Bailout Blame Game
When the bailout passed last week, no one was surprised. In fact, what looked like a principled opposition to massive legal theft on Monday was transformed into a done backroom deal by Friday once the bill ballooned from three to 400-plus pages, filled with crumbs that congressmen could throw to their districts. It may be that, 25 years from now, economic historians will note socialized credit markets came to America in exchange for production credits for "marine renewables" and new regulations for "residential top-load clothes washers," which were among many of the riders added to the bailout legislation as the infamous week wore on.
Personally, I am still a long-term optimist, but as a student of the Depression I know that Congress and the executive can do much damage before the long term gets here, and indeed, they can delay its arrival indefinitely. Will the conservatives who supported this legislation lay into a President Obama two or three years hence, in the event that the economy devolves into a repeat of the 1970s, thanks in large part to government's attempt to forestall market forces over the last two weeks? This seems likely. Our current problems resulted from the infusion of credit in the past. To think that infusion today will not have the same effect in the future is to challenge pesky things like natural and economic laws.
Since societies that challenge them risk peril, I thought it may be helpful to at least identify some of the people whose actions and ideas helped turn the tide last week. Their numbers are many, and any list will by necessity be abridged. Still, if the health of a society and culture is related to the quality of the theories that are accepted, then knowing some of the sources of bad theories is key for turning the tide back again.
Besides, blame games can be fun. My own version involves taking a swig of Victory Gin whenever the following names pop up in bailout analyses.
Karl Marx
He predicted this, sort of, in the fifth plank of the Communist Manifesto, which discusses the inevitability of socialized capital markets in the capitalist countries. The problem is that he believed this would happen because of inherent characteristics in the market system, whereas in truth there is nothing within capitalism per se that motivated Messrs. Bush, Paulson, and Bernanke. In terms of understanding capital, Marx fails in comparison to the Austrian Eugen von Böhm-Bawerk, while those who want to understand the underlying forces explaining government growth would best avoid Marx and read Böhm-Bawerk's student, Ludwig von Mises, on economic interventionism. Nonetheless, there is great irony in the fact that, 17 years after the fall of the Soviet Union, the United States decided that market forces fail when it comes to capital. Somewhere, this slovenly German malcontent must be smiling.
Lawrence Halprin
You may not know this name or how it relates to our current mess, but rest assured, it is closely tied to it. This is because Halprin designed the pretentious and misleading memorial to Franklin Roosevelt that is on the National Mall in Washington, DC. Passersby learn how fear is a great justification for government expansion, which helps inform how the promulgation of unfounded fear was key to the bailout's success last week. They also learn how Roosevelt's "bold" actions, in the midst of the Depression helped combat it. This is also a myth. As my Mises Institute colleague Bob Murphy noted in an email last week, the facts are that Roosevelt's bold interventions prolonged the Depression, turning it into the only market correction that is associated with an entire decade. (The Depression actually lasted 16 years.) Yet somehow, today, questioning the Roosevelt Myth is like pointing out that the emperor has no clothes. Halprin's contribution in promoting this myth was poignant last week. Are there similar shrines dedicated to Stalin (to whom FDR referred warmly as his Uncle Joe) somewhere on the outskirts of Moscow, replete with the man in grandfatherly pose and pet dog nearby?
Joseph Bristow
One cannot discuss the centralization of power in the 20th century without noting the contribution of this senator from Kansas who spearheaded the 17th Amendment into the Constitution. Before Bristow, senators were selected by state legislators, but after him, senators were selected through popular election. The result has been the nationalization of senate elections, irrelevance of state legislatures, weakening of states' constitutional check on the executive branch, and diminution of states' rights. Given the bailout's overwhelming political opposition, it is hard to believe that a senate that had to answer to state legislatures would have supported this bill. Murray Rothbard once wrote about repealing the 20th century. If this isn't possible, then we should settle for repealing the Progressive Era instead.
George W. Bush
He ran as a compassionate conservative and promised a humble foreign policy, but governed as the reincarnation of Woodrow Wilson, Franklin Roosevelt, and Lyndon Johnson all tied into one. (One could argue, along with Bill Kauffman in his highly recommended book, Ain't My America, that the Johnson and Bush presidencies illustrate what a bad deal Texas's annexation has turned out to be for republican government.) Although Bush inherited a recession, this more severe one can be explained by his expansions of bureaucracy and debt, which have occurred at such record levels that his likely successors, though men of the Left, are welcomed because they could be viewed as being to Bush's right. Furthermore, the doubling of the national debt in seven years (and increasing it by a half trillion dollars in the last two weeks alone) is one of the primary unstated reasons for credit problems today, which explains the political desire to blame Wall Street.
Wall Street
This does not refer to a single person, of course, but rather to people like Hank Paulson, John Mack, Chuck Prince, Stan O'Neal, and others who fed the housing bubble in the 2000s and have been successful in forcing taxpayers — the poor and working classes especially — to assume risks investment banks could have assumed with their own resources (according to financial analyst Peter Boockvar). Will anyone view Arturo di Modica's Charging Bull bronze statue on Wall Street, which once symbolized "the strength and power of the American people," to mean anything else than, well, bull? It should be melted down, and used as a competing commodity money to the dollar.
My Congressman
My guy may be much like your guy, in that he is of his district's dominant political party and faces weak opposition in next month's election. He emphasizes the social issues that are important to his constituency, and this allows him the freedom to vote against its wishes when he can thereby accrue political and economic rents in Washington. My guy claimed that his calls against the bailout ran at 300 to 1, but since he is strongly pro-life, he knows he can deviate from his district's wishes. Hence, he is an arch-redistributionist and logroller extraordinaire. Congress never was an institution that protected human freedom, but this was less relevant in a constitutional republic. But it isn't today, and for that we can thank (in part) …
Herb Stein
By demeanor, Herb Stein was a lovable and funny man, and very smart. (I worked a few steps from his office once, as a college intern.) But in terms of his professional contribution as Richard Nixon's chief economic advisor, Stein played the role of buffer between Nixon's desire to socialize and the market's desire to correct, and in the process he set the standard for many DC-based economists who advocated the bailout last week. The early 1970s were similar to today in that they followed years of political manipulation of the economy, leading to a major correction, which led to a crisis for the political class and the need to socialize in order to avoid it. In Stein's case, it was his reputation as an economist working behind the scenes that enabled Nixon to close the gold window and establish the dollar as a fiat currency and therefore enable the largest wealth redistributions in history. Stein's example reminds one of the full cost of public financing of intellectual activity. Let's add the bailout to this cost.
Milton Friedman
Since we are discussing intellectuals, why not this important contributor to the free society who nonetheless argued that noncommodity money could exist? However faulty the institutions were that contributed to the crisis and the ensuing bailout, their damage was surely exacerbated by the endless supply of liquidity that is justified when money is misdefined.
Franklin Raines
He came from a working-class family in Seattle and through political connections he became chairman of Fannie Mae in the 1990s. His expansion of the political misuse of his GSE greatly contributed to the housing bubble and the consequent downward pressure on housing prices today. Though he left Fannie in disgrace, he was given a compensation package worth tens of millions of dollars. Should we take solace in the fact that this money will be worth much less in upcoming years, in inflation-adjusted terms, thanks to the bailout?
Barney Frank
Frank is the Massachusetts congressman who muscled this bailout through the House, first when it failed and later when it passed. In his public statements last week, his message, over and over again, was that the economy is sick and dying, and needs the life support that only looting the taxpayers can provide. As Sheldon Richman noted in his excellent economics blog, Frank (and his confederates) "were choking the American people and while doing so, they picked the people's pockets and handed their money to Wall Street."
So that's my list, incomplete as it is. There are others who deserve mention. I'd be interested in hearing readers' additions to it, either through email or the link to this article at the Mises Institute's blog.
Financial turmoil
No end in sight
Upheaval in global markets as investors see no end to the financial crisis
AMID the uncertainty of the global financial crisis a pattern has emerged. First, the world’s central bankers and finance ministers construct bail-outs and rescue packages for teetering financial institutions. Then investors give their manoeuvres an emphatic thumbs-down. The pattern is becoming ever more pronounced.
In Europe, an unseemly mishmash of bank rescues and a scramble across the continent to beef-up national deposit-protection schemes have done nothing to solve the paralysis in money markets. Stockmarkets steadied themselves a little, early on Tuesday October 7th, after a series of dramatic falls on Monday. But the overnight dollar London interbank offered rate (LIBOR), the rate that banks are charged for borrowing from each other and other investors, climbed by a heart-stopping 157 basis points to 3.94%.
European Union leaders continue to issue reassuring statements promising that governments will take “whatever measures are necessary” to prop up the financial system. Such blandishments ring increasingly hollow. Germany was forced to rescue Hypo Real Estate, a big property lender and financier of local governments, on Sunday, for the second time. And the stumbling rescue of Fortis continued as Belgium’s government took over the remaining Belgian bits and sold a stake in them to BNP Paribas, a large French bank.
As a result full-scale recapitalisation of the sector is edging ever closer. Iceland was forced to take control of Landsbanki, its second-largest bank, on Tuesday. In Britain shares of some of the biggest retail banks fell precipitously after reports emerged of talks over a huge recapitalisation from the government in return for equity stakes. Royal Bank of Scotland was one of the worst hit, with its shares down by some 30%.
Further action is also needed across the Atlantic. The passage of the TARP, a much-trumpeted $700 billion bail-out package, did not stop the Dow Jones Industrial Average dropping below 10,000 points for the first time in four years on Monday, after losing 3.6% on the day.
America’s Federal Reserve is now said to be considering its own plan to take a flame to frozen interbank lending markets, and tackle the equally pressing problem of a shrinking commercial-paper market that could choke off funds to businesses. On top of further efforts to pump liquidity into the banking system, it might begin unsecured lending to banks and businesses, something that central banks rarely attempt and that the Fed has never tried before.
The Fed and other central banks may also turn to another weapon they have so far held in reserve—a co-ordinated cut in interest rates. On Tuesday Australia announced a cut in rates and expectations have grown that the Bank of England will also cut rates at a scheduled meeting on Thursday. Others may yet follow suit at unscheduled meetings. As the scale of the crisis deepens, the authorities know that they have to get the next round of interventions right.
Markets mixed in volatile trade
 London shares have been volatile throughout Tuesday trading. |
World stock markets were mixed in volatile Tuesday trading with investors continuing to worry over the strength of financial institutions.
London's FTSE 100 index rallied despite banking shares taking a hammering. Royal Bank of Scotland - which lost 40% at one point - was down 35%.
Having shed 7.8% in the previous session, the key London index was up 1.5%. France's Cac 40 index added 2%.
In early US trading the Dow Jones index added 0.6%, but the Nasdaq fell back.
Earlier, Asian markets were mixed as traders reacted to the turmoil.
Japan's Nikkei 225 index sank more than 5% - below the 10,000-point barrier - before recovering slightly to close down 3%.
However, Australia's financial markets rallied after the country's central bank cut its official interest rate from 7% to 6%.
'Recession arrived'
 |  A shortage of capital is a big issue for banks...but the really big issue is the breakdown of wholesale markets  Robert Peston BBC business editor  |
The market moves came amid developments including:
- The US Federal Reserve announced plans to buy massive amounts of short-term debt from companies in an effort to unfreeze the money markets
- The Icelandic government took control of the country's second biggest bank, Landsbanki, which owns UK internet bank Icesave
- European Union finance ministers agreed to increase the guarantee for customers' bank savings accounts to at least 50,000 euros
- Taiwan became the latest country to say that it would fully protect depositors' savings should a bank fail
- The British Chamber of Commerce said that the UK was already in recession
- The BBC's business editor Robert Peston learned that a trio of leading UK banks had met with Chancellor Alistair Darling and told him they were disappointed he had not presented a fully elaborated banking rescue plan
- Australia's central bank trimmed interest rates from 7% to 6% - despite inflation being well ahead of government targets
- Moscow's two main stock exchanges opened several hours late on Tuesday having had suffered heavy losses on Monday.
In a choppy day in London, the FTSE 100 index was up 66.8 points at 4,656 after some of its early gains evaporated.
Its 391-point drop on Monday had already wiped £93bn from the value of London's leading shares.
France's Cac-40 index, which lost more than 9% in the previous session, surrendered some of its early gains, but was 70 points ahead at 3,781, while Germany's Dax index added 1.7% to 5,478 points.
On Wall Street, the Dow Jones , which had lost 370 point son Monday, was slightly higher at 9,964.
Earlier, The Nikkei index lost 317.2 points to end at 10,155, while Hong Kong's Hang Seng ended 5% lower.
Oct. 7 (Bloomberg) -- U.S. Securities and Exchange Commission Chairman Christopher Cox's regulators stood by as shrinking capital ratios and growing subprime holdings led to the collapse of Bear Stearns Cos., according to an unedited version of a study by the agency's inspector general.
The report by Inspector General H. David Kotz was requested by Senator Charles Grassley to examine the role of regulators prior to the firm's collapse in March. Before it was released to the public on Sept. 26, Kotz deleted 136 references, many detailing SEC memos, meetings or comments, at the request of the agency's Division of Trading and Markets that oversees investment banks.
``People can judge for themselves, but it sure looks like the SEC didn't want the public to know about the red flags it apparently ignored in allowing Bear Stearns and other investment banks to engage in excessively risky behavior,'' Grassley said in an e-mailed statement.
An unedited version of the 137-page study posted to the Iowa Republican's Web site Sept. 26 showed that Bear Stearns traders used pricing models for mortgage securities that ``rarely mentioned'' default risk.
The firm lost one of its top modelers ``precisely when the subprime crisis was beginning to hit'' and writedowns were being taken, the full report said. ``As a result, mortgage modeling by risk managers floundered for many months,'' according to the unedited document, quoting internal SEC memos from April and December 2007. The comments were removed from the edited version publicly released by the SEC.
Trading and Markets had oversight of holding companies for the five biggest U.S. investment banks via the Consolidated Supervised Entity Program. The division failed to follow up on ``red flags'' raised by New York-based Bear Stearns's increasingly ``significant concentration of market risk'' from mortgage securities, according to the full document.
`Failed' Mission
The SEC, which governed the firm along with the Financial Industry Regulatory Authority, ``failed to carry out its mission in the oversight of Bear Stearns,'' the agency said in both versions of the report. The Federal Reserve will provide $29 billion in financing for JPMorgan Chase & Co.'s March 14 takeover of the investment bank after the government said it stepped in to prevent panic.
The agency censored the report because ``the requests from the Division of Trading and Markets covered non-public information,'' said SEC spokesman John Nester. The information ``was contained in non-public memoranda and documents.''
JPMorgan spokesman Brian Marchiony declined to comment.
A footnote in the uncensored version of the report quotes Bear Stearns Chief Executive Alan Schwartz as saying he hadn't held ``terribly current discussions'' to raise capital for his firm even after the SEC asked in March, two weeks before it failed, about obtaining funds.
No Help
While Bear had retained Lazard Ltd. as an adviser, the report quoted Schwartz saying, ```The time it would take to get that done, it wouldn't help.''' The CEO said rumors would cause more damage in the meantime, according to the SEC.
Schwartz didn't return a phone call for comment.
The SEC took no action even as Bear Stearns provided more collateral to lenders as they lost trust in the 85-year-old firm, the unedited report said.
Ratio Drop
The agency removed a section of the publicly distributed report showing that the Division of Trading and Markets knew Bear Stearns's capital ratio had dropped to 11.5 percent in March from as high as 21.4 percent in April 2006. The ratio measures assets, adjusted for risk, relative to a firm's equity. Ten percent is the minimum standard under international banking regulations.
Regulators from the unit ``inquired whether Bear Stearns was contemplating capital infusions,'' even though they didn't formally or informally pressure the firm to do so, according to the unedited version.
Under the voluntary Consolidated Supervised Entity Program, the SEC couldn't force the firm to raise capital.
The CSE ``was fundamentally flawed from the beginning, because investment banks could opt in or out of supervision voluntarily,'' Cox said on Sept. 26 in announcing the program's shutdown.
``This chain of events raises very significant questions about the supervision of all types of financial institutions, not just investment banks,'' said a written response to the inspector general's report from the Trading and Markets unit, headed by former agency chief economist Erik Sirri.
``With respect to Bear Stearns, the staff applied the relevant international standards for holding-company capital adequacy in a conservative manner,'' the unit said.
`Run on the Bank'
The staff ``added a holding-company liquidity requirement; and yet, they couldn't withstand a `run on the bank,''' the response said.
Kotz, the inspector general, declined to comment, as did Cox.
Bear Stearns was able to ``create capital'' by inflating the value of assets including mortgages, according to the unedited study. Two days before it was rescued, the firm paid out $1.1 billion to ``numerous counterparties to squelch rumors'' it couldn't meet its margin calls, the full report said. The finding didn't appear in the censored version.
`Generous Marks'
The firm ``tended to use the traders' more generous marks for profit and loss purposes,'' it said.
Trading and Markets unit members saw that Bear Stearns traders dominated less-experienced risk managers, the inspector general reported in sections that were excised from the public report.
``As trading performance remained strong for years in a row, it clearly wasn't career-enhancing to stand in the way of increasingly powerful trading units demanding more balance sheet and touting their state of the art risk-management models,'' said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York, and a former chief financial officer at Lehman Brothers Holdings Inc.
The Basel Committee on Supervision published revised guidelines in 2004 that allowed global financial institutions to ``rely on their own internal estimates of risk components'' to help determine the amount of capital they needed.
By censoring the report, ``the SEC didn't do well by the public and the inspector general didn't do well by the public,'' said Tom Cardamone, managing director of the Washington-based Global Financial Integrity Program. ``The buck has to stop someplace. Joe Main Street has to rely on the professionalism of the people doing the job.''
Oct. 7 (Bloomberg) -- U.S. overnight corporate borrowing costs fell as the Federal Reserve invoked emergency powers to create a special fund to backstop the commercial paper market. Seven-day rates soared to the highest since January.
Yields on top-rated overnight U.S. commercial paper dropped 0.74 percentage point to 2.94 percent, according to data compiled by Bloomberg. Borrowing for seven days increased 1.25 percentage point to 4 percent.
Fed Chairman Ben Bernanke is seeking to end the seizure in credit markets that has spread around the globe and ensnared corporate borrowers. Overnight rates soared to an eight-month high of 3.95 percent last week, from 2.08 percent less than a month ago, curbing companies' ability to finance their day-to- day activities. Companies struggled to issue since Lehman Brothers Holdings Inc. filed for bankruptcy Sept. 15 and money- market funds, the biggest buyers of commercial paper, abandoned the market.
``The linchpin seems to be commercial paper,'' said John Silvia, chief economist at Wachovia Corp., in an interview on Bloomberg Television. Lehman was a ``key cog in that commercial paper trading. Once they went out, there really was a great loss of confidence.''
The Fed will lend against a special purpose vehicle at the targeted federal funds rate. The unit will purchase from eligible issuers three-month dollar-denominated commercial paper at a spread over the three-month overnight-indexed swap rate, according to a Statement in Washington today.
Bernanke is scheduled to speak on the economic outlook starting at 12:30 p.m. in Washington today.
Market Shrinks
``What that allows is that other businesses can pick up some reserves, some cash and therefore there's more liquidity in the system,'' Wachovia's Silvia said. He said the world's central banks may coordinate a series of rate cuts as soon as today.
The market for commercial paper, which matures in nine months or less and is used by companies from General Electric Capital Corp. to Microsoft Corp. to pay for daily expenses, plunged last week by the most since at least 2000. The debt outstanding fell $94.9 billion, or 5.6 percent, to a seasonally adjusted three-year low of $1.6 trillion for the week ended Oct. 1, according to the Fed. Financial paper accounted for most of the decline, dropping $64.9 billion, or 8.7 percent, to a two- year low as money-market funds stopped buying.
GE Capital was offering 1.95 percent to borrow overnight, up from 1 percent yesterday, according to Bloomberg data.
`Fear Itself'
Bill Gross, manager of the world's biggest bond fund at Newport Beach, California-based Pacific Investment Management Co., said the Fed should step in to directly buy commercial paper.
``We are to the point of fearing fear itself,'' Gross wrote in a note to clients yesterday. ``The Federal Reserve must now act as a clearing house'' for banks and ``must also take another bold step: outright purchases of commercial paper.''
Efforts to free up lending, including the passage of a $700 billion plan to rescue banks and injections of more than $1 trillion into the global financial system, have failed. The world economy has already fallen into its first recession since 2001, according to JPMorgan Chase & Co. economists Bruce Kasman and David Hensley, and the slump may deepen if the credit freeze persists.
Libor Rises
The cost of borrowing in dollars overnight in London jumped as U.K. lenders held talks with the government on emergency funding and Iceland began talks for a loan from Russia, pegged the krona to a trade-weighted index and nationalized its second- biggest bank.
The London interbank offered rate, or Libor, that banks charge each other for such loans rose 157 basis points to 3.94 percent today, the British Bankers' Association said. The corresponding rate for euros climbed 22 basis points to 4.27 percent, the highest in four days. The Tokyo interbank rate stayed at the highest level this year and the Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record.
Prime money-market funds have pulled $200.3 billion of assets from commercial paper since Sept. 16, the day after Lehman filed for the biggest bankruptcy ever, and built up their safer government debt holdings instead, according to IMarketNet.
Issuance of commercial paper due in one to four days has averaged $145.3 billion a day since Sept. 15, compared with $87.7 billion a day in August, Fed data show. Sales of the debt due in more than that has averaged $31.2 billion a day, compared with $45.5 billion in August and $53.8 billion in 2007.
After falling to $21.3 billion on Sept. 29, longer-term lending has since increased to $44.4 billion on Oct. 3, according to Fed data.
Oct. 7 (Bloomberg) -- The Federal Reserve will create a special fund to purchase U.S. commercial paper after the credit crunch threatened to cut off a key source of funding for corporations.
The Treasury will make a deposit with the Fed's New York district bank to help set up the special purpose vehicle. The central bank will also lend to the program at policy makers' target rate for overnight loans between banks. The Fed Board invoked emergency powers to set up the unit, the central bank said in a statement released in Washington.
Today's action follows a slide in the commercial-paper market to a three-year low of $1.6 trillion last week as investors fled even companies with few links to the subprime mortgage crisis. Companies from newspaper firm Gannett Co. to electricity producer Southern Co. have been forced to tap credit lines or forego raising debt because of the market's disruption.
The Fed didn't say how much commercial paper, which hundreds of companies use to finance payrolls and meet other cash needs, it plans to purchase.
Stocks climbed and Treasuries sank after the Fed's announcement. Futures on the Standard & Poor's 500 Stock Index gained 1.9 percent to 1,073.60 at 9:15 a.m. in New York. Yields on benchmark 10-year notes climbed to 3.55 percent from 3.45 percent late yesterday.
Bernanke Speech
Today's announcement came hours before Fed Chairman Ben S. Bernanke speaks on the economic outlook at 1:15 p.m. in Washington. He and Treasury Secretary Henry Paulson held discussions yesterday as stock markets slid and money market rates climbed as the crisis deepened.
The Fed's new unit will buy three-month dollar-denominated commercial paper at a spread over the three-month overnight- indexed swap rate, which is a measure of traders' expectations for the Fed's benchmark rate.
Commercial paper purchased by the vehicle must be rated at least A1/P1/F1, the Fed said. Issuers will pay the unit an upfront fee based on the commercial paper initially sold to the vehicle. The vehicle will cease buying commercial paper on April 30, 2009, unless the Board of Governors agrees to extend it.
The Fed yesterday said it will double its cash auctions to banks to as much as $900 billion, and telegraphed today's announcement by saying it was looking for other ways to alleviate liquidity strains.
Monday, October 6, 2008
European Disunion
FROM TODAY'S WALL STREET JOURNAL EUROPE
Europe's leaders just committed a blunder known in the literary world as "Chekhov's Gun." The Russian playwright would put a rifle on stage only if someone was going to fire it. Translated into politics this means, don't convene a summit on the financial crisis unless you are going to agree on a solid plan.
Instead of reassuring markets that the European Union is united, the message from the weekend meeting in Paris was: Every country for itself. "Each government will act in its own way, but will have to coordinate with others," French President Nicolas Sarkozy told reporters.
The current panic goes well beyond Europe's shores, just as the credit mania that preceded it was global in nature. The plunge in stock markets world-wide yesterday, as well as in commodity prices, indicates that investors believe the credit and banking crisis is spreading to real economies. Europe and the U.S. are probably falling into recession, and Japan is already there. For all the talk about continued strength in China and India, those economies will be hard-pressed to keep the global economy going if the big three of America, Europe and Japan are stalled.
The ink on Saturday's nondeal wasn't even dry when Berlin violated even that vague promise of coordination. Following Ireland's move last week to secure all deposits, bonds, senior debt and lower Tier-II debt for its six biggest banks, Germany upped the ante Sunday night when it decided to guarantee all private deposits.
British media report that British Prime Minister Gordon Brown is furious that Chancellor Angela Merkel apparently gave no indication the day before that she was planning anything like this. Dublin's beggar-thy-neighbor move had already put pressure on London to follow suit as British savers flooded the supposedly safer shores of Ireland. The U.K. Friday raised its deposit insurance to £50,000 from £35,000, and Berlin's move may force London to raise the stakes again in Europe's bailout poker. If new limits were going to be introduced, a unified announcement would have been much more effective in staving off a European bank run.
Let's hope depositors won't call their leaders' bluff. Deposit insurance is designed to prevent bank runs from occurring in the first place. To do that, they have to be credible and therefore limited. Berlin's step secures more than €1 trillion of savings, equivalent to around half of its GDP. By guaranteeing such astronomical sums, Berlin may cause more panic, not less, if savers conclude that the insurance can't be upheld -- at least not without ruining public finances for generations.
Also on Sunday night -- the late hours just before Asia's market opening have become the preferred time for European rescue deals -- Berlin had to resuscitate a bailout plan for Hypo Real Estate. A consortium of private banks had stepped back from the original €35 billion deal; Berlin's arm-twisting got them back on board with a new €50 billion credit line.
Hypo's troubles show that Europe's ad hoc bailouts aren't working as smoothly as originally hoped. The Fortis bank rescue negotiated 10 days ago between the Benelux governments almost came undone, too, when the Dutch decided to take over all of Fortis's operations in the Netherlands. That forced Belgium to quickly find a solution for its stake. Early yesterday, BNP Paribas agreed to take control of Fortis's operations in Belgium and Luxembourg in a €14.5 billion cash-and-shares transaction.
The developments with Fortis show that public intervention can open the doors for private capital to follow, which is the preferred solution. But the Dutch move could have left the Belgians standing in the rain. If even The Hague and Brussels, with decades of experience with cooperation, can't rely on each other, how much hope is there that other capitals will be able to quickly save a bank with cross-border operations?
Europe would fare better with a more comprehensive approach. That doesn't mean copying the Paulson plan. Ideally, a Continental resolution authority with enough money would help recapitalize the banks. Such funding is crucial as the financials of European banks are even more overleveraged than their U.S. competitors. Though BNP stepped up in the Fortis case, it's more likely that public capital will be needed as long as much private money is heading for the exits.
Cooperation makes sense, too, because national solutions may outstrip any one government's resources. Non-EU member Iceland is the most urgent case. Reykjavik is struggling to rescue its banks, whose assets dwarf the island's GDP.
German Finance Minister Peer Steinbrück acknowledged late yesterday that "at some point individual solutions are no longer enough." He said Berlin was looking at putting up an "umbrella for Germany as a whole." That at least has the ring of a more comprehensive national approach, even if the details are still unclear.
The reason the money markets have seized is that banks don't trust each other. The reason Europe struggles to find a systemic solution to this crisis is that governments don't trust each other. This is a poor record for the EU 51 years after its founding, one that may cost it dearly.
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