text: On life support | The Economist
  Oct 2nd 2008 (Updated Oct 13th 2008) |
  AFTER lurching robotically into their worst crisis in more than three-quarters of a century, the fundamental weakness of banks in America and Europe has now become horribly clear. With funding markets frozen and American plans to remove toxic assets from banks' balance-sheets in limbo for much of this week, confidence in a raft of institutions evaporated. Between September 28th and 30th, governments on both sides of the Atlantic shored up or split up six banks threatened by failure. Other institutions remain on high alert.
  Observers scratch their heads to think of any other industry that has been reshaped so quickly or so dramatically. In America, where the authorities have helped to shovel failing banks into the hands of bigger ones, the retail-banking landscape now has three towering figures. On September 25th JPMorgan Chase overtook Bank of America as the country's largest deposit-taking institution by snapping up the assets and deposits, but not the other liabilities, of Washington Mutual (WaMu), a Seattle-based savings-and-loan bank that had been suffocated by bad mortgage loans.
  Four days later Citigroup, its risks capped by a loss-protection agreement with the Federal Deposit Insurance Corporation (FDIC), strengthened its domestic deposit base by acquiring the banking operations of Wachovia. Further consolidation is likely. Jim Eckenrode, an analyst at Tower Group, a consultancy, reckons that a top tier of five banks (Wells Fargo and US Bancorp are two other contenders) may end up holding as much as half of America's deposits.
  Another approach has been to borrow from the American model, parcelling out the good bits of failing banks to solvent rivals and keeping the rest. The deposits and branches of Bradford & Bingley, a British mortgage lender that made Northern Rock look well managed, are now in the hands of Santander, a respected Spanish bank. Its mortgage book now rests with the luckless taxpayer. Germany's Hypo Real Estate, a commercial-property lender which found that the tenor of its funding was becoming shorter as investors shied away from long-term lending, got help of a different sort—a €35 billion secured-credit facility from a consortium of unnamed German banks and the government.
  The most sweeping intervention of all came from Ireland's government, where concerns about spiking credit-default swap (CDS) spreads, falling share prices and jittery depositors led the finance minister to announce, on September 30th, a blanket guarantee on the deposits and almost all the debts of the country's six biggest banks until September 2010. "The Irish move confirms that this is a systemic crisis in certain countries," says Simon Adamson of CreditSights, a research firm. Investors and creditors of Irish banks liked the move, which recalled one of the actions taken by Sweden during its feted 1990s bail-out. The European Commission and other banks, worried about deposit flight to Ireland, are bound to be less enthused.
  The first source of pressure is concern about solvency, and the ability of banks to withstand further losses. The unexpected rejection of the American bail-out plan on September 29th cast doubt on one obvious mechanism to remove the worst-performing assets from banks' balance-sheets. But even if it is revived, as most expect, the cycle of losses will continue as the drumbeat of bad economic news intensifies. WaMu and Wachovia were undone not by mark-to-market losses, after all, but by the appalling quality of their loan books. It is the same story in many parts of Europe.
  The problem is that attempts to shore up liquidity do not necessarily address the capital shortfalls, and vice versa. Even Ireland's lavish guarantee does not quell concerns about rising impairments on the Irish banks' property portfolios. Glitnir's capital ratio looks robust after the government's investment, for example, but its CDS spreads still surged, indicating rising fears of a national crisis (see chart).
  Worse still, the effect of most government interventions, necessary as they are, is to make it even harder for private investors to heal the system on their own. Shareholders are losing both money and reputations as bank failures multiply. TPG, a vaunted private-equity firm, was wiped out by the collapse of WaMu. Shareholders in Wachovia, Fortis and Bradford & Bingley had all recently dipped into their pockets to raise fruitless capital. The risk of sudden dilution by governments, or worse, hangs darkly over prospects for industry recapitalisation. Creditors have also become far more risk-averse in recent days, thanks to the bankruptcy of Lehman Brothers and the brutal treatment of WaMu's senior creditors (see article). Hypo Real's new credit line will presumably have shunted unsecured creditors down the queue too.
  This article appeared in the Finance & economics section of the print edition under the headline "On life support"