Eurozone learnt nothing from 2008

Allister Heath
FOR anybody with ears to hear it, the message yesterday from Deutsche Bank’s boss was chilling. Many Eurozone banks would go bust if they were forced to accept a “haircut” to fully reflect current market valuations on their sovereign debt holdings, Josef Ackermann, Deutsche Bank’s chief executive warned. He was speaking at Frankfurt’s annual Banks in Transition conference, a meeting where speakers appeared to compete to draw the most gruesome parallels with the crisis of 2008. They were, of course, right to do so.

Then it was sub-prime that was the trigger, though there were many other separate problems caused by years of global bubblenomics – today the problem is government debt, especially in the Eurozone, after an equally lengthy bubble in government spending and the abysmal failure of the single currency project.

When the last crisis broke properly in 2008, mark-to-market accounting forced banks, hedge funds and others to slash the value of the assets held on their balance sheets, triggering huge losses and many insolvencies; in the many cases when this reflected reality, this was a perfectly sensible (albeit painful) outcome.

But uncertainty, a lack of information and the opacity of relationships, products and counterparty risks meant that mark-to-market accounting often overshot and in some cases destroyed firms that should have been able to survive. Liquidity issues turned an already bad solvency crisis into an even worse one. This was triggered by massive redemptions from institutional investors, in turn causing forced-selling; at times, it seemed that nobody was willing to buy anything at any price, which temporarily pushed down mark-to-market valuations to excessively low levels, unfairly bankrupting some institutions.

This time around, the opposite is true, at least at this stage of the crisis. It is a joke that Greek bonds are being valued at a haircut of just 21 per cent when Greek two-year yields are at 50 per cent. There are other signs that a 2008-style crisis is in the making. The inter-bank lending market has become infected, with banks finding it tough to raise long-term financing.

The conference yesterday was told that no bank is currently able to issue a seven- or eight-year bond in the current environment. No wonder, therefore, that the STOXX Europe 600 banking index closed down another six per cent yesterday to its lowest level in 29 months. The US lawsuit against many of the largest global banks didn’t help either, of course.

Regulatory changes are making the problem even worse for many Eurozone institutions: the rules say that they should stock up with lots of supposedly safe government debt. But if the state fails, it will thus automatically take down the financial system. The authorities have clearly learnt little from the subprime debacle. Transparency must always be key: it is imperative that market participants understand each others’ balance sheets and are therefore able to trust each other. But because the Eurozone is in denial about the severity of the crisis facing several of its governments, and thus refuses to accept that write-downs will almost certainly have to be massive, banks can no longer afford to trust those players deemed most at risk from an outbreak of reality. It’s looking grimmer by the day for the Eurozone; we will all pay a heavy price for its implosion.
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