German Bailout of Hypo; Growing European Crisis

123jump.com Staff
06 Oct, 2008
New York City

European leaders struggle to formulate a regional response to a growing banking crisis. Germany was forced to bailout the second largest real estate lender Hypo Real Estate Holding. Unicredit in Italy offered 6.6 billion euro recapitalization plan. Fortis was seized in Holland.

[R]2:30AM New York – The European leaders struggle to bail out banks as the U.S. sparked banking crisis spreads in the region.[/R]

The American banking crisis has now spread to the Europe and leaders of the nation are struggling to find a common solution.

Germany agreed to offer 50 billion euros to the second largest real estate lender Hypo Real Estate Holding AG and Fortis was nationalized by Holland; Fortis Belgian and Luxembourg operations were sold. Germany and Denmark acted to guarantee bank deposits.

Leaders of Region Gather

On Saturday, the heads of nations failed to agree on a pan-European solution to the widening banking crisis but decided to work closely to save banks that are reeling under pressures of mounting losses. The leaders of Germany, France, Italy and UK gathered in a hastily arranged meeting in Paris along with European Commission President Jose Manuel Barroso and European Central Bank President Jean-Claude Trichet.

People across the Continent are angry at rich bankers who are now protected by the government action. German Chancellor Angela Merkel and Finance Minister Peeer Steinbrueck in an address on television promised to tighten regulation and stressed that people involved in the reckless lending “will be held responsible” and noted that “we owe it to the taxpayers.”

Banks in Europe for months have been suffering from the losses linked to the U.S. sub- prime mortgage loans. The Swiss based UBS and Credit Suisse have written down $55 billion in asset and two smaller banks in Germany have nearly collapsed before the government intervention. The UK based private mortgage lenders Bradford & Bingley and Northern Rock were nationalized. But, the European leaders until now had treated the crisis as the American crisis.

It was the emergency funding for Dexia and Forits crisis that spurred the leaders of European nations in action. Dexia, the largest Belgian bank needed 6.6 billion euros and Fortis was given emergency lending of 11.2 billion from the governments of Belgium, Netherlands and Holland at the end of last week. Fortis still fell apart after depositors removed more funds banks.

Blame Game

European leaders were forced to look for a common solution to a growing banking crisis which until now was seen as an American problem.

The European leaders until this weekend had blamed American policies and loose banking regulations for the current crisis. But the excessive risk taking in the region and weak management controls at banks and a lack of regional oversight by regulators also contributed to the widening crisis.

In the Paris meeting this weekend, leaders failed to endorse a regional plan but agreed to work together and look for a need to relax mark-to-market accounting rules. The rule forces banks to lower the asset values reflecting the current market conditions even though the assets are not likely to be sold in the immediate future.

Widening Crisis

On Friday, the Netherlands took over Fortis banking operations in the country and on late Sunday Belgium and Luxembourg governments assisted the transfer of bank’s operations to Paris based BNP Paribas SA. The BNP Paribas will acquire Fortis insurance operations and 75% of Fortis Bank Belgium for 8.25 billion euros.

On Sunday, Italy based Unicredit announced a recapitalization plan of 6.6 billion euro that includes 2008 dividend in stock and an issue of 3 billion euro of convertible debt.

On Sunday, Germany was forced to step in after the government supported 35 billion euros industry bailout plan for Hypo Real Estate collapsed. The Finance ministry was forced to support the lender with 50 billion euro guarantee.

The crisis in Europe quickly spread from UK to Germany, to Benelux countries and Italy, all in less than three days.

Banking Deregulation

European nations developed a common currency in the early nineties and let banks expand across their borders in the last fifteen years but failed to put additional regulatory infrastructure to monitor risk exposure. European Central Bank is responsible for setting interest rate and monetary policy but has no regulatory teeth to enforce lending standards on banks. The national central banks are responsible for the banking regulations in local countries and banks have very wide ranging priorities in promoting growth. The nationalistic feelings prevail in many cross border mergers that thwart agreements when large banks are involved.

But the emergence of cross border mega banks is a recent phenomenon that is still playing out in the last three years. Spain based Banco Santander, Italy based Unicredit, the UK based HSBC, and Germany based Deutsche Bank are some of the leading acquisitive banks that have expanded beyond their national borders and the Continent.

As recently as last year, the head of the central bank of Italy had said that banks in the country should consolidate to create few national champions that can rival with other emerging regional players. Roughly 700 banks are expected to disappear in the next five years from Europe as merger wave continues. After the fall of banking regulation in the U.S., in the next ten years nearly 26% of banks were consolidated according to a report from the accounting firm Deloitte Touche.

American Bailout

However, the latest bailout bill in the U.S. deeply unpopular. The U.S. Congress passed $700 billion bailout package that has been sold to Americans as the only available alternative to deal with the worst financial crisis since the Great Depression. The hastily enacted law is widely derided as a reward to the rich and reckless bankers who caused this crisis to begin with. The U.S. Treasury will have the authority to spend $250 billion to purchase and hold illiquid assets at a discount price and provide cash to banks so that they can increase commercial lending.

The passage of bill, as the Treasury Secretary Henry M. Paulson had said repeatedly will unlock credit markets and improve liquidity in the system, failed to lift confidence in the commercial paper market. On the contrary, interest rates in the short term loan market jumped to a new high not seen in the last seven years as crisis of confidence persisted.

Europe Extends Deposit Insurance Coverage

European leaders were forced to act after Ireland offered unlimited protection to bank deposits of six largest banks. That action forced the UK to increase the bank deposits coverage to £50,000 from £35,000. German Chancellor on Sunday offered to cover all deposits but it is not clear that it has the regulatory regime to make that happen. Before the recent changes in Europe, German deposits are covered by a group of banks and that too only 90% of the first 20,000 euros and the UK also had similar limitations on its deposit coverage.

While the U.S. has taken the approach of setting a large special fund to deal with growing national banking crisis, the European nations are still dealing with the emerging problem as it happens but are likely to coordinate more closely.