Ambrose Evans-Pritchard says it is ironic that European banks have turned out to be deeper in debt than their US counterparts.
It took a weekend to shatter the complacency of German finance minister Peer Steinbrück. Last Thursday he told us that the financial crisis was an “American problem”, the fruit of Anglo-Saxon greed and inept regulation that would cost the United States its “superpower status”. Pleas from US Treasury Secretary Hank Paulson for a joint US-European rescue plan to halt the downward spiral were rebuffed as unnecessary.
By Monday, Mr Steinbrück was having to orchestrate Germany’s biggest bank bail-out, putting together a €35 billion loan package to save Hypo Real Estate. By then Europe was “staring into the abyss,” he admitted. Belgium faced worse. It had to nationalise Fortis (with Dutch help), a 300-year-old bastion of Flemish finance, followed a day later by a bail-out for Dexia (with French help).
Within hours they were all trumped by Dublin. The Irish government issued a blanket guarantee of the deposits and debts of its six largest lenders in the most radical bank bail-out since the Scandinavian rescues in the early 1990s. Then France upped the ante with a €300 billion pan-European lifeboat for the banks. The drama has exposed Europe’s dark secret for all to see. EU banks took on even more debt leverage than their US counterparts, despite the tirades against ”le capitalisme sauvage” of the Anglo-Saxons.
We now know that it was French finance minister Christine Lagarde who begged Mr Paulson to save the US insurer AIG last week. AIG had written $300 billion in credit protection for European banks, admitting that it was for “regulatory capital relief rather than risk mitigation”. In other words, it was underpinning a disguised extension of credit leverage. Its collapse would have set off a lending crunch across Europe as banking capital sank below water level.
It turns out that European regulators have allowed even greater use of “off-books” chicanery than the Americans. Mr Paulson may have saved Europe.
Most eyes are still on Washington, but the core danger is shifting across the Atlantic. Germany and Italy have been contracting since the spring, with France close behind. They are sliding into a deeper downturn than the US.
The interest spreads on Italian 10-year bonds have jumped to 92 points above German Bunds, a post-EMU high. These spreads are the most closely watched stress barometer for Europe’s monetary union. Traders are starting to “price in” an appreciable risk that EMU will break apart.
The European Commission’s top economists warned the politicians in the 1990s that the euro might not survive a crisis, at least in its current form. There is no EU treasury or debt union to back it up. The one-size-fits-all regime of interest rates caters badly to the different needs of Club Med and the German bloc.
The euro fathers did not dispute this. But they saw EMU as an instrument to force the pace of political union. They welcomed the idea of a “beneficial crisis”. As ex-Commission chief Romano Prodi remarked, it would allow Brussels to break taboos and accelerate the move to a full-fledged EU economic government.
As events now unfold with vertiginous speed, we may find that it destroys the European Union instead. Spain is on the cusp of depression (I use the word to mean a systemic rupture). Unemployment has risen from 8.3 to 11.3 per cent in a year as the property market implodes. Yet the cost of borrowing (Euribor) is going up. You can imagine how the Spanish felt when German-led hawks pushed the European Central Bank into raising interest rates in July.
This may go down as the greatest monetary error of the post-war era. The ECB responded to the external shock of an oil and food spike with anti-inflation overkill, compounding the onset of an accelerating debt deflation that poses a greater danger. Has it committed the classic mistake of central banks, fighting the last war (1970s) instead of the last war but one (1930s)?
After years of acquiescence, the markets have started to ask whether the euro zone has the machinery to launch a Paulson-style rescue in a fast-moving crisis. Who has the authority to take charge? The ECB is not allowed to bail out countries under EU treaty law. The Stability Pact bans the sort of fiscal blitz that has kept America afloat. Yes, treaties can be ignored. But as we are learning, a banking system can implode in less time than it would take for EU ministers to congregate from the far corners of euroland.
France’s Christine Lagarde called yesterday for an EU emergency fund. “What happens if a smaller EU country faces the threat of a bank going bankrupt? Perhaps the country doesn’t have the means to save the institution. The question of a European safety net arises,” she said.
The storyline is evolving much as eurosceptics predicted, yet the final chapter could end either way as the recriminations fly. Germany has already shot down the French idea. The nationalists are digging in their heels in Berlin and Madrid. We are fast approaching the moment when events decide whether Europe will bind together to save monetary union, or fracture into angry camps. Will the Teutons bail out Club Med? If not, check those serial numbers on your euro notes for the country of issue. It may start to matter.