Bankrupt Belgian Bank Dexia Is Nationalised, After Passing “Stress Test” Just a Few Months Ago – Need To Inject Hundreds of Billions In Other European Banks – EU Policy-Makers Still Unwilling To Take Big Steps – Britain Only Case Of New Fiscal Course
By Paolo von Schirach
October 9, 2011
WASHINGTON – Dexia, Belgium’s biggest bank, just went under. The French and Belgian governments hastily decided to nationalize it in order to avoid possible “contagion”, this way limiting the damage to the European financial system. But how did this big failure happen? Remember that just a few months ago European banking authorities conducted a “stress test” on all the major banks in order to verify that their affairs were in order and that they could withstand major market tremors and possible new crises. Almost all of them, including Dexia, did very well. So, sigh of relief and congratulations to savvy manager who kept thing in good order, while building solid reserves able to withstand unforeseen events that might originate in Greece or elsewhere.
Stress test not for real
Well, not quite. Even then, US and other financial industry experts commented that the European banks stress test did not test much of anything. Therefore it was meaningless and in fact misleading, implying a degree of health that was most probably overstated.
IMF Lagarde Jackson Hole warnings
Later on, at the end of August, Christine Lagarde, former French Finance Minister and now Head of the International Monetary Fund in Washington, DC, was chastised for strongly advocating in a public address at the annual Jackson Hole meeting of world financial leaders stronger capitalization for European banks. Her fellow Europeans loudly complained because her stern warning/advice implied that the European banks –that had just passed the stress test– in truth were not strong enough. In their view, with her unwise public comments, Lagarde undermined confidence in the solidity of the European banking system. Well, it turns out that Lagarde who, as former French Finance Minister, probably knows a thing or two about the real solidity of European banks, was right.
Dexia had bad debt, other European banks also in bad shape
And so, here we are now with Dexia, after having passed the stress test, nationalized in a hurry. And what is Dexia’s problem? A lot of credits that may not be recoverable, including about 20 billion euros worth of Greek Government bonds, and other questionable sovereign bonds within a package of about 700 billion loans made here and there.
Chancellor Angela Merkel of Germany and French President Nicolas Sarkozy met on Sunday October 9 to reassure the rest of Europe and world markets that the situation is under control. Still, they conceded that other European banks would need billions of euros in additional capital injections to stabilize them.
So, guess what, it turns out that the critics of the stress test were right and that Lagarde’s warnings about the need to re-capitalize Europan banks were totally appropriate.
Time for bold action in Europe?
Alright, what do we make of all this? Nothing good. The Europeans know that there is a deep credibility crisis affecting both the finances of many states and the banking systems that support them by buying bonds an extending other credits. They know all this. But, amazingly, notwithstanding the failure to stabilize Greece via liquidity injections, the prevailing attitude is still to delay, to minimize, to propose stop gap measures and to keep kicking the can down the road. The problem with this attitude –as savvy financier Warren Buffett said in a recent interview– is that the road in Europe has ended. You cannot kick the can any further. In plain language: this would be the time for bold action.
America resorted to unprecedented policies in 2008
By comparison, when America was about to be swallowed by the 2008 financial disaster, the US Government and the Federal Reserve went into overdrive. May be they did not do everything right, but they put in place, in a hurry, unprecedented measures. Via TARP, (Troubled Assets Relief Program), they essentially took over major banks, and other institutions like insurer AIG, by injecting hundreds of billions of dollars in them, this way preventing collapse. The policies initiated at the end of the Bush mandate were continued in 2009 by Secretary of the Treasury Tim Geithner in the new Obama administration.
The Federal Deposit Insurance Corporation, FDIC, extended its standard guarantee on all deposits, making sure that depositors would know that, whatever might have happened to their banks, their savings were safe. Later on, as the crisis unfolded, The FDIC took over a large number of small and medium failed banks, at great cost, no doubt, but in an orderly fashion, without creating market panic. As a result, the re-emerged slimmed down US banking sector, while not great, is definitely in far better shape.
Europe still in denial
But in Europe, as things stand, there is not even the honesty to fully admit the magnitude of the problem. Stress tests that test nothing. Banks that disguise bad assets until they can. At the same time the Governments that caused all this disaster by hoping to borrow more and for ever for public expenditures that they know they could not and cannot afford have yet to say that the whole model was and is flawed and that they should change course.
Britain is the exception
The only major European power that said so and has done something about it is Great Britain. It took the Conservative-Liberal Democratic coalition a couple of weeks after the elections to come up with a total reformulation of public spending that amounts to a clear repudiation of the previous Labor Government profligacy. Britain is not in the Euro, but it is in Europe. sure enough, new fiscal course notwithstanding, it is going to be a long and hard road to recovery with an economy that is still sputtering. But Britain’s bonds are solid and nobody questions UK solvency.
End of the road
Could anybody in Continental Europe take notice and perhaps follow London’s lead? This is no joke. The core issue at the root of all this mess is that the statist, ultra-expensive welfare state model is flawed. It is time to ditch it and start fresh. As Warren Buffett said, European policy-makers cannot kick the can down this road anymore. There is no more road.Print This Post