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Europe to the Rescue?

by: Felix Salmon October 13, 2008 | about stocks: C / DB / LEH / MS / RBS    
Felix Salmon

Felix Salmon

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While all eyes were on Washington this weekend, who would have thought that the real breakthrough would happen in Paris?

European financial and political leaders agreed late Sunday to a plan that would inject billions of euros into their banks in a bid to restore confidence to the teetering financial system.
Taking their cue from a rescue plan announced last week by Britain, the European countries led by Germany and France pledged to take equity stakes in distressed banks and vowed to guarantee bank lending for periods up to five years.

Spurred into action by the heads of state in Paris, the finance ministers in Washington even managed a useful contribution themselves:

The world's leading industrialised nations have pledged to do everything in their power to prevent any more Lehman Brothers-style failures of systemically important financial institutions...

There is unanimous agreement that the global system in its current extremely stressed state could not take the collapse of another systemically important firm such as Morgan Stanley, which came under attack last week in the markets.

This is much more important, for Morgan Stanley (MS), than any cash injection from MUFG, no matter how it's structured. The G7 is essentially telling market-makers that they can write credit protection on Morgan Stanley with impunity: They're not going to let it go the way of Lehman Brothers, with all the systemically-disastrous messiness that would entail.

This is by no means an overnight solution to the crisis. Markets are going to remain jittery for the foreseeable future, and it will take years rather than hours for banks to start implicitly trusting each other again. Bonds of trust, once broken, are not easy to restore, and in the near term banks are going to continue to borrow from central banks rather than from each other -- thereby keeping Libor, and the TED spread, elevated. But as Steve Waldman notes,

To the degree that LIBOR does not reflect banks' effective cost of funds, an elevated rate can be viewed as a hidden tax of the nonfinancial sector by banks.

In other words, banks aren't just getting public-sector billions and government guarantees, they're also getting much wider profit margins on all their Libor-linked loans. With luck, that will make them profitable enough that they can start buying back their equity from their governments within a couple of years.

The indicator to watch, I think, is the senior debt of TBTF financial institutions. If the G7 statement is reliable, the Pimcos of the world are going to start loading up big-time on senior debt from the likes of Citigroup (C), RBS (RBS), and Deutsche Bank (DB). And since the equity markets are taking their cue from the debt markets these days, if those spreads start coming in, that could mark an end to the carnage on Wall Street. Not a bottom, necessarily, but it might at least utter in a period where people can start breathing again.

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This article has 2 comments:

  •  
    Oct 13 09:43 AM
    And thus the Moral Hazard continues. Governments will bail out whatever stupid play you make as a bank, so don't bother looking at any deal in terms of risk/reward. Just do it. You will be made whole by the taxpayers of the world.

    If the central banks are going to guarantee everything, why do we need any intermediary banks at all? Let's just all go to the FED for every borrowing need and save ourselves the headache of keeping the other banks in business.
    Reply
  •  
    Oct 14 01:13 AM
    Indeed, we do not need any intermediary banks except to perpetuate the strangle-hold the elites of the elites have on the country. I don't remember who made this quote but it went something like this:

    Give me control of the money creation structure of a nation, and I don't care who makes its laws.

    This crisis has exposed the now not so "invisible hand" of the market...

    I recommend the link below for a more thorough explanation of the questions, "where does money come from?".

    video.google.com/video...
    Reply
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