THE CREDIT CRUNCH

Banking Crisis Leaves Europeans with Bill in the Billions

This week Europe has fallen deeper into the credit crunch. With multi-billion euro bailout packages, Germany, Britain and the Benelux states have saved banks from collapsing.

Hypo Real Estate, Fortis, Bradford & Bingley. Three European banks nearly collapsed in the course of just two days on Sunday and Monday, showing that the Wall Street financial crisis is pulling European companies into its pincers at an ever-faster clip. With trust between banks waning, analysts believe Europe is threatened with a serious credit crunch.

AFP
The logos of Europe's crisis banks: The crisis is accelerating here and pulling an increasing number of institutions into its pincers.In order to protect the financial system from collapse, governments across Europe are being forced to intervene. Britain, Germany, Belgium, Luxembourg and the Netherlands all began spectacular rescues at the start of the week:
the British government nationalized large parts of mortgage lender Bradford & Bingley on Monday, taking over some €63 billion ($90.6 billion) in bad loans;
the governments of Belgium, Luxembourg and the Netherlands nationalized large parts of wobbling finance giant Fortis; in Germany, the government is providing a massive loan package together with a consortium of banks to prevent the collapse of the Munich-based Hypo Real Estate.

The latest wave of bad news indicates the crisis could hit Germany and Europe harder than politicians previously believed. "The effects of the financial crisis in Germany will be greater than initially expected," Dagmar Wöhrl, a senior official in the German Finance Ministry told SPIEGEL ONLINE.

The budget committee of Germany's federal parliament, the Bundestag, is expected to address the financial market crisis in a special meeting on Tuesday afternoon. SPIEGEL ONLINE has learned from sources close to the committee that Finance Minister Peer Steinbrück, as well as Axel Weber, president of Germany's central bank, the Bundesbank, and Jochen Sanio, president of German financial services regulator BaFin, have been asked to attend.

The most important item on the agenda at what is expected to be a closed-door meeting is state guarantees being used to bailout Hypo Real Estate. Inside sources say up to €35 billion is needed for the rescue operation. The Finance Ministry says the state guarantees will be comprised of two parts. A consortium of banks will assume responsibility for 60 percent of the first part of the bailout, which will total €14 billion, and the state will provide 40 percent. The second part of the bailout will be comprised of a €21 billion guarantee provided solely by the government.
Without the government guarantee, Hypo Real Estate would be unable to pull together the money it needs to recapitalize itself. But if it is unable to pay back the loans, taxpayers will be stuck with the costs.

Further German Banks Threatened
It's also possible that Hypo Real Estate's near bankruptcy will not remain an isolated case for long. Hans-Peter Burghof, a banking professor at Germany's University of Hohenheim, warned that the crisis could quickly spread to other banks. "If you look at the current mechanisms, the crisis is still accelerating and its effects are increasingly being felt in Europe and Germany," he said. His colleague Thomas Hartmann-Wendels, a banking expert at the University of Cologne, also spoke of "numerous factors" that are spurring the crisis in Europe.
European and German private banks are being forced to write-off billions of euros in from securities portfolios linked to the US subprime crisis.
European banks also provided bankrupt Lehman Brothers with credit that, for now at least, is lost.

Through the collapse of numerous financial institutions, an atmosphere of mistrust has emerged in the money markets, making it harder for European banks to refinance themselves. They are lending each other less money and interest rates for interbank loans are rising. These conditions led to the near collapse of Hypo Real Estate.
The downward spiral in European stock markets is also causing an increasing number of bonds to lose value. As that happens, investors are flooding the market with new issues, creating an oversupply that is causing prices to sink even further. That, in turn, is forcing all banks that have those bonds in their portfolios to accept even further write-offs.
Burghof and Hartmann-Wendels believe these factors pose a serious risk for Europe.

Part 2: How Solid Is Germany's Commerzbank?

In Germany, at least two other banks rely heavily on interbank money markets to refinance themselves like Hypo Real Estate: Essen Hypo and Euro Hypo. Both lenders are particularly vulnerable to credit crunches in the money markets, and both are subsidiaries of German banking giant Commerzbank. If they start to crumble, it would mark the first time a German private bank has been massively affected by the crisis.
Commerzbank has significantly greater capital on hand than Hypo Real Estate because the bank itself is less reliant on the money markets for financing. According to its own figures, in Germany alone Commerzbank has private customer deposits of €38.2 billion, as well as customer deposits at subsidiary Dresdner Bank valuing €20 billion. On the money market, Commerzbank finances itself primarily using long-term bonds. "We have already covered our refinancing needs for 2008," a Commerzbank spokesperson told the wire service Reuters.
Still, the company's €9.8-billion acquisition of Dresdner Bank from Allianz has caused its share price to collapse, making it vulnerable in the current financial crisis. The crash of Benelux banking giant Fortis, weighed down by its partial purchase last year of competitor ABN Amro for €24 billion, showed that the credit crunch can create serious problems even for full-service banks.

Economics Expert: ECB Should Lower Interest Rate
Peter Bofinger, a member of the German Council on Economic Experts, which advises the government on economic policy, said he believed the financial crisis is creating a burden for European markets. In order to counter the impact of the global credit crunch, he is calling for three concrete measures

Global Credit Register
Disempower Ratings Agencies
Standardize Securitized Loan Packages

Bofinger argues that banks, insurance companies and funds worldwide should be required to declare the scope and origins of all liabilities. This global credit report would show where high credit risks have been concentrated. Such a register already exists in Germany and is used by banks as an important instrument for credit analysis. One year ago, the idea that the American or English governments might have been moved to adopt such a measure would have been dismissed by many as utopian. But Bofinger argues the time is now right to take that step.
Bofinger is calling for the creation of a state-run European ratings agencies. The problem with private ratings agencies, he argues, is that they aren't held responsible for their credit-worthiness estimates -- even in cases where the money of thousands of investors is threatened because they have given a bank an overly positive rating. "Following the current market earthquake, the state can no longer put its blind trust in the ratings agencies," says Bofinger. "They have to be controlled -- and governments might as well just take over the job." He also argues that there is no true competition between the three ratings agencies.
That fact that growth on the markets has remained uncontrolled, Bofinger argues, is demonstrated by the fact the contracts for some securitized loan packages are hundreds of pages in length. "That makes an objective valuation extremely difficult," the economics expert says. He argues that a minimum of standards must be applied to securitized loan packages in order to make the derivatives market more transparent. -->
He also urged the European Central Bank to act. "The ECB must ensure that banks are able to borrow money at significantly lower interest rates," Bofinger told SPIEGEL ONLINE. The problem with the ECB's current policy is that it lends money through auctions, meaning that money is lent at interest rates far greater than the euro zone's key interest rate.
"The key interest rate is 4.25 percent, but the banks are actually having to pay the ECB 4.78 percent interest for one-week loans," Bofinger said. "If banks want to create liquidity on the market for three months, the current interest rate is over 5 percent -- that's the highest interest rate we've seen since the introduction of the euro."
In light of the difficult situation in the money markets, Bofinger said the ECB should offer one-week loans at a fixed interest rate in line with the current key interest rate in order to ease the situation for banks. He also said the ECB should move to lower the key interest rate to 3.75 percent.

On Thursday in Frankfurt, the ECB's board will hold its regular meeting, at which it will determine further monetary policy for the euro zone, the countries that share the European common currency. Despite the current tensions in the market, economy experts do not anticipate the ECB will lower the interest rate.

In order to limit the effects of the credit crunch in Europe, Bofinger also advised governments to create aid packages similar to the US bailout. "In my opinion, it is would also be better in Europe if the state acquired bad loans than to allow further banks to collapse, which could cost taxpayers a whole lot more," Bofinger said.

But banking expert Burghof called for reserve. "European banks should first try to meet their needs through the US package," he said. Still, he added, many won't be able to secure that aid, and if the crisis continues to escalate, he argued, a European bailout package would be inevitable. "And then," Burghof said, "Europe would be exposed to the maximum damage."