“April is the cruelest month,” wrote T.S. Eliot at the beginning of his great poem, “The Waste Land.” But, if Eliot had been a professional investor who had observed European financial markets over the last few years, I am quite certain that his choice would have been August.
In August 2007, the decision by BNP Paribas to close two of its hedge funds exposed to the subprime sector precipitated a liquidity crisis for all European banks during that summer. This year, BNP’s great rival, Société Générale, has been in the spotlight. Its stock fell by more than 14 per cent in one day in mid-August, plumbing depths not seen for two and a half years. Rumors have swirled about a possible downgrade of France’s sovereign debt, accompanied by speculation about the consequences for French banks.
Since the French, of all continental Europeans, most respect the convention that no useful work should be done in the month of August, this is harsh treatment for their bankers. They have not been slow to claim that they are being singled out unfairly.
They have a point. France is not the epicenter of the eurozone crisis. There is much – too much – competition for that position. Greece was an early favorite in the race to claim it, but faced a stiff challenge for a time from Ireland. Portugal made a sprint towards the front, but is now falling back a little, with Spain and Italy moving up. France likes to think that it is at the back of the field, strolling leisurely in lockstep with Germany.
The evolution of the crisis has, however, thrown European banks’ balance sheets into sharp focus. Eurozone governments have proven unwilling, or unable, to produce a solution that persuades markets that they are on top of the problem. It seems inevitable now that either the eurozone will have to contract, with parts of the uncompetitive periphery dropping out, at least for a time, or that member countries’ debts will have to be collectively guaranteed, which implies some form of fiscal union. Nothing less will persuade investors to go near debt issues from the eurozone’s fiscally challenged members.
The political problem is that the second solution cannot yet be sold to German voters, let alone to nationalist fringe parties like France’s National Front and Finland’s True Finns. Perhaps it will be possible to persuade the Germans if the alternative is eurozone collapse, which would put the Deutschemark, or a Northern Euro, in the uncomfortable position that the Swiss franc occupies today – too strong for its own good. But things might have to get worse before the political mood swings.
In the meantime, the European Council continues, as the Americans would put it, to “kick the can down the road.” Of course, the can is not in the road; it is in the banking parlors. EU banks are holding sovereign debt that clearly is not worth 100 cents on the euro. But even the financial “stress tests” conducted by regulators did not require the banks to acknowledge that inconvenient truth.
Many eurozone banks have made far less progress in strengthening their capital adequacy and liquidity than have American and British banks since the financial crisis erupted. The disparities were exposed in the IMF’s last Global Financial Stability Report, published in April, which contains a striking analysis that shows the changes in tangible common equity over the last two years, and the degree to which banks are reliant on wholesale funding. One EU central banker described this to me as the “killer chart.”
What it shows is that banks in the United States have increased their equity from about 5.5 per cent to about 7.5 per cent, and have reduced their reliance on wholesale funding from 30 per cent to 25 per cent. British banks have made less progress with tangible common equity, rising from just under 3 per cent to a little over 4 per cent, but they have significantly reduced their reliance on wholesale funding, from almost 45 per cent in 2008 to less than 35 per cent now.
The writer is a former chairman of Britain’s Financial Services Authority, Deputy Governor of the Bank of England, and Director of the London School of Economics, is a professor at Sciences Po in Paris
Project Syndicate
