AFTER lurching robotically into their worst crisis in more than three-quarters of a century, the fundamental weakness of banks in America and Europe has now become horribly clear. With funding markets frozen and American plans to remove toxic assets from banks’ balance-sheets in limbo for much of this week, confidence in a raft of institutions evaporated. Between September 28th and 30th, governments on both sides of the Atlantic shored up or split up six banks threatened by failure. Other institutions remain on high alert.
Observers scratch their heads to think of any other industry that has been reshaped so quickly or so dramatically. In America, where the authorities have helped to shovel failing banks into the hands of bigger ones, the retail-banking landscape now has three towering figures. On September 25th JPMorgan Chase overtook Bank of America as the country’s largest deposit-taking institution by snapping up the assets and deposits, but not the other liabilities, of Washington Mutual (WaMu), a Seattle-based savings-and-loan bank that had been suffocated by bad mortgage loans.
Four days later Citigroup, its risks capped by a loss-protection agreement with the Federal Deposit Insurance Corporation (FDIC), strengthened its domestic deposit base by acquiring the banking operations of Wachovia. Further consolidation is likely. Jim Eckenrode, an analyst at Tower Group, a consultancy, reckons that a top tier of five banks (Wells Fargo and US Bancorp are two other contenders) may end up holding as much as half of America’s deposits.
In Europe the pace of consolidation has not been quite as rapid but the scale of government intervention is just as breathtaking. The continent has turned into a laboratory of bank bail-outs. One approach has been to inject equity into institutions and try to keep the show on the road. Fortis, a Belgo-Dutch bank overstretched by its role in acquiring ABN AMRO, is now part-owned by the Benelux governments. The Icelandic government has taken a 75% stake in Glitnir, a bank with outrageous reliance on gummed-up wholesale funding markets. The French, Belgian and Luxembourgeois authorities stumped up €6.4 billion ($9.3 billion) to bolster the capital base of Dexia, a public-sector lender that dabbled fatally in bond insurance.
Another approach has been to borrow from the American model, parcelling out the good bits of failing banks to solvent rivals and keeping the rest. The deposits and branches of Bradford & Bingley, a British mortgage lender that made Northern Rock look well managed, are now in the hands of Santander, a respected Spanish bank. Its mortgage book now rests with the luckless taxpayer. Germany’s Hypo Real Estate, a commercial-property lender which found that the tenor of its funding was becoming shorter as investors shied away from long-term lending, got help of a different sort — a €35 billion secured-credit facility from a consortium of unnamed German banks and the government.
The most sweeping intervention of all came from Ireland’s government, where concerns about spiking credit-default swap (CDS) spreads, falling share prices and jittery depositors led the finance minister to announce, on September 30th, a blanket guarantee on the deposits and almost all the debts of the country’s six biggest banks until September 2010. “The Irish move confirms that this is a systemic crisis in certain countries,” says Simon Adamson of CreditSights, a research firm. Investors and creditors of Irish banks liked the move, which recalled one of the actions taken by Sweden during its feted 1990s bail-out. The European Commission and other banks, worried about deposit flight to Ireland, are bound to be less enthused.
Safe as houses
All this activity had one immediate prize: not a single bank needed rescuing on October 1st. But for those with longer-term horizons, the future remains bleak, and in some ways, worse than before. There are two sources of pressure on the banks. To date government intervention has tended to focus on one or the other, but not both.
The first source of pressure is concern about solvency, and the ability of banks to withstand further losses. The unexpected rejection of the American bail-out plan on September 29th cast doubt on one obvious mechanism to remove the worst-performing assets from banks’ balance-sheets. But even if it is revived, as most expect, the cycle of losses will continue as the drumbeat of bad economic news intensifies. WaMu and Wachovia were undone not by mark-to-market losses, after all, but by the appalling quality of their loan books. It is the same story in many parts of Europe.
The second source of pressure is liquidity. Even the most solid-looking banks are having trouble raising long-term debt. As their debt matures, they are having to refinance with shorter-term debt, ratcheting up their costs and their vulnerability to a sudden withdrawal of credit. If banks have enough funding through deposits, problems in the wholesale markets should be navigable. But others are much weaker. Witness the continuing pressures on Morgan Stanley and Goldman Sachs, despite their conversion into bank holding companies. Mitsubishi UFJ, a Japanese bank, lost more than $500m on its $9 billion investment in Morgan Stanley on September 29th, the day the deal was inked.
The problem is that attempts to shore up liquidity do not necessarily address the capital shortfalls, and vice versa. Even Ireland’s lavish guarantee does not quell concerns about rising impairments on the Irish banks’ property portfolios. Glitnir’s capital ratio looks robust after the government’s investment, for example, but its CDS spreads still surged, indicating rising fears of a national crisis.
Worse still, the effect of most government interventions, necessary as they are, is to make it even harder for private investors to heal the system on their own. Shareholders are losing both money and reputations as bank failures multiply. TPG, a vaunted private-equity firm, was wiped out by the collapse of WaMu. Shareholders in Wachovia, Fortis and Bradford & Bingley had all recently dipped into their pockets to raise fruitless capital. The risk of sudden dilution by governments, or worse, hangs darkly over prospects for industry recapitalisation. Creditors have also become far more risk-averse in recent days, thanks to the bankruptcy of Lehman Brothers and the brutal treatment of WaMu’s senior creditors. Hypo Real’s new credit line will presumably have shunted unsecured creditors down the queue too.
So far only the Irish solution has avoided this adverse effect, by indemnifying most creditors and allowing shareholders to reap the subsequent gains. Moral hazard, it seems, can go hang. So too can other governments, which are under pressure to match the Irish guarantee but may not be able to, either because their sovereign-debt rating is less strong or because the liabilities of their banks are too big.
There are other dangers in the rapid consolidation of the sector. A world of fewer, bigger banks promises even greater havoc if one was ever to fail. The universal banks have remained largely above the fray in recent days, but on October 1st, UniCredit, a big Italian bank, announced plans to raise its capital ratio by spinning off property assets. If banks of this size and geographical scope were to get sucked into the mire, the consequences would be devastating. In the meantime, they have little choice but to present a steely exterior and carry on as if nothing were wrong.