency of U.S. banks and are starting to reduce their exposure. And if this run accelerates–as it may now–a total meltdown of the U.S. financial system could occur.

    The U.S. and foreign policy authorities seem to be clueless about what needs to be done next. Maybe they should today start with a coordinated 100 basis points reduction in policy rates in all the major economies in the world to show that they are starting to seriously recognize and address this rapidly worsening financial crisis.’

    Yves…Thanks for the great site.

    http://theautomaticearth.blogspot.com/

  2. Abbott_Of_Iona

    Europe does not have a response to this crisis.

    Ireland has guaranteed €400Bn of liabilities. More than twice the GDP.

    Ireland does not have the cash.

    Ireland is no longer the Celtic Tiger.

    It is the Celtic Leper.

    Ireland was the country that stopped the Lisbon Treaty (the federalisation of Europe) in its tracks.

    We have no friends in Europe. They will not bail us out.

    The major banks in Ireland are technically bankrupt.

    BUT IT DID NOT GUARANTEE THE SHARE PRICE OF THESE BANKS.

    If you held €100k in shares of Anglo Irish Bank you would be an idiot not to swap that for €100k of Anglo Irish Debt @ 6.5% GUARANTEED BY THE GOVERNMENT.

    These banks are toast.

    The Euro has never faced a real challange.

    This is it.

  3. Anonymous

    Some have suggested that individually European countries might not have the capacity to handle the collapse of their biggest banks. While I would suspect that Hyppo does not pose that threat to the Germans, could a rescue create expectations that could not be fulfilled. Thus, the Germans opt to let it fail and hope that Deutsche Bank doesn’t follow?

    I know that sounds pretty conspiratorial, but…

  4. Abbott_Of_Iona

    Sorry Yves, I have to post this again, delete if you wish

    Police & Thieves

    Junior Murvin (Not the Clash)

    Police (SEC & Herr Paulson) & Thieves (Goldman Sachs & Herr Paulson) in The (Wall) Street

    Guns & Ammunition (Bazooka?)

    Genesis (The SEC allowing Wall Street gear up from 12:1 to 30:1 and that piece of cowardly filth Greenspan and his spawn Bernanke)

    Revelation (Bankrupt Wall Street ~ America wakes up)

    The next Generation WILL BE (have FAITH)

    Hear Me (The Fascists always loose even if many of the free die)

    http://www.youtube.com/watch?v=OID0h7X6hmk&feature=related

    “Police & Thieves in the Street
    FIGHTING……… the Nation with their Guns & Ammunition

    Police & Thieves in the Street
    SCARING……… the Nation with their Guns & Ammunition

    From Genesis to Revelation

    The next generation….WILL BE……………HEAR ME

    All the crimes committed day by day
    No one try to stop it in any way
    All the peacemakers turn war officers

    Hear what I say

    Police & Thieves
    Police, Police & Thieves
    Police & Thieves
    Police, Police & Thieves”

    Don’t wait.

    Fight FACISM NOW.

    EVERYWHER YOU SEE IT, HEAR IT, SMELL IT

    DON’T WAIT FOR CRYSTALNACHT

  5. Don

    Yves, the previous nutcase post may reflect poorly on my question, but I am wondering your thoughts on historical context and the weighing of inflation and depression risks when dealing with an unstable monetary system. I am guessing that Germany may be the only G8 that would err on the side of depression. I think whichever tail is longer is also a lot fatter than is conventional wisdom, but even if that was not the case this would not be strictly an academic question when applied to current policy outlook.

  6. Abbott_Of_Iona

    Don,

    If it walks like a Duck and quacks like a Duck ….It is a Duck.

    I thank you for you concern of my mental health.

    How’s yours.

  7. Chris

    This was published in Welt-on-Line.
    As you will see tt is in German.

    http://www.welt.de/wirtschaft/article2530154/Das-europaeische-Bankensystem-ist-in-Gefahr.html

    There will perhaps be more things like these in other languages.

    There is an issue between Ackermann of Deutsche Bank and Merkel CDU Chancellor. HER is in the middle of this issue between the two of them. Ackermann was involved with the now-failed effort.

    Ackermann wants a European wide solution modelled on what Paulson has pushed here. (Parenthetically Christine Lagarde the French Finance Minister has also promoted this and knows Paulson from her days in a Chicago law firm).

    Merkel does not want this and wants the banks who have done this (whatever it is) to pay. So there is an account here of a late night telephone fight September 30th before the Tokyo opening.

    This split carried into today’s festivities in Paris. For sure Brown’s demand that not one bank be allowed to go under will be noted here. Both Sarkozy and Merkel opposed this.

    Maybe there will be a huge crisis out of this for European banks and the euro. There again there may be other things going on.

    I do believe that the question which money markets, regulated by whose rules, in which country, to what effect and consequence may turn out to be of no small interest. Much more interest than sweeping statements about European banks and the Euro.

    Immediately after the passage of the Bailout here, the Bank of England agreed to a 40bill per week three month finance extension deal in the total amount of $280 billion. I read it in the Times or Telegraph. But I do believe money number like this indicate where market stresses are fiercest. Even though political fall out from Bavarian real estate financial outfits during October may not mix too well with the traditional fare of beer and roast pigsknuckles.

  8. Yves Smith

    Abbott,

    I think readers have some tolerance for musical and video references, but not when they take up a lot of comment space real estate.

    Don,

    That is a huge topic, so just a top-of-mind response. In a crisis, the important thing is to try to prevent collapses that cascade. The focus on inflation has to be put aside, and in fact, if semi-normal conditions can be restored, excessive liquidity can be sopped up pretty quickly. At least for the earlier rounds of the Term Auction Facility, the Fed withdrew liquidity through its open market operations to counter the additions via the TAF.

    That is in theory, although the Germans don’t really buy that theory.

  9. Vijay

    This is a great example of how cartels always fail. The incentive to make a profit/avoid a loss is always higher than the incentive to stay within the cartel.

  10. Richard Kline

    Well, well, so the next shoe to drop is an army boot, with crampons attached—and the foot and foreleg of the previous owner inside. *tsk* The zombies everywhere have been starving for some time, tender morsels of citizen financial flesh notwithstanding; now, these capital dead banks and bank-alikes are starting to keel over. Gonna be ugly-mugly, and no payouts of ughola are gonna prop up the dead mooks, there’s just tooooo many of ’em.

    Don’t bail ’em, fail ’em. Fortis was nationalized. Hypo Deal Estate Sinkings will have to be as well.

    There is a reason that public authorities have only tended to guarantee _bank deposits_, and those of modest size: governments don’t have and can’t get the money to guarantee more. Governments need to hold to that mandate, fort up around basic depositors, and let the rest of the system go. Lotta broken crockery, but there it is. Do a salvage and rebuild after the fact.

    And Abbott: “Ireland was the country that stopped the Lisbon Treaty (the federalisation of Europe) in its tracks.” I, too, was thinking of this yesterday. The Irish ‘refused to compromise their sovereignty’ and build solid institutions when times were good. Now in a desperate spot, they have compromised the security of everyone else in the ECB by issuing a guarantee that they can’t match on their own. The irony here is too, too rich.

    The upshopt _might_ be the ‘failure of the euro.’ That is what all euro-doomsayers have been pitching for twenty years and more. The alternative is that a more centralized crisis management outfit is given sweeping financial powers to intervene. Place your bets on outcome where you want, but since the first outcome means most if not all sink, the second outcome where the lifeguard pulls the swimmer along strikes me as far more probable. Crisis don’t just tear apart, they weld together, too.

  11. Don

    thanks Yves. So if the Germans don’t buy that theory (for understandable historical reasons in my opinion), is the EU kaput at least as a monetary institution? It seems a contradiction that can’t be resolved short of a miracle stabilization of the financial system. Or is mass nationalizations a way to resolve the contradiction?

  12. walt

    I didn’t understand why this is going to cause the Euro to fail, or why it’s all the Germans fault.

  13. paddy

    http://news.bbc.co.uk/2/hi/europe/7648249.stm

    Brown, probably the most economically literate of the lot said “no sound, solvent bank should be allowed to fail through lack of liquidity”

    German Chancellor Angela Merkel – who said she was not happy with Ireland’s action in guaranteeing bank deposits – said each country must act in “a balanced way” that did not cause harm to other EU member states.

    “Each country must take its responsibilities at a national level,” she said.

  14. Abbott_Of_Iona

    Richard,

    You are correct.

    “Don’t bail ’em, fail ’em”

    In the case of Ireland there is insufficient breadth in the banking system. All of the banks have been playing the same game. They are up to their necks and beyond in property speculation.

    While I appreciate your point on a crisis bringing people together, Ireland just went on a solo run, and given that Europe is failing to come up with (if not a European) at least a Euro wide strategy I think that Ireland may, out of desperation, have thrown a fly in the ointment.

    The media here is of course universal in its praise of the great innovative solution.

    Let’s see how the share prices of these banks progress and whether the bluff is called.

  15. Anonymous

    I thought there was no housing bubble in Germany. What happened to all the talk about “covered bonds”? What assets was Hypo holding?

  16. Richard B

    Can someone explain Mr. Auerbach’s conclusion that the failure of Hypo Bank means “bye bye Euro?”

  17. Matt Dubuque

    Yves-

    Thanks so much for putting together this comprehensive summary from disparate sources. Quite helpful!

    Don-

    If I may broaden the historical discussion just a bit, it was the Weimar hyperinflation in November 1923 that gave rise to Hitler, who was thrown in jail for demanding that beer workers in Bavaria be paid three times a day (instead of two) so that that they could shop during their breaks before prices went up further. Hitler was thrown in jail for this beer worker putsch in November 1923 and wrote Mein Kampf while in jail for these charges of organizing an illegal strike.

    As you implicitly point out, this horrible radicalization of German politics flowing from the hyperinfation of November 1923 is something that the German public is determined not to repeat.

    And the German public was justifiably outraged at having to commingle their monetary policy with Greece and Italy and Spain, without a vote, as Yves pointed out in her quote.

    Nevertheless, one of the key problems in central banking (and in military strategy) is to avoid fighting the last war.

    It is pretty clear to me that, by and large, the Federal Reserve is not currently fighting “the last war”, but unfortunately the Germans, as well as Trichet, are still tilting at the windmills of inflation despite the now overwhelming evidence that the key risk to be managed over the near and intermediate term is of a deflationary burst.

    This type of entrenched flaw in decisionmaking (i.e. fighting the last war) is known in behavioral economics as incorrect “anchoring”, whereby an economic actor incorrectly assumes that their present experience formally resembles a decisional frame.

    If you care to delve more into the theoretical aspect of this, you might enjoy picking up some of Daniel Kahneman’s work for which he finally won the 2002 Nobel in Economics on these topics. It’s been studied pretty extensively over the last 20 years, but it doesn’t seem to be fully understood in key European banking circles.

    Should you be interested, I’ve attached a link on “anchoring” and on Kahneman.

    http://tinyurl.com/4t6r3k

    http://tinyurl.com/2ptyuy

    Matt Dubuque
    mdubuque@yahoo.com

  18. Matt Dubuque

    Typo Correction:

    “Incorrect anchoring describes how an economic actor incorrectly assumes that their present experience formally resembles a PREVIOUS decisional frame.”

    Sorry.

    Matt

  19. River

    I have been reading Doug Noland’s weekly ‘Credit Bubble Bulletin’ at Prudent Bear for a long time and respect his opinions. His statistical roundups and personal outlooks have been getting more dire by the week. Here is a bit from his latest effort:

    ‘The “Freidmanites” thought they understood the (post-crash) policy mistakes that led to The Great Depression. They believed the “Roaring Twenties” was the “Golden Age of Capitalism.” The great bust could have been avoided with a simple ($5bn or so) banking system recapitalization. As we are witnessing today, the issue is not some manageable amount of new “capital” to replenish banking system losses. Instead, the predicament is the massive and unmanageable amount of new Credit necessary to, on the one hand, sustain a mal-adjusted Bubble Economy and, on the other, the Trillions more required to accommodate a gigantic speculative de-leveraging. I have a very difficult time seeing a way out of this terrible mess.’

    And…

    ‘The leveraged speculating community played such an integral role in the overall Credit Bubble and, more specifically, to the Bubble in Wall Street Finance. They were instrumental in both spurring financial sector Credit creation/leveraging, while directing this Flood of Finance to the asset markets. And the more the leverage and the greater the Flow to inflating markets, the higher the returns generated by this expanding pool of speculative finance. And the greater the returns, the more robust the “investment” flows into the hedge fund community – spurring more leverage and more potent fuel for additional self-reinforcing asset inflation. Well, this historic speculative Bubble is now in the process of blowing up. One of the greatest manias ever – surely The World’s Greatest Episode of “Ponzi Finance” – is absolutely coming apart. And the wreckage is accumulating in all markets – everywhere.

    Here at home, our maladjusted economic system will only be sustained by somewhere in the neighborhood of $2.0 TN of new Credit. It’s simply not going to happen. The $700bn from Washington would seem like an enormous amount of support. In reality, it’s nowhere even close to the amount necessary for systemic stabilization. To the $2.0 TN or so of new Credit required this year (and next) add perhaps as much as several Trillion more necessary to accommodate speculative de-leveraging (liquidations forced by huge losses). Importantly, the Bust in Wall Street Finance has ensured that insufficient liquidity will be forthcoming to maintain inflated asset prices and sustain the Bubble economy – creating catastrophe for the leveraged speculating community.’

    I agree with Doug Noland. I would like to see a way out of this train wreck but I do not…I believe Bernanke vastly overestimated the power of the Fed to stem the deflationary tide of financial events. I also believe Bernanke underestimated the importance of the mood of financial institutions, businesses and citizens as they retrench once they become afraid. Once instilled, fear will not melt away quickly.

    http://www.prudentbear.com/index.php/commentary/creditbubblebulletin?art_id=10125

  20. Yves Smith

    On the narrower question of why the euro is at risk, Marshall e-mailed a further comment:

    The short answer is the Stability and Growth Pact, which the Germans foisted on the rest of Europe, as a quid pro quo for junking the DM and joining the European Monetary Union. They were afraid that the Italians were going to get a free ride off EMU (which in fact has happened; thanks to Germany’s pristine credit rating, the Italians, once they joined the euro, were able to borrow at German levels of interest rates).

    This post from earlier in the week gives a lot more detail on the existing stresses in the EU and how bank rescues could push the system beyond its limits.

  21. FairEconomist

    This is not the death of the Euro. According to rumors Iceland is in danger of not being able to get food and oil because nobody wants their currency. That’s the fate of countries with shaky finances and their own currencies. Very soon almost every country in Europe will be desperate to be in the Euro, whether they’re in it now or not. Certainly those in will do almost anything to stay.

    Currencies can survive major banking panics. Used to happen all the time, actually – panic and depression while the currency sails serenely on.

  22. Anonymous

    It’s not that it’s different this time, it just the debt involved (promises to pay if this or that happens) is so huge. You know how you feel if you get ripped off or even if someone fails to pay you back, how do countries feel about it and react?

    Never no mind, the US is in worse shape than Euroland.

  23. Yves Smith

    FairEconomist,

    I beg to differ with you a tad. The euro is not a normal currency, so I am not certain how much comfort you can take from past financial crises. Some of the defects in institutional design could cause a lot of grief. You still have national economies with their own central banks, national governments issuing their own debt, which means that the ECB, due to the need to coordinate certain actions with national governments, or worse, get their central banks to act on its behalf, is not able to perform all the tasks of a modern central bank effectively.

    Even a central bank with more authority (although politically more compromised), the Fed, is at the end of its rope and has had to lean on the Treasury. By all accounts, EU banks as a whole are in as bad, by reports I am hearing, worse shape than their US counterparts. The lack of tools, authority, and ability to move as quickly is likely to make a difference.

  24. Jojo

    Hey, we’ve got plenty of money over here in the USA, let’s send some over to Europe. How could we not do so as the FINANCIAL SYSTEM IS FAILING, OMG!

    Anyway, it’s just paper, if we run out, we’ll print some more.

    And I am sure Congress will go along if Paulson asks nicely again because THE FINANCIAL SYSTEM IS GOING TO FAIL, OMG! OMG!

  25. FairEconomist

    The Fed is struggling to keep the banks afloat. It’s not having any trouble maintaining the dollar as a viable currency.

    The Euro’s messier structure may leave them unable to handle this credit crunch and their banks may fail; but that doesn’t make the currency fail. Even if every bank in Europe fails the Euro will still be able to buy oil if the governments collectively stick by it. Ditching the Euro isn’t going to help any country save its banks; actually it becomes harder because they’d have to handle a currency transition at the same time and almost certainly worsen the bank runs. Finally, if they leave they risk losing access to world commodity markets because the new currency may not be accepted. It’s a lot of cost for no benefit to abandon the Euro.

  26. a

    “The euro is in serious trouble with this Hypo Real Estate collapse. Germans remain completely in denial. The French get it, largely because their clever finance minister, Christine LaGarde, was educated at the University of Chicago and consequently understands something about markets. “

    Hardy har har. I’d say this gets my vote for the most fatuous comment posted here in a long time.

    Christine Lagarde is clever? She understands something about markets? Oh I get it, she was educated at the *University of Chicago*, where economic liberalism, which has brought the US to the brink of collapse, has its home.

    Methinks if a fund is receiving advice from Marshall Auerbach, it is not getting good value for money.

  27. Steve

    Hypo’s exposures are overwhelmingly European. CRE exposure is 9% US, 9% GB, 47% Germany, most of the balance in W Europe. Most structured CMBS and RMBS exposures are in Europe.

    Hypo is ludicrously over-levered and appears to have a severely mis-matched asset/liability book. Their short-term funding requirements look to be 25% of assets.

    It’s clear that Hypo’s troubles are home-grown and the result of bad funding management and weak oversight. European CRE is in for a hellish ride.

    This failed rescue is particularly significant given Germany’s recent tradition of beating healthy banks into aiding their dopier brethren.

  28. Anonymous

    I agree that these (apparently imminent) bank failures are going to hit the Eurpean economy hard, as companies have traditionally financed primarily through debt, not equity. However, the duration of that impact is largely dependent on government's response.

    So far, the conversation from center-right and neoliberal politicians and bureaucrats has been exclusively about loading up governments with massive amounts of debt in order to bail out a system whose players are mostly responsible for bringing this catastrophe on themselves. Perhaps Merkel and her Finance Minister are simply not willing to do that, recognizing that there are other alternatives. When the Germans tried to institute new regulations in the last G7(?) meeting, they were stung by being dismissed out of hand. There was one report where, in recent negotiations for state assistance, the government felt that, in effect, they were being bullied by banks making strident demands.

    I would hope that European leaders and the EU bureacracy would be able to fuse their positions into a coherent plan, but the EU project as a whole has been in neutral since the turn of the century, and when I look at the current cast of characters, I don't see much hope for that (unless they bring back Jacque Delors, LOL). In fact, one of the worst aspects of this crisis is simply in its timing, with EU institutions still neutered, and a changing of administrations in America. Otherwise, bold and creative leadership might have been able to contain the damage early on.

    Perhaps the Germans will wait for the collapse, rescue who they can rescue without recklessly endangering the country's financial position, and immediately step in with state banks that will ensure economic continuance, and which will act as a foundation for private sector banks to rebuild upon. At that point, a regulatory regemine could be hammered out by the EU.

    As for the Euro, the Growth & Stability Pact was crucial in syncing the many disparate national economies, and in forcing CEECs to embrace sound macroeconomic policies. Perhaps I am just expressing my ignorance on this subject to people who are industry experts, but I'm not sure I see how the current unpleasantness could have a lasting impact on the currency. The Euro represents one of the most advanced economies in the world, has had remarkable stability in its short history, and enjoys a robust level of transactional use. And what's the alternative-for each national government to start printing their own money again…and in the midst of economic duress, try to find solid footing for launching that currency?

    I think what we may have here is a bit of an ideological divide, between those leaders who are trying to save an economic philosophy as much as they are trying to save the economy, and those leaders who are simply trying to save the economy.

  29. Anonymous

    I think the euro is finished. Or rather the euro in its current incarnation is finished.

    I can easily see a scenario where it splits into two currencies. You have a hard euro and a soft-euro. Germany et all keep the strong euro. Spain Ireland, Italy etc get the soft euro. And the soft euro trades at a floating 20% / 40% discount to the hard euro.

    That would solve most of the euros current macro-mismatch problems. The banks in the soft euro area, however, are still mostly insolvent.

    jmc

  30. a

    “I think what we may have here is a bit of an ideological divide, between those leaders who are trying to save an economic philosophy as much as they are trying to save the economy, and those leaders who are simply trying to save the economy.”

    Well said!

  31. Anonymous

    The US let Lehman go under because it was deemed politically unacceptable to save it, and now the US and euro banking system is on the verge of collapse.

    The Germans are about to let Hypo go under, and if they do, it will be because they deemed it to be politically unacceptable to save it. The banking system has high odds of going into collapse. A non-functioning or barely functioning financial system means large scale business failures and a rapid rise in unemployment.

    I would guess that that is what the gentleman meant when he said that the Germans are in denial If they don’t save Hypo (or similarly orchestrate a rescue, whether with private help or support of other countries), they will be the ones that (along with the US with Lehman) ushered in a US-eurozone depression.

    I also suspect what he is saying is that mere bank intervention at the country level will not suffice. I think you’ve misconstrued the drift of the gist. There have been widespread observations that the biggest financial firms in the EU are too big for any one government to save.

  32. Anonymous

    Yves,

    I sometimes marvel at the lack of knowledge on European matters this blog and its readers display.

    1. The Germans didn't get to vote on the euro because referendums are forbidden there, according to German law.

    2. The Germans did lose the Bundesbank, but that was the price to pay if they wanted the rest of Europe to support them on German reunification and Eastern Europe's prospective membership.

    3. It was Germany who broke the Stability Pact, not Spain.

    4. Each member country CANNOT issue debt above the 3% annual deficit ceiling. If they do, they get a HUGE (macroeconomically significant) fine. For all the quarrel on the Stability Pact, no country with a deficit >4% has ever got away with no fine.

    5. Why would any country want to get out of the euro? They can't get lower rates out of the euro, they would need much higher rates to prevent a massive devaluation. And anyway, a massive devaluation they would get.

    The eurozone is growing every year. Next year, Slovakia; some time afterwards, Poland. And for those not understanding the relationship between the European Union and the eurozone: EU members (but for the UK and Denmark) MUST eventually introduce the euro; if they do not, they can be expelled out of the EU. Those in the EU but not on the eurozone are in a transition, temporary period.

  33. Anonymous

    Sorry, I didn’t sign last message. I am Diego from Spain.

    Yves, I love your blog (but on European matters); it’s my first morning reading.

    Diego from Spain

  34. Anonymous

    You may not believe this but AIG insured most of the debt being talked about and AIG never funded the swaps (underfunded to be more polite). The USofA is now in control of AIG. Just send the bill to the US taxpayer, well add it to our list of things to do.

  35. Yves Smith

    Anon of 4:03 AM,

    1, No one ever said the Germans had or could have had a vote. The comment in the post said the German public was never consulted, and said HAD there been a referendum it would have been voted down.

    2. That does not directly answer the point effectively made by Marshall, that from a German perspective, the loss of the Bundesbank may not be worth what they gained.

    3. The charge was not that the Germans broke the Stability Pact, but that they required it in the first place.

    4. The Spanish effectively have circumvented the ceiling by their banks to the ECB and parking their dud real estate loans there, similar to the US Term Auction Facility, except the asset quality is worse. It is a huge cause of friction,

    5. If Hypo collapses, and the interbank markets freeze totally, each country will retreat to its own devices. That is precisely what happened in 1931` International capital flows came to a screeching halt and each government focused strictly on dealing with the problem at its doorstep, meaning within its own borders.

    You are assuming life continues as normal. The odds are very high of a systemic collapse if the next few weeks are not managed well, and it may not be possible to manage them well enough if too many firms hit the wall in too compressed a time frame.

    The future direction of the EU is up in the air due to the defeat of the Lisbon Treaty by Ireland, when the treaty required a unanimous vote to be implemented. And knowing business owners in Poland, they do not regard joining the EU as a plus. Their wage costs have shot up and I have been told that small business bankruptcies are rising. While there are presumably long-term benefits, the short term costs and dislocations of integration are considerable.

    I welcome criticism, but I suggest you read the post closely enough to respond to it accurately before launching broadsides.

  36. Anonymous

    “I thought there was no housing bubble in Germany.”

    There was none. The trouble was allegedly caused by Hypo’s Irish subsidiary, Depfa, which they acquired in 2007.

  37. a

    “If Hypo collapses, and the interbank markets freeze totally…”

    The interbank market is already totally frozen. I’m somewhat amused by the talk about the interbank market and banks not lending to each other. As if were only Bank A to lend 100 to Bank B, Bank B to lend 100 to Bank C, and Bank C 100 to Bank A, the problem would be solved. That’s not the problem. The problem is that Banks A, B, and C *all* need to borrow, but nobody (other than the central banks, depositors, and bondholders) are lending. And the financial system simply needs more.

    If Hypo collapses, the problem IMHO will be that one of the trio of lenders to banks – bondholders – will disappear, and banks will no longer able to sell bonds to raise cash.

  38. jmf

    Moin again,

    it looks like they (DEPFA ) have choosen to get a little bit of extra yield in ramping up their repo funding a whopping 41% since the end of 2007 to € 89 billion ( see Page 27 HRE Analyst Presentation
    ) while their long term covered debt funding is flat since the end of 2006…..

    Quote CFO at this presentation ” We take advantage of the very favourable conditions of the repo market…..”

    Needless to say that he is now the former CFO…….

  39. Anonymous

    Yves,

    1. A unified Germany wasn’t worth the price of losing the Bundesbank? I personally don’t think so. Moreover, the Germans didn’t want the French and the Spanish to devaluate out of every recession, as that meant recession was transferred to Germany.

    2. The German D-mark was a hard currency not only because of the Bundesbank, but also because of prudent fiscal positions. When Spain had a 7% deficit in 1992, it was no surprise Spanish bonds yielded a higher interest than German bonds. In 2003, when the reversed situation hold true, it was German bonds that yielded a higher interest than Spanish bonds. (The same may be applied to the US, if and when the Chinese stop buying US Treasuries as a political weapon whose consequences most Americans do not understand yet).

    3. Spanish banks have high-quality assets parked at the ECB, in an amount equivalent to Spanish GDP’s relative weight in the eurozone (unlike Ireland, whose assets at the ECB are 15 times its relative weight). Spanish mortgages are different to US mortgages. There is no “jingle mail”. If you don’t pay your mortgage, you lose your house but you still have to pay for the difference (a judge sets the monthly fee you have to pay AFTER LOSING YOUR HOUSE). I cannot see how those mortgages may be worth less than their face value.

    4. In 1931, Europe had to pay its debt to the US; they sold them goods, and part of the revenue paid that debt. There would have been no problem (no Hitler, no WWII) if international trade hadn’t been stopped by the US Congress (not that they knew its consequences, no finger-pointing here). Now, the debt is on the US, so I can’t see the similarities.

    5. Poland, as Sweden, the Czech Republic, etc. has signed a treaty saying it will eventually introduce the euro. That may mean in 5 years’ time, or in 15 years’ time. But not longer, because the other members may expel them out of the European Union if they feel they have waited for too long. By the way, Poland will introduce the euro in 2012.

    I hope these comments are interesting for you.

    Once again, Yves, thank you for your blog, and greetings from Madrid,

    Diego

  40. kevin de bruxelles

    A large portion of these predictions of the eminent death of the Euro are products of Anglo-Saxon propagandists. While there are certainly flaws in the basic architecture of the EU’s financial institutions, the coming crisis will serve as a catalyst for further financial integration which will ultimately lead to a European version of the US’s Fed. And since many parts of Europe still continue to reject the wisdom of their Anglo-Saxon betters and insist upon maintaining their manufacturing bases, any decline in the value of the Euro will be more than welcome as that will serve as far greater stimulus for European exports than any pathetic rate cut would.

    The huge mistake many of these articles make, whether intentional or not, is imagining that Europeans will direct their coming anger towards the Euro. This is hardly likely. Now don’t get me wrong, there will be anger, lots of it. But it will instead be directed straight towards America — not the Euro. More specifically towards the stereotype of a fat, lazy, and credit-addicted American’s avaricious appetite for hard-earned European savings accounts. Very soon the penny is going to drop and the mild-mannered European saver will finally realize that the huge noise he hears represents American financial institutions literally sucking his children’s savings accounts across the Atlantic in order to refill the American consumer’s crack pipe of cheap credit. The resulting outrage will be for further EU integration, after of course booting Ireland’s cheeky asses out as an example pour encourager les autres. But more importantly there will be calls for a European financial quarantine from anything remotely American. The famous decoupling from American financial hegemony will finally begin as Europeans try to erect a firewall between their fundamentally health economic way of life and the decrepit contagion-spewing mess that is America. You will see ads on TV with banks proudly claiming that they have succeeded in disinvesting all their American holdings.

    The American brand will take a fatal blow. Leaders of the companies or areas of Europe (Denmark, England, and Spain, for example) which blindly accepted the Anglo-Saxon model will be sent to re-education camps to rid them of all that supposed know-how they picked up at Wharton or the University of Chicago as a condition for European help in fixing their financial messes. CV’s across Europe will be washed clean of any reference to education or experience in America. And the Anglo-Saxon propaganda organs like BFM in France will be shut down for good.

    Free markets work on a continuous interplay between fear and greed. It looks as if the leaders of Europe are going to let a whole lot of pain enter their economies and use the resulting fear to build stronger and lasting European institutions. The European project has been stuck in the mud the last decade but this crisis, far from destroying it, will make it all the stronger.

    Most Europeans have no idea of just how powerful the coming financial storm will be. But make no mistake about it, whether rightly or wrongly, they will almost unanimously know where it came from — the United States of America.

  41. Anonymous

    The 3 pct ceiling of the stability and growth pact is irrelevant in the context of this discussion. the pact has a clause that allows the ceiling to be breached in exceptional circumstances, and this weekend’s meeting in paris has made clear that the clause will be invoked. looks like even trichet was ok with it.

  42. aw70

    O.k., to take kevins comments a bit further…

    I’m also someone from the Eurozone, who has been closely following the unraveling of this mess for more than a year.

    Please tell me why the HRE failure will be the end of the Euro, or why it will bring financial Armageddon to the Eurozone. Things Might get Nasty in some cases, sure, and there is the very real possibility of people (including “normal”, risk-averse savers) taking haircuts.

    But a complete collapse? As long as you can’t tell me why this *has* to happen, I’m skeptical. Because the economic fundamentals are much, much healthier in a significant part of the Eurozone than in the U.S. – as kevin has pointed out, most of the Eurozone has retained manufacturing capabilities, and has not let the “financial industry” become its primary economic vehicle. Those european states which have let that happen, well, for them things might Get Ugly indeed.

    U.K. and Ireland, I’m looking at you here…

    But the rest? Please enlighten me on why the end of the world is imminent there as well…

    A.

  43. Yves Smith

    Diego,

    From the Times Online today:

    The Great Depression was an economic crisis built out of a global financial crisis, not only the 1929 Wall Street crash but also the powerful shockwaves that knocked the international monetary system off its axis in 1931.

    The failure of Credit-Anstalt, Austria’s biggest bank, produced something akin to the current scramble by banks to hoard cash. Sir Montagu Norman, the Bank of England governor, had to shore up Lazard’s, one of the City’s most blue-blooded merchant banks. Panic spread.

    “All over Europe, banks rushed to safeguard their assets,” writes Selwyn Parker in a new book, The Great Crash, published by Piatkus. “If they could, foreign depositors withdrew funds from Austrian and European institutions, albeit too late in many cases.

    “In a bid to shore up the public finances, a panicking Austrian government blocked all but essential gold and foreign exchange transactions, locking £300m of foreign deposits inside its borders. Just as had already occurred in the United States, Europe was starting to hoard capital. The fire was spreading.”

    Every country looked after itself.

    Britain led the departure from the gold standard, not only devaluing the pound but also precipitating the collapse of the international monetary framework that had held the global economy together.

    Washington had already passed the Smoot-Hawley Tariff Act, adding protectionism to the down-draught facing the world economy.

    http://business.timesonline.co.uk/tol/business/economics/article4880829.ece

    I am also reading a chapter on the German currency crisis of 1931. The economist who sent it to me believes there are strong parallels with our current situation. This will be grist for a post when I finish later today.

  44. Anonymous

    kevin de bruxelles,

    Spain did blindly accept the Anglo-Saxon model? How may I have missed this one?

    The banking sector in Spain is heavily regulated, no SIVs, no high leverage, no subprime mortgages, no investment banking. Just plain, vanilla retail finance. That’s why Banco Santander is buying the Anglo financial sector’s debris.

    A different thing is we don’t get the point of the State having a stake in every big company while the State itself is drowning in debt, or having millions of State workers paralyzing the country whenever a reform is introduced.

    Diego

  45. Yves Smith

    aw70,

    I need to turn in, so forgive me for being brief. However, a colleague who has extensive contacts, both at the banks themselves and with top-level regulators (his reading is good enough that he has told me of some of the pending Treasury moves, which I was instructed not to publish in advance) has said in no uncertain terms that European banks are in even worse shape than US banks. There will be even more failures there than here.

    A badly impaired banking system leads to a severe economic contraction. That is the nature of deleveraging.

  46. Anonymous

    Yves,

    as you know, for some economists, it was the Smoot-Hawley Tariff Act that made the Great Depression an international, lasting event, and not the American credit-taking spree in itself.

    Of course, no consensus exists in this topic.

    Best regards,

    Diego

  47. aw70

    yves, thanks for your reply – even if the actual message is not really what I wanted to hear.

    Without wanting to breach the confidentiality of your contact – did that person give any hints on a possible regional bias w/r to which banks are in a bad shape? Or is that contagion evenly spread throughout Europe, according to him/her?

    The latter I would find somewhat hard to believe, given the rather diverse nature of the European financial landscape. I can see a lot of banks in some countries being in a bad shape, but *everywhere*? That sounds a tad pessimistic – could you perhaps elaborate a bit more (as far as confidentiality allows)?

    Best regards

    A.

  48. Yves Smith

    He did not go into any detail with me.

    However, one issue is that many European institutions bought crappy US paper, in most cases the later vintage, which was the worst in terms of quality.

    The big institutions that were involved in the risky businesses are an obvious focus of worry, but my understanding, (not through my buddy, but merely via the Financial Times) is some (many? not sure) smaller EU banks bought enough poor quality paper to weaken them, so if they had any other problems, the combination could put them in serious trouble.

  49. aw70

    yves,

    that may all be as you say, but you no doubt realise that in such fuzzy form this information is more of a problem in itself, than actual, useful information.

    Lack of precise information on the state of individual financial institutions is one of *the* problems in this whole mess, and judging by how many people read your – otherwise excellent – blog, such fuzzy tidbits of information can start to be part of the problem in no time.

    Not all European banks have engaged in risky U.S. ventures, and not all of them are in bad shape. I would further venture that there are also huge differences depending on which country you are looking at; in some countries, most of the banks have focused on the emerging economies of the former communist states, and are doing well with these ventures. And will continue to do so, since any loans to this area are, much more so than elsewhere, coupled to tangible assets that resulted from real growth in these countries (these places had to do a lot of catching up). Any *such* banks I do not believe to be in grave danger, at least not yet.

    What is your take on this – does the possibility of a domino effect override any such real-economy backings, or will the EU banking sector merely fracture along such fault lines?

    A.

  50. kevin de bruxelles

    Diego,

    Here is a paper by Katinka Barysch where she explains the difference between the Anglo-Saxon and Continental economic models. In it she places Spain in the Anglo-Saxon camp but qualifies it by saying they are there to a lesser extent than the UK and Ireland.

    http://www.cer.org.uk/articles/43_barysch.html

  51. kevin de bruxelles

    Here is what happens to small European countries outside of the Eurozone:

    Iceland is on the brink of collapse. Inflation and interest rates are raging upwards. The krona, Iceland’s currency, is in freefall and is rated just above those of Zimbabwe and Turkmenistan. One of the country’s three independent banks has been nationalised, another is asking customers for money, and the discredited government and officials from the central bank have been huddled behind closed doors for three days with still no sign of a plan. International banks won’t send any more money and supplies of foreign currency are running out.

    People talk about whether a new emergency unity government is needed and if the EU would fast-track the country to membership. On Friday the queues at the banks were huge, as people moved savings into the most secure accounts. Yesterday people were buying up supplies of olive oil and pasta after a supermarket spokesman announced on Friday night that they had no means of paying the foreign currency advances needed to import more foodstuffs.

    http://www.guardian.co.uk/world/2008/oct/05/iceland.creditcrunch

    The leaders of the EU should be e-mailing this article to Irish leaders and letting them how easily that “c” in “Iceland” could become an “r” as in “Ireland”. The only difference being that the Irish don’t eat all that much pasta and olive oil.

  52. Richard Smith

    aw70,

    There is indeed a dearth of good info. But the data points that are available aren’t encouraging and do support the idea that there is a risk of systemic collapse.

    Nobody comes out of it well. Some samples.

    UK: Barclays’ balance sheet gearing: 60. Stupid Anglo-Saxon banking model. Historically, Banks with that level of leverage go bust. Barclays is so big that saving it will be hard for the UK, if it comes to that.

    Germany: Deutsche Bank has gearing of 50. Historically, Banks with that level of leverage go bust.
    Hypo Bank is in trouble in two ways: a) duff Irish real estate loans b) its funding model depended on the Repo market which…isn’t so liquid any more. It is Northern Rock on a much bigger scale. Likely outcomes for both Deutsche and Hypo Bank seem to me indistiguishable from outcomes produced by the stupid Anglo-Saxon banking model.

    France: who knows what French traders have been up to? French bank boards may not (see Kerviel case).

    Spain: has stringent rules re mortgages and a big property crash, but is pinning a lot of faith in the ability of its courts to turn round all the repossession cases (that there are going to be) fast enough to help their banks.

    Ireland: Irish banks have large exposure to the Irish real estate crash. Are the banks too big for the Irish to save by themselves?

    Switzerland: UBS too big for the Swiss to save if it goes belly up.

    Sweden: Contra your comment on Eastern Europe, Swedbank (via its subsidiary Hansabank) has lent on a massively imprudent scale to Estonia and it is going to go sour on them. Not all these E-Europe economies were such wonderful borrowers.

    Iceland: Oh dear.

    This is enough of a mess to cause system problems, isn’t it? Even good banks can get pulled under by bad ones when it’s like this (see 20s and Great Depression). All the above outfits will turn out to be heavily interconnected (even if one doesn’t know the precise links). If they were regulated the same and in the same sovereignties and in the same currency with the same legal system with a unified executive it would be hard enough to fix the mess. But they aren’t. Look at the German, British and Spanish commentary in this thread for an idea of the slightly raised voices that we are going to hear as the crisis evolves. The sheer complexity of the situation militates agains timely decision making.

    Lastly, to repeat an earlier commenter, many of the capital impaired Eurobanks (not obvious who, sorry – but they could easily include some systemically important one) are very dependent on the goodwill of the USA since the banks insured several hundred billions of US mortgage debt with AIG – which is now under US state control.

    We’re all in the same boat. A fact which, if recognised, might foster closer cooperation between European authorities. Here’s hoping.

  53. Anonymous

    Pardon me while I interject this:

    from the L.A. Times: “His [Paulson’s in 2006} top domestic goal, he said, was to revive President Bush’s efforts to partially privatize Social Security by creating individual investment accounts.”

    Motivation for manipulating the stock market envisioned as an appropriate vehicle for basic needs peace-of-mind at retirement age as opposed to a government check backed up by the full faith and credit of the US adjusted to inflation, and therefore Paulson’s creation of the PPT [Plunge Protection Team] or plumbers to stabilize markets (in an emergency) by manipulating the stock market, the first ‘broad powers’ given to Paulson which he has been abusing with the FED to do what heretofore has been ILLEGAL.

    ..and has led to the current sorry state with the result the US has lost its claim on faith and credit in the world.

    I declare Paulson a kleptomaniac enabled by Bush, the biggest f*-up in history, and an example of what happens when civics is not taught in grade school. These guys have no idea of the basic principles of US governance, indeed it could be this entire generation now in charge that hasn’t a clue.

    You be the judge.

    This from last Thursday’s New York Post business section quoting Phillip Goldstein, manager of hedge fund Bulldog Investors who supports the ban on short-selling of stocks:

    “I am confident our regulators at the SEC have a good handle on things,” he told The Post in an e-mail. “[It’s] nice that the SEC is propping up stocks in these stressful times. That is their mission, right?”

    to give him credit …maybe he’s being sarcastic?

  54. Charles Butler

    Yves,

    On what do you base your claim that the asset quality backing Spanish mortgage bonds is worse than in the U.S.? If you’re talking about construction loans, you might have an argument. But otherwise you’re not even in the ball park. The elasticity of the real price of Spanish property in the face of falling demand approximates zero because of very specific cultural attitudes.

  55. River

    Some comments above suggest that Europe will erect a ‘firewall’ between their economy and the US. ‘Firewall’ is another word for trade barriers…They might begin as financial barriers but will spread to other trade. As is well known trade barriers often lead to wars, especially if said barriers are targeting commodities that are basic to the survival of a soverign nation. See Japan and WW2 as one example that comes to mind quickly.

    Trade barriers should be avoided. See Smoot/Hawley as another example of such disasterous policy.

  56. Matt Dubuque

    Yves-

    I look forward to your post on 1931!

    River, given your interest in alternative viewpoints on the legacy of Dr. Friedman, you may enjoy reading Disaster Capitalism by Naomi Klein.

    Here is a very funny (and informative) link to her appearance last week on Stephen Colbert:

    http://tinyurl.com/4gt6cm

    Matt Dubuque
    mdubuque@yahoo.com

  57. Marshall Auerback

    Wow! Lots of comments about my post. I will try to answer in as detailed a manner as possible. All further comments welcome: What most people don’t seem to understand are on the institutional limitations of EMU. Monetary policy is the only policy instrument which can be exercised at the European level, combined with the emphasis of that policy on the control of inflation (i.e. an asymmetric inflation target which is also too low) tends to generate a deflationary economic environment as any signs of inflation or “overheating” of some part of the European economy is likely to be met by increase in the interest rate. This is exacerbated by the lack of active fiscal policy and the absence of other mechanisms (such as the promotion of investment) to stimulate aggregate demand. The current crisis serves to illustrate that the existing institutional framework is not adequate.
    The size of the EU budget is relatively small, around 1.3 per-cent of the combined GDP of EU members, and is still dominated by the Common Agricultural Policy. Also, by mandate, the EU budget must be balanced. Under these conditions, there is no scope for active fiscal policy.

    The other problem is the payments system: The Maastricht Treaty led to the establishment of two new institutions in the area of central banking in Europe: the European Central Bank (ECB) and the European System of Central Banks (ESCB), with the latter comprising the ECB and the pre-existing national central banks (NCBs) of EU countries (ECB 1999c). While not mentioned in the Treaty, it is the Eurosystem
    which is the actual entity performing the central banking functions for the euro and Euroland,
    comprising the ECB and the NCBs of only those EU countries that have adopted the euro.
    Within this narrower system of central banks, on which the following focuses, the ECB is
    supposed to be in the driving seat; as Article 107(3) of the Treaty establishing the European
    Community (TEC) says that the Eurosystem is “governed by the decision-making bodies of the
    ECB.”
    The relevant bodies are the Governing Council (ECB Council) and the Executive Board
    (ECB Board). The former includes the members of the ECB Board as well as the NCBs’
    Governors. The ECB Council’s job is to adopt the guidelines and take the decisions necessary to
    ensure the performance of the tasks entrusted to the Eurosystem. Particularly, the ECB Council
    formulates monetary policy, including the decisions relating to intermediate monetary
    objectives, key interest rates, and the supply of reserves, and establishes the necessary
    guidelines for their implementation. Meeting twice monthly, since November 2001, decisions
    on the monetary policy stance are normally only taken at the first meeting of the month.
    The ECB Board includes six members: the President, Vice-President, and four other
    members, to be “appointed among persons of recognized standing and professional experience
    in monetary or banking matters by common accord of the Heads of State of Government” (Art.
    112 TEC). The Board is charged with implementing monetary policy in accordance with the
    guidelines and decisions laid down by the ECB Council, which involves giving the necessary
    instructions to the NCBs.
    For the actual execution of the ECB’s policies is largely left to the NCBs. This follows
    the principle of decentralization, requiring that “to the extent deemed possible and appropriate: “the ECB shall have recourse to the [NCBs] to carry out operations that form part of the tasks
    of the [Eurosystem]” (Art. 12 Statute of the ESCB). While the ECB is the supposed head of the
    system, the NCBs, in turn, “are an integral part of the [Eurosystem] and shall act in accordance
    with the guidelines and instructions of the ECB. The Governing Council shall take the necessary
    steps to ensure compliance with the guidelines and instructions of the ECB, and shall require
    that any necessary information be given to it” (Art. 14(3) Statute).
    This peculiar design of the Eurosystem’s structure reflects a balancing act of national
    interests and European aspirations that raises a number of issues. On the one hand, a single
    currency means a single monetary policy common to all member countries, which requires clear
    leadership in policymaking and commonality in policy execution. On the other hand, completely
    abolishing existing NCBs (together with the national currency symbols) and starting from
    scratch was deemed politically impossible.
    And now this half-baked compromise is coming home to roost. As a solution, the NCBs were combined to a system of central banks, with a new head added to it. The point is that while the NCBs lost their previous
    authority in monetary policy matters, they may still be engaged in other central banking
    functions that have a more national rather than system-wide focus. Recall here that Euroland
    lacks a common fiscal authority, as for the time being fiscal policy remains under national
    control.
    One issue is that conflicts can thus arise between system-wide responsibilities and other
    more national functions and interests. Another that the NCBs, given their loss of monetary
    policy authority, could also be expected to keenly fight against any further drains of their
    prerogatives vis-à-vis their respective national authorities and players. This is what is happening in Germany today. In this regard, the lack of a common fiscal authority that could provide the “deep pockets” required in case of serious financial system problems and bank re-capitalizations creates huge problems for the euro, as we see today.
    Essentially, the NCBs continue to be in charge within their respective national financial
    systems, as national lenders of last resort in case of country-specific problems, while it remains
    to be seen how cross-border systemic problems would play out and be responded to should they
    arise. Tomaso Padoa-Schioppa, a former ECB Board member in charge of this area saw this as a case of “constructive ambiguity.” But the markets clearly regard otherwise.
    As to the question of what comes next, nobody knows. This is the real problem. It would be very messy, indeed chaotic, to go back to national currencies and would no doubt exacerbate the current systemic stress. More likely, I think is what I suggested to Yves the other day: it will end with the payments system being closed down until it reopens with bank deposit insurance at the ‘federal level’-in this case from the ECB itself. That’s the only real solution, along with scrapping the Stability Pact so that additional aggregate demand can be created.
    ESSENTIALLY, THE EUROZONE NATIONAL GOVTS. CAN’T FUNCTION WITHOUT BEING ABLE TO ISSUE NEW DEBT.

    ONCE SUSPECT, MARKET FORCES TEND TO TEST THE LIMITS VIA ‘PRICE DISCOVERY’

    SO FAR IT’S BEEN GERMANY, ITALY, AND BELGIUM. THE REST CAN’T BE FAR BEHIND, AS FALLING ASSET PRICES CUMULATIVELY TAKE THEIR TOLL.

  58. Anonymous

    kevin de bruxelles,

    as I see it, the Spanish system combines an ultra-conservative banking system and markets mostly free from State intervention.

    The Spanish left, unlike the French one, understands the basics of economics and management; trade unions don’t encourage aggresive strikes, etc.

    As I see it, that doesn’t make as Anglo-Saxons, just 10 years ahead of France on some political/economic issues (and even social issues, think gay marriage and regional minorities).

    Diego

  59. polit2k

    Full deposit protection is nigh

    * Robert Peston
    * 5 Oct 08, 05:04 PM

    The decision by the German federal government to guarantee all private savings in German banks is momentous.

    In a globalised banking market, in which money can leak across borders like a sieve, it will be almost impossible for the UK not to follow Germany’s lead.

    I would be immensely surprised if Alistair Darling, the Chancellor of the Exchequer, didn’t announce a similar commitment within the next 24 hours.

    The formalisation of full protection for depositors throughout the European Union became almost inevitable after similar decisions were taken over the past few days by the Irish and Greek governments.

    But Germany is the biggest economy in Europe, a global powerhouse, with a banking sector that for years prided itself on its conservativism.

    That Germany is the first of the major European economies to provide 100 per cent insurance to private savers shows just how fragile its banks have become.

    The trigger for the announcement seems to have been the desperate straits of Hypo Real Estate, the commercial property lender whose rescue in jeopardy.

    But that’s only the trigger.

    The underlying cause is a near-total collapse of confidence by creditors to banks and by bankers themselves.

    And I hope you’ll forgive my stating the blooming obvious, that there’s an unfortunate Great Depresssion resonance in the decision of the German administration to stand behind all private savings.

    http://www.bbc.co.uk/blogs/thereporters/robertpeston/2008/10/full_deposit_protection_is_nig.html

  60. Edward Harrison

    Let me add my two cents here for a second. The crux of the HRE debacle is that a company with mostly-German domestic real estate exposure is being forced into bankruptcy because of liquidity concerns. That’s big news. Why?

    The Germans had their own massive property bubble in the 1990s and did not participate in the global housing run-up after 2002. Therefore, one would think HRE was safe. But, the break-down in inter-bank lending means that anyone too dependent on the wholesale market for funding like HRE is going to run into difficulties regardless of country of origin.

    This means, as Marshall says, it is not limited to Italy, Germany and Belgium. The Spanish and Danish are two places where contagion should soon spread.

    EMU, the stability and growth pact, and EU harmonization rules are going to make it very difficult for the likes of Spain to use fiscal r monetary policy to act as a counter-cyclical force. This is the inherent problem with EMU. It doesn’t provide a way to address crises of this nature because the monetary and fiscal power reside at different levels of the European governmental structure.

    This fact, along with poor capitalization amongst European banks means that we are witnessing only the beginning of volatility in the European banking sector.

    Edward

  61. Anonymous

    Interesting!

    Yves, Great post but ” (Hypo Bankruptcy)… Threatening … Future of Euro”? You sound a bit like our good friend Ambrose. (His missives are great entertainment and sometimes contain food for though but he basically has some difficulties understanding Europe or the euro.) You are right that euro is “special”. It is just a common currency (fiat, to be sure) and not the liability of the subsidiary of the treasury of a single country. It cannot and should not be used to “fix” problems that currencies cannot really fix. The ECB just makes sure that it prints enough money so that people can buy “brot” and “vin” at reasonably stable prices. At the end of the crisis, the euro may come out a winner and may show the world how to make monetary policy — but we have to wait and see.

  62. Marshall Auerback

    Diego, an interesting comment, but I don’t think it addresses the immediate issue at hand. And in spite of the Left’s progressivity on social issues and understanding of markets, the real estate bubble in your country is a real problem for Spanish banks. Unfortunately, maybe the banks could have used a bit more state intervention!

  63. Charles Butler

    The stability pact cannot survive the current predicament – so it won’t. Write it off. Aside from the irony of the German situation (given a number of recent sanctimonious pronouncements), if they follow through with the promise to guarantee all bank deposits it forces all the rest to do the same. Beggar-thy-neighbour redux to be logically followed by withdrawal limits as ‘price discovery’ tests the system. It all opens the door for a more amply empowered ECB, but doesn’t necessarily get it inside.

    The least-of-evils bet here is on Spain, btw. So far the most solvent banks, tons of cash in circulation and a country very adept at dealing under the table.

  64. Anonymous

    marshall auerback,

    the real-state bubble in Spain is a problem mainly for tiny Spanish savings bank based on the coast, many of which will get bankrupt and will need regional government to rescue them. Not so for commercial banks, as they are diversified (Latin America and China). The point here is leveraged banks stupid enough to trust US ratings agencies are going bust, but Spanish banks have no leverage and no US paper.

    Had we had a US-, UK- or German-style banking system, Spain would have been in nuclear winter for a long time now.

    Diego

  65. Anonymous

    This is Anonymous Oct5, 1:04 PM again.

    I think that Europe will suffer a financial crisis and a recession but c'est la vie. It is not a catastrophe, it is part of the cycle. The news you get from the non-Anglo-Saxon press is informative. For example from the periphery I have two news items from Kathimerini (in Greece):

    http://www.ekathimerini.com/4dcgi/_w_articles_economy_1_04/10/2008_100991

    "Economy and Finance Minister Giorgos Alogoskoufis is seen being mobbed by reporters after his meeting with Prime Minister Costas Karamanlis at the latter’s office yesterday. The minister did not state anything about plans to guarantee deposits, but one ministry official was quoted as saying that this was a mere political commitment and the government does not intend to table a bill on the issue the way that the Republic of Ireland has done. Reports yesterday suggested that the government intends to ask the competent authorities in the European Union for an increase in the ceiling on guaranteed deposits under the Deposits Guarantee Fund (TEK) from 20,000 euros to 30,000 euros." In other words, the government, through a bureaucrat, gave a finite-duration political promise to make whole any depositor in Greek banks. The Greek equivalent of FDIC will increase the guarantee from 20K to 30K. Not what we read in English-speaking newspapers.

    Here is another:

    http://www.ekathimerini.com/
    4dcgi/news/economy_1KathiLev&xml/&aspKath/economy.asp&fdate=04/10/2008

    "Southeast European banks may have remained essentially untouched by the financial turmoil in the USA and elsewhere around the world but are facing indirect negative effects from the crisis, central bank governors from the region said yesterday. The heads of the national banks of Greece, Cyprus, Albania, Bosnia-Herzegovina, Bulgaria, the Former Yugoslav Republic of Macedonia, Montenegro, Romania and Serbia met in Sofia to discuss the state of their economies and precautionary measures to escape any possible setbacks from the crisis. “Sometimes being less developed is an advantage, as we do not have sophisticated instruments in the region like those that triggered the problems in the US,” Bulgarian National Bank Governor Ivan Iskrov said. The crisis has had little effect on the region as yet and no direct effect on banking systems, he said."

  66. Anonymous

    I don’t really think the Euro will be an issue other than it will most likely fall significantly in value tomorrow and the satbility rules will have to be relaxed.
    Hypo is obviously interesting becaue the german authorities are clearly heading off and suggestion of a bank run with the deposit guarantee. I wonder if there was the first hint of a bank run much as is rummoured to have precipitated Ireland’s action. What we should be asking is who holds the credit default swaps and what happens to the CD’s (certificates of deposit) issued in the US as a source of funding. French and swedish commericial paper is also mentioned as a sourse of funding so this may cause problems elsewhere in the Eurozone.
    Claims that spanish banks are in a sound position depends much apon the bank. While regulation was signifcantly better in Spain some banks used wholesale funding to a large degree and are exposed to bad loans in the collapsing building industry.
    UK banks are in a poor state although most that were signifcantly exposed to US MBS have taken over. RBS through ABN have some exposure as does Barclays but its not that high. Equity withdrawal in the UK was not at the same levels as the US and defaults are running at around a sixth of those in the US. Taking into account house prices have another 25 percent to fall, Builders are struggling to pay loans, sterling has fallen and the UK government has lost a considerable stream of revenue from the banks, the economy looks in bad shape.
    In contrast european economies are in much better shape although the bansk there have considerable exposure to US MBS and those that dabbled in the wholesale funding markets are in deep trouble.
    I expect to see a rescue from the UK and Nordic countries for Iceland especially since Icelandic firms have lots of assets in those regions which could be sold at depressed prices.
    Banks to watch may commerzbank in Germany and unicredit in Italy. Swedish and austrian banks also look a bit exposed to downturns elsewhere in the eurozone having quite high leverage ratios.

  67. Marshall Auerback

    Charles Butler is right. The Stability Pact is dead (thank goodness). And Germany’s act to guarantee all bank deposits effectively forces all to do the same. But you still need a federal payments system and the capacity of the ECB to issue national debt. We’re not quite there yet, but things are moving very quickly.

  68. Anonymous

    Hypo RE did not have any meaningful retail deposits (at least in Germany). So why did Merkel (did she formally already?) guarantee all deposits? The government must have feared a run on Hypovereinsbank (the former parent) for name reasons or funding reasons to its former sub. Also Deutsche Bank´s balance sheet makes one nervous.

    Or the next case is already brewing and this time it is a depositary institution ?

  69. Anonymous

    marshall auerback,

    the Stability Pact is dead in the sense the 3pc ceiling does not apply anymore. But a European country cannot arbitrarily incur a 7pc deficit without being fined; in that sense, the Stability Pact is well alive, just more flexible than before.

    Anyway, you are right that more integration is needed.

    Diego

  70. Marshall Auerback

    I think it is somewhat absurd to describe Ambrose Evans-Pritchard’s critique of the euro as “europhobic”. He has merely highlighted longstanding structural flaws in the European MOnetary Union, which have been highlighted by any number of economists since the euro’s inception. No need to shoot the messenger for eloquently expressing this problem. Even the head of the IMF (a Frenchman) has acknowledged that no single country can sort out this financial crisis in the absence of a global coordinated effort. Surely in the euro context this must mean the development of a supranational entity than can do fiscal policy? Why is it wrong for Evans-Pritchard to point this out?

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