European bank bail-outs

Europe is unprepared for a systemic bank bust. With a pan-European regulator not expected until 2012, countries have had to take an ad hoc approach to the accelerating crisis. Since Sunday, the UK has nationalised Bradford & Bingley, Germany has extended a €35bn credit guarantee to Hypo Real Estate, and Iceland has injected €600m into Glitnir, its third biggest bank. Nothing systematic about that, nor with Fortis’s bail-out. Given the spread of its operations, the Belgian, Dutch and Luxembourgeois bureaucrats united to throw the bank a combined €11bn lifeline over the weekend. Yet even that rare turn of regulatory speed did not staunch the problem. European bank stocks continued to plummet on Monday.

If anything, investors believe the crisis will be worse in Europe than in the US. Banking stocks there have fallen by some 40 per cent since their peak last year. In Europe the benchmark index has fallen by 50 per cent. Europe’s underperformance is not because shareholders in bailed-out banks have done worse than in the US. If anything, they have done better. Yet European bank investors remain just as unwilling to step up to the plate. Reports that Franco-Belgian lender Dexia might raise funds sliced almost a third off its share price. And other banks have supplied capital only when elbowed into action by the government – as with Hypo Real Estate, where German banks will contribute or, if allowed to, pick over the remains, as Spain’s Santander did with B&B.

Other than supply liquidity, the European Central Bank has, meanwhile, kept aloof. Unlike the hyperactive Federal Reserve, the ECB has no lender of last resort role, nor responsibility for financial stability. But nor has it engineered an upward-sloping yield curve among government bonds. A near-painless route to recapitalising banks, this allows banks to borrow at low short term rates, lend at higher long-dated rates, and pocket the spread. Inflation worries have kept short-term rates high and the yield curve flat. As the deflationary bust continues, this will have to change.

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