Global financial turmoil

SLAUGHTER IN EUROPE

Recovery harder with European dis-Union

By Zhen Ming


BEER festival Oktoberfest, usually a 16-day event held each year in Munich, Germany, ended last Sunday and attracted six million visitors. This is 200,000 fewer than last year.

Beer consumption fell by 300,000 litres to 6.6 million litres - due probably, in part, to the cold and rainy weather.

Thankfully, there wasn't much real-life blood-letting at the festival - the number of oxen slaughtered for food remained stable at 104.

Not so, on the morning after. Not so, for the tens of millions of cowering bulls slaughtered in financial markets throughout Europe and elsewhere globally.

With the party over, visions of German men in hillbilly lederhosen and German women in milkmaid dirndl vaporised the moment Europeans awoke on Monday from their drunken stupor to the stark realisation that the European Union (EU) now faces a banking and economic crisis of its own, not linked solely to bad US sub-prime debt.

Consequently, on what's now called Red Monday, many of the already-castrated financial bulls throughout the EU were gingerly slaughtered in a market bloodbath on a scale not seen in recent times.

And while the thundering herd throughout the EU and elsewhere tried to flee helter-skelter by selling frantically - on a growing realisation that the global credit crisis was likely to take a heavy toll - their mass panic only helped them to collectively lose US$2.5 trillion ($3.7 trillion) on that one day alone.

Thus far this week, European bankers are still scrambling to complete mergers and win government backing for emergency rescue packages. The EU's once-proud financial sector resembled a jungle in which only the fittest are likely to survive.

But as the disunited European leaders continue to bicker over the need for a continent-wide bailout solution, Britain and Spain couldn't wait. They have moved ahead to mount separate rescues of their own financial industries.

For instance, UK Prime Minister Gordon Brown on Tuesday night ordered a massive taxpayer-backed cash injection to rebuild the balance sheets of Britain's High Street banks, effectively part-nationalising the sector at a cost of tens of billions of pounds.

Loss of confidence

The root cause of the EU's current banking woes? Simply put, it's the loss of trust and confidence among the banks themselves.

Mr Bob McDowall, European research director at financial services consultancy Tower Group in London, said: 'Banking is like religion. It's all about trust and confidence.

'Governments and regulators are trying to demonstrate firm leadership and show confidence, but banks don't trust each other.'

Underlying this panic is the EU's over-leveraged banking system.

The more you borrow on top of the funds (or equity) you already have, the more highly leveraged you are. Take the 'overall leverage ratio' - a measure of a bank's total assets to its shareholder equity. For the average European bank, the ratio is 35 (due to large in-house investment banking operations). For the largest US banks, it is below 20.

This means that relatively small writedowns on a typical European bank's assets could have a potentially devastating impact on its razor-thin capital.

Power vacuum

The EU is also in a financial quandary because of a perpetual power vacuum. There's no real boss, so to speak. So, while the US is being governed from Washington, the EU governs itself from 27 national capitals and Brussels (its capital city).

The resulting irony could be that even though banks in the EU have, on average, engaged in less of the risky lending that pulled down so many of their American counterparts, a European banking recovery could take even longer.

The problem here is not a lack of understanding of how to stop financial crises. The problem here is a lack of political will.

Sadly speaking, unless European leaders unite to address this crisis before it spirals out of control, they may find themselves fighting over how best to salvage what's left.


Source: The New Paper, Thu 09 Oct 2008