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Sunday, 5 October 2008

Sunday's travels in Hypo-reality

The flurry of announcements, if not about financial security, sound like the mobilisation announcements in 1914 by one European power after another!
Germany’s decision to guarantee all deposits, following Ireland and Greece's example, is most embarassing after the Bundesbank had stated clearly that Germany's banks are insulated from the credit crunch and US sub-prime exposures (though clearly not the case for Dresdner Bank and some others). The FT report that Germany says it will guarantee all private German bank accounts – currently worth €568bn – in a dramatic move to prevent panic withdrawals as financial crisis spreads to Europe's largest economy. What is curious about this (details not yet available) is that Ireland's 100% coverag of deposits is worth €400bn, so why is Germany's only worth 42% more - something wrong here surely? The answer is probably that Germany's guarantee only cover "privat" accounts, not business accounts.
In the UK, the Government is worried about small businesses and wants a €12bn EU-wide initiative, but this seems scarcely adequate. It is also considering intervention in the form of convertible loans whereby the Government can emulate Warren Buffet's profitable approach to helping banks.
Actions to protect all depositors' savings (personal or personal & business) follows what was briefly deemed controversial (and even against single market rules) by Ireland. This was criticised in the UK as un fair competition for depoits. But, the funds flow into Irish banks from UK banks was probably mainly by Irish citizens. The UK had double the level of deposit insurance protection compared to Ireland and other EU countries (typiclly £35k v. €20k) for years without complaint.
The UK and France were trying on Sunday to learn details of the German plan, but had not done so by this morning! They are concerned to avoid cross-border flights of capital. At the EU weekend summit, chaired by France, leaders from France, Germany, Italy and the UK agreed not to let any large financial institution fail (according to people close to the talks).
The Danish government this morning guaranteed all bank deposits in a deal with banks (i.e. banks pay into a liquidation fund) covering up a Dkr35bn ($6.5bn) liquidation fund. Austria and Portugal are quickly following, but may wait on the German details before clarifying what the new limit will be, if not 100% for private deposits. It seems no news is good news in the case of Spain?
The Belgian government agreed with BNP Paribas to sell it a controlling stake in the remaining Fortis assets following the shock nationalisation of Fortis’s Dutch banking and insurance businesses on Friday that in effect cancelled the bank's banking and insurance licenses in what was Fortis's country of origin until it became Belgium's biggest bank.
In Iceland, where the 3 main banks appear properly solvent, the PM said at a press conference on Sunday he hoped to announce a partial rescue package for the banking sector, and refused to comment on the idea that Kaupthing would take over Landsbanki. The PM and central bankers were also in talks with pension funds and banks as the country looked overseas for freeing up short term funding. Then the latest; trading in all Icelandic banks's shares halted and Kauphing ordered to sell foreign assets and focus more on domestic loans and less abroad!
On Sunday too, the Italian bank UniCredit approved the raising €6bn in new capital to shore up its defences against a falling share price (asking shareholders for €2.5bn convertible bonds, scrapping its cash dividend and to issue shares equivalent to another €3.5bn in core capital. This is a surprise as the Italian banks have been the most conservative consumer credit and mortgage lenders. Of all OECD countries, Italy has been the least of a credit boom economy. The title for this blog comes from Umberto Eco's essay "Travels in Hyper-reality" where history and business cultures of Europe and USA are each viewed by the other as if down the wrong end of a telescope.
German Government embarassment is total. Ministers very recently pooh-poohed any necessity to have access to TARP or a European equivalent. Days later all that is dust in the mouth. Government and financial regulators yesterday (Sontag) agreed a revised bail-out package for Hypo Real Estate after the abrupt re-calibration of capital needs as measured only a week ago! Angela Merkel, the German chancellor pledged not to let HRE endanger the country’s financial system. HRE (with a €400bn,$550bn balance sheet), one of Europe’s biggest commercial property lenders, which would be the biggest bank failure in modern Germany with cross-border repercussions. Ms Merkel warned the HRE’s managers they face sanctions if they are not forthcoming about all the risks the bank took. Clearly, there had been some number-crunching through the accounts during the week that threw up far more in potential losses than were known only a week earlier! (And here we may be mindful of the action by the DNB in the Netherlands over Fortis Netherlands.) HRE needed liquidity lines from banks and the Bundesbank because it could not get enough short-term, unsecured finance to support Depfa, its Ireland-based (off-shore?) public sector lending arm. The first rescue attempt in which the German governement would provide most of the €35bn credit guarantee required to enable HRE to borrow (having lost AA-status). The second deal raised the amount to €50bn from €35bn and Government raised its credit guarantee from the €25.6bn to €35bn with €15bn from other banks.
At the same time, spreading a security blanket over the whole banking sector was possibly a condition that the other German banks insisted upon to remain involved with HRE's rescue? The banks that pledged support had during the weekend at first pulled out of the second deal when they saw €15bn was now required, having previously only agreed to €9bn. The HRE bank's accounting system was now severely in question? If no deal had been struck by today, the collapse of HRE would have had repercussions not only on the other banks (and their shares have fallen anyway) but just as importantly on the all important market that finances Germany's largest branks, Pfandbriefe, bank covered bonds. HRE is a Munich-based group (Bavaria) and was a major issuer of the Pfandbriefe, which are backed by high-quality pools of conservatively valued property collateral and/or corporate loans. HRE is not a retail bank, so the issue was not one of protecting retail customers and SME's per se.
All this had political repercussions too at the polls days earlier. The HRE crisis also followed on from severe embarassments in February, also in Bavaria, over Hypo-Vereins Bank and the Bavarian State Bank, which became the butt of satirical comment: see,1518,538200-2,00.html
The conservative CSU lost Bavaria a week ago, which is a blow to its partner the CDU which governs Federally. The CSU had campaigned Under the slogan, “Socially acceptable is he who makes no debts,” and on this basis cuts were made in various social programmes (mainly education and health) even though the budget has been balanced for 3 years and there had been a dramatic increase in numbers in poverty! The state government freed up large sums to cover the losses of the Bavarian State Bank (Bavaria LB, which in April reported losses of €4.7bn due to speculation in the US sub-prime paper, plus €300m lost due to the collapse of Lehman Bros. The state government undertook to cover losses with €6bn (as a direct cost to taxpayers). The CSU then lost power in Bavaria for the first time in half a century!

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