EU struggles for unified response
By Mark Rice-Oxley | 10.07.08
London
So much for European unity.
With banks teetering, its financial system seizing up, and citizens beginning to fret about their savings, the European Union is struggling to produce a united, coordinated response that can restore confidence.
For more than 50 years, the bloc has built up formidable mechanisms for cooperation, coordination, and closer integration, yet in the face of the biggest-ever challenge to its financial system, the EU appears fragmented as its 27 members fall back on national solutions rather than working together on an EU-wide response.
Individual countries are scrambling to guarantee their own savers’ deposits, drawing anger from neighbors who say it is unfair and against EU rules. Leaders are squabbling about whether to mount a “Paulson plan for Europe.” A weekend meeting of leaders from France, Germany, Britain, and Italy not only snubbed the other Big Five country, Spain, but produced little of substance.
The market response? European markets are arguably suffering more than any others at the moment, enduring their worst day for a generation Monday. The FTSE 100 index saw its biggest-ever points loss. On Tuesday, European stocks saw some modest gains.
“This is a once-in-a-lifetime, totally extraordinary event for which the [EU] project was not prepared and so far it’s been pretty bad in terms of a European response,” says Daniel Gros, director of the Brussels-based Center for European Policy Studies. “They have concentrated on saving their own national problems one at a time. That has done nothing to alleviate the systemic problem: that banks don’t trust each other.”
Howard Archer, an economist with the Global Insight forecasting group, adds: “At the moment it seems a pretty fragmented approach with countries coming up with their own solutions, which can cause problems for other countries. It needs a more coordinated approach.”
“At times of crisis, national interests seem to come to the fore,” he adds. “That always seems to happen. There are signs that the European institutions aren’t working well enough to coordinate a response on this. It’s something they need to improve.”
Take Ireland. When it moved last week to guarantee all deposits – retail and wholesale (i.e., guaranteeing savers and all other creditors) – at six national banks for two years, the initial response was relief. But only in Ireland. Elsewhere, countries fumed that the move contravened EU competition rules, skewing the playing field. Britain was particularly alarmed that savers and businesses would take one look at the Irish guarantee and shift their funds out of British banks. Some in fact already have.
Other countries looking on have quickly responded. Some – Greece, Denmark, and Germany – offered full guarantees to retail savers. Others, Britain and Sweden among them, are raising the threshold to which savings are guaranteed. On Tuesday, EU finance ministers agreed that all EU savings up to 50,000 euros ($67,902) should be guaranteed. That raises the European minimum but felt short of the 100,000 euro threshold some nations sought.
Different countries are reacting differently to struggling banks, too. Some have been nationalized, others recapitalized by the state or a consortium or bought by wealthy investors. Now some countries, among them Britain and France, are floating the idea of taking national stakes in banks to restore confidence, shore up balance sheets, and then refloat them to recoup the taxpayers’ investment at a later date.
Carsten Brzeski, an economist for the Dutch bank ING, says the problem is that investors are unimpressed at the piecemeal responses. “Some of the measures were not so bad, but the timing and the lack of coordination were a problem,” he says. “If there had been some coordination in advance, we wouldn’t have seen the [market] conclusions.”
Analysts say there could have been greater coordination on:
•Deposit guarantees. Reassurance could have been greater if EU countries had established a rule early. It is unlikely they would have gone as far as the Irish blanket guarantee, as the cost would have been prohibitive. But an early decision to raise the guaranteed savings threshold might have injected confidence into the market.
•Regulation, capital adequacy, supervision, and credit ratings to spread risk more evenly throughout the EU. As it is, Spain is congratulating itself for its minimal exposure to the subprime fallout, while Germany and Britain are wincing.
•A capital injection into banks. Daniel Gros says that if every EU country placed a sum equal to 2 percent of GDP with the European Investment Bank, it would have a fund of 300 billion euros to buy stakes in troubled banks.
Mr. Gros says this response would demonstrate the very purpose of European unity: that everyone would benefit from a holistic solution.
The problem for Europe is that the EU doesn’t have the same federal institutions that the US has. The European Central Bank operates only on behalf of 15 out of the 27 EU countries, and aside from that, there is no central fiscal or regulatory authority.
“What the US can do because it has central fiscal authority [is] get into the game of ensuring solvency,” says Katinka Barysch, deputy director of the London-based Center for European Reform. “We can’t do that. As a result, in the middle of a crisis, we don’t have the mechanisms available, so it means we can’t do a European bank bailout.”
In Europe’s defense, Ms. Barysch argues that there has been some good multinational cooperation, such as with the rescue of crossborder banks Fortis and Dexia. “Think about what would have happened if you had a bank based in El Salvador, Venezuela, and Uruguay that went bust. It would have been mayhem,” she says.
But with countries increasingly determined to rescue their banks by taking state stakes in them, Europe is taking a giant stride back from decades of closer financial integration that saw multinational banks build and grow. “Banks are becoming more national,” Barysch concedes.
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Stock markets’ plunge puts pressure on Fed to cut rates
By Ron Scherer | 10.06.08
Following a wild and woolly day in the stock market, the world’s central banks are now under intense pressure to drop interest rates.
If the banks agree to a coordinated rate cut, economists expect it to be between one-half and three-quarters of a percentage point.
The catalyst for a cut was today’s roller-coaster day on Wall Street where the Dow Jones Industrial Average at one point was down 800 points but ended with a loss of 369.88 points, a loss of 3.58 percent.
“We need a coordinated rate cut,” says Fred Dickson, chief investment strategist at D.A. Davidson in Lake Oswego, Ore. “You would think the fall of 800 points would catch the Fed’s eye. And a coordinated rate cut would help” ease the credit crisis.
The call for the rate cut came despite the efforts by the Fed to unclog the financial system. On Monday, the Fed said it would increase its loans to banks to $900 billion. And on Monday, the Fed said it would begin to pay interest on banks’ excess reserves and required reserve requirements. This will give the commercial banks greater profit but reduce the Fed’s profitability.
“Together, these actions should encourage term lending across a range of financial markets in a manner that eases pressures and promotes the ability of firms and households to obtain credit,” said the Fed in a statement. “The Federal Reserve stands ready to take additional measures as necessary to foster liquid money-market conditions.”
Some credit-market participants said the Fed’s moves would help somewhat. “Little things may help, but the markets are pretty crazy,” says Bob MacIntosh, chief economist at Eaton Vance in Boston. “I can tell you the credit markets are still lousy.”
Although there was no specific news item that precipitated the stock market drop, Mr. Dickson wonders if some large hedge funds, which have borrowed heavily, are getting margin calls. But he notes that the market’s sharp drop also comes at a time when analysts are reducing their earnings estimates for the fourth quarter. And “right now we have a crisis in confidence in the banking system,” he says.
In fact, some economists wonder if an interest-rate drop will help. “Interest-rate levels are not the problem,” says David Wyss, chief economist at Standard & Poor’s in New York. “The problem is that no one is lending any money.”
Last week, for example, the commercial-paper market – short-term lending to everyone from large corporations to states and cities – shrank by nearly $100 billion or 6 percent. On Monday, the overnight interest rate for prime commercial loans was 3.68 percent, as high as interest rates right after the House of Representatives voted down the $700 billion bank rescue plan last Monday.
The dry spell has at least two states, California and Massachusetts, calling for government loans. “The tax-exempt money-market funds are just afraid to lend,” says Mr. MacIntosh. “They have the cash, but they literally do not want to put it to work.”
The turmoil in the credit markets means that many large corporations that normally would access the commercial-paper market have not been able to do so. GMAC, for example, was unable to get investors to buy a $2.7 billion offering from its commercial finance unit. The offering was withdrawn. “It’s just an example of how shaky the financial markets are,” says Dickson.
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Why Asian banks are stronger than US banks
By Simon Montlake | 10.06.08
Bangkok, Thailand
Asia’s markets are tumbling, but their banks aren’t.
A decade after their own debt crisis shook the world, Asian banks have so far averted the crippling run of failures afflicting the US and Europe. By staying away from risky US securities, prudent lenders in Asia may even stand to benefit from the current crisis, as stricken Western banks seek fresh capital.
Asia is feeling the credit squeeze. And fears of a global recession have pummeled equity markets here, too – Tokyo’s key index was down 4.25 percent Monday, pushing it to the lowest level in 4-1/2 years – but none of its financial institutions have collapsed.
A handful of banks in Hong Kong and India have had to reassure nervous savers not to pull their deposits. Regulators have also pumped extra money into credit markets, but there’s been no panicked rescues of stricken lenders, as in Western countries.
That’s because relatively few banks bought into the promises of US mortgage-backed assets. Those that did had only limited exposure before last year’s subprime blowout: Asia currently accounts for only $24 billion of $550 billion in global subprime-related loan write-offs, according to Bloomberg.
“We’re not really seeing a lot of pressure on Asian bank systems…. They just didn’t seem to build up their exposure [to US subprime loans] in a way that other banking systems did,” says James McCormack, head of Asia-Pacific sovereign ratings at Fitch Ratings in Hong Kong.
Many bankers in the region have painful memories of the 1997-98 crisis and prefer to lend cautiously, avoiding the kinds of high-risk, high-return bets that they can’t manage. Japan had its own experience of a real estate crash that kept economic growth on hold through much of the 1990s.
The US housing bubble came at a time when dynamic economies in Asia were offering ample lending opportunities, so there was less pressure to buy sophisticated US derivatives. A global economic slowdown is bound to crimp Asia’s export-led growth, but its bankers can breathe more easily knowing that they’re not saddled with toxic assets.
A culture of risk aversion underscores the differences between the US and Asian financial markets, says Cyn-Young Park, a senior economist at the Asian Development Bank in Manila. Regulators are more hawkish on monitoring banks, and companies are less likely to pile on debt so soon after the last crisis, which led to waves of bankruptcies.
But over the long term, such conservatism may be a handicap, she adds. “Asia wasn’t developed enough to digest all these [US] financial innovations into their system. In some senses, this isolation is a reflection of weakness,” she says.
Whatever the reason, cash-hoarding Asian banks – and governments – now appear to be in good stead as US banks try to dig out of a hole.
In a reversal of the 1997-98 crisis, Asian capital is beginning to flow West to buy marked-down assets in the financial sector. Japan’s Mitsubishi UFJ Financial recently paid $9 billion for a 21 percent stake in Morgan Stanley. Merrill Lynch and Citigroup have both raised capital this year from Singapore’s government, one of several in the region with ample foreign-currency reserves that are mostly held in US government debt.
Middle East oil producers also hold large reserves that could provide a lifeline for cash-strapped banks. Abu Dhabi’s sovereign fund last year spend $7.5 billion on a stake in Citigroup.
Fear of a nationalist backlash to their investments and the risk that asset values could decline further – as Merrill Lynch did after Singapore’s initial investment last year – may keep foreign governments on the sidelines. But the pressure on US banks to rebuild their capital base will continue, even if the Congressional bailout sucks out bad loans from the system.
That should be a magnet for sovereign wealth funds and healthy banks. “They’re the ones with the capital right now. You can assume that Western governments are happy to embrace their investments,” says David Cohen, director of Asian economic forecasting at Action Economics in Singapore.
Despite the relative strength of Asia’s banks, investors have been dumping stocks in the region. Leading the downward charge, Japanese stocks tumbled Monday, largely on fears that Asian exporters will be hit hard by an expected US recession.
Newspapers in Hong Kong quoted an executive of HSBC, a regional banking giant, warning that any slowdown in Asia would be “far more severe” than that of a decade ago and that recovery would be slower. Hong Kong’s Hang Seng index lost 5 percent, while markets in mainland China, South Korea, India, Singapore, Australia, and Thailand also slid.
Any global slowdown will eventually hurt banks in the region, says Emmanuel Daniel, founder and CEO of The Asian Banker, a publisher and research company in Singapore. Companies that rely heavily on demand from the US for their products and services are certain to feel the pinch, probably by early next year.
“There is concern that when that happens, the quality of borrowers within Asia will come into question and that in turn will affect the banking industry. This is the big one that Asian banks are bracing themselves for,” he says via e-mail.
Mr. McCormack says he’s monitoring banks that are vulnerable to tighter credit conditions, such as those in South Korea and Taiwan. “I think that the pressure we would see would be on banking systems that are dependent on capital markets for funding,” he says.
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Big job losses point to consumer woes ahead
By Ron Scherer | 10.03.08
Another important part of the economy is now starting to falter: businesses that cater to consumers.
As families stop making so many trips to the mall or cut back on their dining in restaurants, the consumer sector is now laying off workers. Jobs are disappearing for people in furniture stores, electronics retailers, and department stores. Even food-services companies are reducing their staffs.
“This is the first consumer-led recession we have had since 1990-1991,” says Dan Meckstroth, chief economist at Manufacturers Alliance/MAPI in Arlington, Va. “Consumers are overleveraged and it’s going to take some time for this to unwind.”
On Friday morning, Americans got their bleakest view yet of the problems in the consumer sector: The Department of Labor reported that the US lost 159,000 jobs in September, the most since March 2003. The nation’s headline unemployment rate stayed at 6.1 percent but would have been higher if more people had not dropped out of the labor force. Losses in the retail sector amounted to 40,000 jobs, the second largest loss next to construction.
The problems in the consumer sector point to more economic trouble ahead, say some labor-market specialists.
“It suggests a tapped-out consumer and that could have serious repercussions for a poor holiday season,” says John Challenger of Challenger Gray & Christmas, a Chicago outplacement firm.
Over the next two quarters, consumers will cut back spending by more than a 2 percent annual rate, predicted Scott Anderson, senior economist at Wells Fargo Banks in Minneapolis, on Friday. This would help to drive the economy into a recession that won’t end until the spring of next year, he wrote.
Part of the consumer economy’s problem is the drying up of funds. Most consumers have either spent the checks sent out by Congress this spring or used them to pay down debt. Now they are getting caught up in the credit-market crisis, says Bill Hardekopf of LowCards.com, a consumer website.
“Credit markets seem to be dropping for a significant number of customers, especially those with riskier credit,” he says. In addition, he has noticed that credit card companies seem to be reclassifying their customers downward. An individual considered to be an excellent credit risk may be downgraded into a “good” category.
“So instead of getting the 8.99 percent rate that was advertised, instead they get the 10.99 percent rate,” he says.
Retail workers often come from the lower-income echelons. Unemployment in this sector is rising, says Andrew Stettner, deputy director of the National Employment Law Project in New York. “When you look at the numbers … there has been a big increase in unemployment for people of color and less education,” says Mr. Stettner. “This is hitting the lower end of the social spectrum.”
But Stettner is also alarmed over the rising number of people – some 2 million – who have been out of work for more than six months. He says this has not happened in five years.
“Some 21 percent of the unemployed have been out for more than six months,” says Stettner. “When it’s over 20 percent that means hiring is very slow. People can’t find jobs.”
But it’s not totally bleak. Roy Krause, president of Spherion, a staffing and recruiting firm based in Fort Lauderdale, Fla. For the past 18 months, temp hiring has been dropping each month. However, he notes that in September temp hiring was down 9 percent compared with September of last year. The 9 percent drop was the same as August. “The good news is that it was not getting any worse,” he says.
Part of the problem in the job market is the economic uncertainty. A $700 billion bank rescue plan from Congress can remove some of that uncertainty, Mr. Krause says. The announcement by Well Fargo that it will acquire Wachovia without any government aid – topping Citigroup’s bid – may also be a positive for the financial markets.
“It shows business at the right price will look at [mergers] and expansion,” says Krause.
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Emergency summit in Paris to focus on a pan-European response to credit crisis
By Jeffrey White | 10.03.08
Berlin
As the House of Representatives considers another vote Friday on a historic rescue of the US financial sector, attention in Europe is on whether countries here can agree on sweeping reforms to their own tottering banking systems this weekend.
Leaders of Europe’s biggest economies are expected to meet in Paris Saturday for an emergency summit to discuss stricter rules that the European Union (EU) proposed this week and whether Brussels, too, needs to pass some sort of bailout fund to prop up the European economy.
The meeting appears to be a sign that the EU leaders, long thwarted in attempts to create a unified economic policy, believe that only a pan-European response can save the world’s largest economic bloc from sliding into a deep recession.
“European economies are much more at risk,” says Stefan Bielmeier, an analyst at Deutsche Bank. “The US is economically more flexible, and therefore they are better suited to maneuver out of a crisis compared to the Eurozone,” he says.
Major European financial markets, from Germany’s DAX to London’s FTSE, showed slight gains Friday. Economists attribute the minor rally to Wednesday’s US Senate approval of the government’s $700 billion bailout legislation, and anticipation that the House, which rejected the measure on Monday, would soon follow.
There have been calls for the European Central Bank in Frankfurt, which sets EU monetary policy, to cut a key rate currently at a seven-year high of 4.25 percent, but bank officials Thursday decided against it.
On Wednesday, Charlie McCreevy, the EU’s commissioner for internal markets, proposed a broad reform to the European banking system, which would prohibit banks from lending more than a quarter of their funds, force lenders who sell precarious loans as securities to assume more risk, and create centralized oversight for institutions that operate in multiple EU countries.
But the sense that Europe is in an economic crisis persists across the continent, following a week in which the Netherlands, Belgium, Luxembourg, Germany, and Britain rallied to rescue their own failing banks.
The largest, the privatization of Britain’s eighth largest bank, Bradford and Bingley, got swift approval from the EU on Wednesday. The same day, Italy’s lending titan UniCredit, whose shares had been suspended on the Milan stock exchange, announced it was selling some of its property holdings to allay fears about its solvency.
Swiss giant UBS, the European bank hardest hit in the credit crisis, announced Friday that it is cutting 2,000 jobs.
But this weekend the question remains whether the EU can overcome a record of division on other key issues – energy, Russia, and its own constitution to name a few – and find consensus on economic policy. It’s necessary if leaders are to make the kind of sweeping changes that the European financial system needs, which would include creating a EU bailout fund, analysts say.
“The only thing they can do is to take very drastic measures. That’s the only choice they have,” says Karel Lannoo, chief executive officer of the Center for European Policy Studies in Brussels.
Mr. Lannoo says failure to do so will result “in the Balkanization of the European financial markets. Every country for itself. That is the danger.”
Members of the European Parliament are split on how to proceed, with liberal members favoring Brussels’ proposed banking reforms and conservatives saying the reforms involve too much regulation.
EU states are also floating their own proposals to toughen up the overhaul. France, which holds the rotating EU presidency, wants to require greater cooperation among national regulators. Germany is leading the call for a suspension of EU state aid restrictions, which would give countries more financial muscle to help struggling banks.
Leaders are also expected to debate the extent to which governments should guarantee bank deposits, following Ireland’s announcement this week that it would back all deposits in its banks – a move seen as automatically putting other national banks at a disadvantage unless their governments follow suit.
“Where should I go if I have €20,000? To an Irish bank, because I know I’ll get bailed out,” says Olaf Gersemann, a financial columnist for the German newspaper Die Welt.
The EU’s call for more centralized financial regulation is a sharp departure from the way things have always been done.
Unlike the US Federal Reserve System, Europe lacks a central oversight authority for its financial system. The European Central Bank sets policy and is a lender of last resort, but it does not hold any supervisory mandate. Instead, banks in Europe are regulated on the national level: If a bank fails in France, it is up to France to bail it out.
“This has always been a cause for concern,” says Gerhard Illing, research director at the Institute for Economic Studies in Munich. “The question has always been how effective this system is if there are shocks in the international banks” operating in several countries.
“Regulatory reform will take some time. This won’t happen fast,” Professor Illing says.
