Global: Euroland to Guarantee Bank Loans
Overview: The G7 meeting seemed on the surface to be a disappointment as the overall G7 statement only presented general principles for action instead of specific measures. However, Euroland followed up on Sunday night presenting a coordinated plan which included a state guarantee on all bank loans through 2009 and money to recapitalise the banking system will be set aside. Country-specific plans are likely to be presented on Monday. The measures now being taken address both liquidity issues as well as solvency issues in the banking system. Bank guarantees should help to make money markets function again and a recapitalisation of banks will ensure that the major banks can continue their operations. These are very important steps in containing the crisis and ensuring that financial flows can again get to the real economy. It may very well take a while for both money markets and risk markets to recover but the measures now taken should work to provide a turning point in the financial crisis. Governments seem committed to take further measures if necessary.
Details: The measures in Euroland mirror the British rescue plan as efforts are aimed at:
- Unfreezing money markets through state guarantees on bank debt. Bank debt up to five years will be guaranteed at commercial rates
- Adding liquidity to the system. ECB has pledged it will look at widening the eligible collateral to include commercial paper, but it may not yet have the legal power to do so. More investigation into this area will be necessary but there is a strong commitment to add further liquidity to the system.
- Recapitalising financial institutions with injections of public money of "appropriate value" where necessary, with the state taking preference shares or other instruments in return.
- Loosening mark-to-market accounting. "Under the current exceptional circumstances, financial and non-financial institutions should be allowed as necessary to value their assets consistently with risk of default assumptions rather than immediate market value which, in illiquid markets may no longer be appropriate". This will mitigate some of the losses taken on assets that have been written down substantially due to assets being dumped in the market at fire sale prices.
The fact that the EU ministers presented a coordinated plan is positive and shows renewed commitment to fighting the crisis. It also ensures a level playing field for banks across countries in terms of competition. It is up to the individual countries to implement the common measures according to national conditions. France, Germany, Italy and other Eurozone members have pledged they will present detailed national plans on Monday.
In the US, Treasury secretary Paulson made it clear that the TARP programme will be used to recapitalise financial institutions through equity purchases. Paulson had already strongly hinted at this as a possibility in a speech on October 8. The programme would be designed to "encourage the raising of new private capital to complement public capital" and any equity purchased through the programme would be on a nonvoting basis.
Assessment and outlook: By presenting measures on all relevant issues, governments are attacking the financial crisis with renewed forcefulness. By removing the counterparty risk in Euroland, the action taken should help to unfreeze money markets and lead to a decline in money market rates. Money should also increasingly flow into risky assets if markets start to believe that total meltdown will be avoided. The process may take a while, though, as markets have proven difficult to convince.
There is a strong commitment to do whatever is necessary and more measures are likely to be taken, should the current ones not be enough. In Euroland, further measures could include more aggressive rate cuts which have become more feasible as the rapid decline in commodity prices will work to reduce inflationary pressures.
On top of further monetary easing from the Fed, more measures will almost certainly be implemented to solve the problems in the US money and credit markets. The latest move by the authorities is to target unsecured lending. The Federal Reserve's newly announced (and not yet operating) commercial paper credit facility is an important step in that direction. Should this prove not to be enough, further measures in the US could include guarantee on interbank lending - as seen now in Euroland - unlimited deposit insurance and large government infusion of capital in the banking system as already outlined by Treasury secretary Paulson.
On the fiscal side, we would not be surprised to see another round of rebates or further increases in public spending. While Democrats are already discussing a new stimulus package, it is hardly feasible to pass new legislation until after the presidential election on November 4 and it will probably have to wait until the new president takes office in January.
Danske Bank
http://www.danskebank.com/danskeresearch
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