What central banks did not do and did create the conditions for collapse
The political and economic class in Europe is under the illusion that the financial crises in the United States have almost nothing to do with it.
They are refuted every time.
Eurozone banks have so far managed to shake off the contagion from falling dominoes among US regional banks, which now face the triple whammy of deposit flight, commercial real estate contraction and portfolio loss from US debt holdings.
There is a great deal of enthusiasm for complacency in EU political circles, where it is believed that tougher European regulations have suppressed the problem.
One cannot but answer: Thank God for that.
If something goes wrong – and there is a strong possibility that it will, given the rapid contraction in the money supply – the eurozone still lacks the mechanisms to contain a banking crisis.
EU authorities do not have the legal authority to implement the kind of bailout measures that the US Treasury, Federal Reserve and Federal Deposit Insurance Corporation have devised and are working in concert with.
This is not to say that Washington has done a good job.
The US has inadvertently invited a broader downward spiral by insisting that the banks must be taken over and shareholders and bondholders eliminated before a subsidized purchase can take place.
It is now much more difficult for any bank that is having difficulties in raising capital or finding a buyer.
Who exactly is responsible for bailing out the banks in the eurozone and under what legal terms?
The Bank’s Recovery and Resolution Directive (BRRD) does not allow national governments to bail out uninsured depositors in the event of a crisis.
There is no equivalent clause to the US “systemic risk” exemption clause, which (briefly) limited transmission after the collapse of the Silicon Valley bank.
BRRD is simply… breakfast.
Its purpose is to ensure that taxpayers are never in a position to bail out banks again.
Instead, what it does is guarantee doom.
The terms are so harsh and contradictory that many European banks have not been able to meet the “bailout” limit without having to confiscate the deposits of ordinary savers (as happened in Cyprus).
The deeper point is that the eurozone never completed its long-promised banking union.
There is no joint deposit insurance for banks yet.
The infamous death loop from 2011-2012 continues.
Each country is still responsible for bailing out its own banks, though it can’t print its own money or set its own interest rates, it no longer has its own lender of last resort – and though it has no way of preventing risky inflows of speculative capital (as it happened in Spain).
The banking crisis still threatens to drag any heavily indebted eurozone country down with it.
The deeper point is that Germany, the Netherlands and the creditor nations of the North still refuse to accept fiscal union and the perpetual issuance of joint debt, on the reasonable grounds that to do so would undermine taxation and consumer sovereignty parliaments.
Nor do they want to share their credit card with the heavily indebted and unreformed economies of the South.
This leaves the cluster vulnerable to “spreading” drama every time a problem hits.
Weakness of the European Central Bank
The European Central Bank is at a disadvantage, which is partly what it created.
Core inflation is stuck at 5.6 basis points after rising for several months, but the eurozone economy has stumbled and is almost in recession.
Bank lending is shrinking.
The ECB’s latest survey of bank lending says banks are tightening net lending standards at the fastest pace since the eurozone debt crisis, which would have dire consequences for an economy with rudimentary capital markets that still relies on bank lending for 93% of total credits.
The risk of a full blown credit crunch is growing day by day.
The Board sees inflation as the most immediate threat.
Not only did it raise interest rates by a quarter point on Thursday and bemoaned that two more would follow, but it also said it would double the pace of quantitative tightening, accelerating the decline of broad M3 money.
It removes crucial support for the weakest banks in Italy and Spain.
Nor have any steps been taken to soften the blow, with €1.2 billion in emergency low-cost loans (TLTRO) coming due in tranches.
About 470 billion euros must be returned to the European Central Bank next month.
“We think this was unwise given the global banking pressure,” said Krishna Guha of Evercore ISI.
The Bank of Italy’s Financial Stability Report warned last week that “slightly less than half of Italian banks do not have sufficient reserves to repay TLTROs in the coming quarters.”
They can find other sources of financing, but only at much higher borrowing costs, which affects their operating margins.
In the coming months, we will find out whether this monetary tightening is, at this point, a blunder akin to the ECB’s excessive policy in 2008, when the global financial crisis was approaching – and again in 2011, when Italian and Spanish bonds were. The markets were collapsing.
On paper, European banks are healthy.
Non-performing loans fell to 2%.
Total Common Equity Tier 1 (CET1) is safe at 15.27% and the Liquidity Coverage Ratio is ample at 161%.
But Credit Suisse also had strong security reserves.
This did not stop the death by flight of deposits.
European banks face the same threat as US banks.
The difference is that the stress cycle started several months later and will affect it later.
They are also incurring significant losses from the bond portfolios they acquired when interest rates were -0.50% and most European government bonds were trading at negative yields.
The European Banking Authority has ordered an investigation into these “interest rate risks”, but has not yet told us the extent of these losses.
real estate market
Eurozone banks are more at risk of a commercial real estate bubble than their US counterparts, as less risk is passed on to others in bundles of mortgage-backed securities.
In addition, they finance the mortgages directly and hold €4.1 trillion of it on their books.
The income they receive from the old mortgages is dwarfed by the interest they now have to pay to attract deposits.
What banks on both sides of the Atlantic have in common is that they have been victims of collective mismanagement by regulators and central banks in charge of the financial system.
Jacques de La Rozière, former governor of the Banque de France and former head of the International Monetary Fund, launched a catapult for the Forum of Official Monetary and Financial Institutions.
He accuses the same authorities of undermining the private banking system with crippling amounts of quantitative easing long after it became economically toxic.
“Central banks, who do not encourage stability, have made a master class on how to regulate a financial crisis.
“It reminds me of Goethe’s classic story of a magician’s apprentice, whose clumsy use of magical powers produces an uncontrollable course of destruction,” he said.
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