Wed, October 08, 2008
Bank Troubles Spread to Europe
As recently as the end of September, many European commentators were describing the current subprime-ignited financial crisis as evidence of American arrogance. Now, however, the other shoe has dropped, and credit-related sickness is evident in the European banking system too.
Britain has announced a banking bailout package in which the government will inject capital into UK banks by purchasing the equivalent of preferred shares to the tune of $80+ Billion. The concern is that British banks, short on capital, have been dramatically cutting their lending, and without lending business capital dries up. Today I received an e-mail from the educational website http://www.learnmoney.co.uk, an English personal finance and investing site. The fellow who runs the site is so worried about the liquidity of British banks that he’s advising his subscribers to pull a couple of month’s funds out of their accounts. It sounds extreme, but it illustrates the level of concern there.
As David Merkel and others have noted, European banks have even higher leverage (ratio of borrowed money vs. equity) than American banks. Paul Kedrosky, who runs the blog Infectious Greed, pointed out last week that the US government’s bailout of AIG was a huge help to European banks, which were exposed to $300 billion in credit insurance contracts written by AIG. The ultimate magnitude of the problem may even be greater than in the US.
A key problem for European banks is the fact that the European Central Bank is not a central treasury. The EU countries share the euro, but individual countries make autonomous decisions about bailing out their banks unless the nations agree to create some sort of temporary central authority. This leads to problems as, for example, Ireland guaranteed the debt of several Irish banks, causing depositors from other countries to shift funds out of their own countries’ banks and into Irish ones.
It’s clear that the financial crisis is a global one. Although I don’t think investors with well-diversified portfolios should be bailing out of stocks, I reiterate the comments I made earlier about reducing one’s overall risk profile. Now is definitely the time to be living at the conservative edge of your risk tolerance.
Postscript added Oct. 8, 2008: This morning FT Alphaville drew attention to a very revealing graph from Citi that shows European bank assets as a percentage of the host country’s Gross Domestic Product (sorry it’s sideways, but if it were rotated and scaled the text would be unreadable). It shows just how huge some European bank’s assets are relative to their host economies. This is undoubtedly part of the reason that the Federal Reserve, the European Central Bank, and the central banks of China, the U.K., Canada, Sweden and Switzerland acted in concert today to cut interest rates in order to ease credit pressures: some of these banks have asset bases (and hence, debt exposures) that dwarf their host countries’ annual economic output.