Euro crisis like 1,000 rogue traders

Allister Heath
BY far the biggest threat to the world economy comes from the Eurozone crisis. Rogue traders are a danger to us all, but well-capitalised large banks can cope quite easily with a $2bn loss (the well-deserved reputational disaster is another matter). That is why all recent global banking reforms have emphasised the need for financial firms to hold far more capital to protect themselves against trading losses or, more likely, write-offs from their loan books.

While invariably making fascinating case-studies in hubris, rogue traders fortunately are a sideshow to the real issue: the situation facing the world is now so bad that the top central banks were forced yesterday to announce liquidity providing operations to boost the supply of dollars to the European banking system. Such concerted moves don’t take place if there is nothing wrong. They confirm that international financial institutions now believe that the counter-party risk entailed in dealing with some European firms is too high to bear because of their exposure to dodgy Eurozone governments.

The real rogues are those responsible for this situation: those in politics, business and the media who (in an act of hubris orders of magnitude greater than anything a trader could ever manage) supported the creation of a flawed single currency despite warnings this could only end in tears; and the profligate politicians who spent years mismanaging their economies, aided and abated by those who stood to gain from such incompetence.

American companies are especially worried by the Eurozone crisis. Many large US institutions have moved their deposits from any European bank they perceive to be at risk to larger institutions deemed solid or likely to be bailed out. One major US financial institution told me that it has been testing its lines of credit to gauge the strength of the banks with which it has dealings; fortunately, in this case it discovered that all seemed still to be fine. On top of the sovereign default risk, there is a widespread belief that many European banks may be holding vast amounts of property assets held at unrealistic valuations on their books. One top Wall Street executive is privately predicting European versions of the Troubled Asset Relief Programme (Tarp) as well as of the UK’s asset protection scheme.

But if these sorts of things do happen, they will have a host of consequences. UBS’s woes are bad for the City in general, but wait until European governments – or even the European Financial Stability Facility (ESFS) – starts taking stakes in big Eurozone lenders.

UBS shareholders deserve to be furious at their management’s shocking inability to put in place proper systems to stop unauthorised trades. Counter-intuitively, however, UBS’s disgrace is almost reassuring: it shows that the system can easily cope with a random hit. The bank lost just 0.4 per cent of its capital, even when defined on the strictest Basel rules; it could have coped with much more. Fortunately, even the largest trading losses tend to pale in comparison with the less high-profile losses regularly incurred on property-based loans, dud long-term investments or goodwill write-offs.

The real systemic worry is the Eurozone. The financial system simply cannot cope with the uncontrolled default of European countries. Imagine UBS’s rogue trade – and then multiply it by a thousand. It just doesn’t bear thinking about.
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