Next Move in European Bailouts: Paying for Them
Here we go. It appears that the public is now being made aware of the ‘potential’ risk to government finances involved with these worldwide bank bailouts. This is like watching a slow-motion train wreck. With the world’s economy destined to collapse – you are watching some highly intelligent people setting up the world’s governments to collapse as well. This is not going to be pleasant.
Watching all of this develop is like standing on a beach watching a 1,000 ft tidal wave approaching. You yell for everyone to get off the beach and prepare for the inevitable – but few are listening.
jg – Oct 14, 2008
OCTOBER 14, 2008
Next Move in European Bailouts: Paying for Them
Governments' Bets on Banking Systems Begin to Lift Markets and Ease Lending, but Expose State Finances to Risk
Wall St. Journal
By MARCUS WALKER in Berlin, SARA SCHAEFER MUñOZ in London and DAVID GAUTHIER-VILLARS in Paris
Now that governments across Europe have stepped in with bold plans to bail out their banking systems, they are facing a new challenge: How to pay for it all.
The U.K., Germany, France, Spain and Italy on Monday provided further details of measures that will see their governments spend tens of billions of pounds and euros on stakes in struggling banks and offer hundreds of billions more in guarantees aimed at helping banks borrow the money they need to do business. The U.S. followed suit late Monday, telling the nation's top financial institutions in a meeting in Washington that it would buy preferred equity stakes in those banks, and lift the insurance limits for non-interest bearing bank deposit accounts, among other measures.
But even as markets rose sharply on news of the concerted efforts, economists were fretting about the potential effect on taxpayers and government finances.
In essence, governments are making massive bets on the futures of their banking systems. If the plans work and banks do well, taxpayers could profit as the value of the government stakes rises. But if banks suffer further losses, governments could see their national debts grow and credit ratings fall as they are forced to pay up on guarantees. That, in turn, could boost governments' cost of borrowing, discourage private investment and put the brakes on economic growth.
"It's incredibly risky," said Simon Johnson, a professor at MIT and former chief economist of the International Monetary Fund. "You don't really know the losses that these [banks] are going to have."
Tom Bemis, a London-based MarketWatch editor, discusses the wave of capital injections that European governments are providing banks. Stocks are rebounding on the news, but it remains to be seen whether the action will unlock frozen credit markets.
So far, the U.K. and Germany have put forth the most ambitious bailout plans. The U.K. is planning to issue some £37 billion ($63.1 billion) in new government debt to pay for purchases of the common and preferred shares of three banks: Royal Bank of Scotland Group PLC and the soon-to-be-merged Lloyds TSB Group and HBOS PLC.
If private investors don't take part in the banks' share issues, the government will likely end up with a 60% stake in RBS for £20 billion and a 40% stake in the combined Lloyds-HBOS for £17 billion. The U.K. will also guarantee some £250 billion in bank debts with maturities of up to three years. The guarantees extend to the vast and frozen market for interbank lending, or short-term loans among banks, a Treasury spokeswoman said.
Left to Right: Reuters, Getty Images and Reuters
Left to Right: British Prime Minister Gordon Brown, German Chancellor Angela Merkel, French President Nicolas Sarkozy.
Germany plans to borrow as much as €80 billion ($107.3 billion) to buy stakes in banks and provide an additional €400 billion in debt guarantees. The government didn't identify any targets for capital injections, but people familiar with the matter said officials have concerns about several of the country's state-sector Landesbanken, or regional lenders. Several of these, such as Westdeutsche Landesbank and Bayerische Landesbank, have suffered heavy writedowns on U.S. subprime-related securities since mid-2007. A spokeswoman for BayernLB said the bank needs capital but would have to study the details of Germany's plan. A spokesman for WestLB declined to comment.
The French government said it would inject as much as €40 billion into its banks and guarantee a total of €320 billion in bank debt. The government's first move will be to inject €1 billion into Dexia SA, the municipal lender that the French and Belgian governments have agreed to bail out.
Meanwhile, the Spanish government approved plans to guarantee as much as €100 billion in bank debt in 2008 and set up a mechanism to inject fresh capital into Spanish banks, though it said none needed the facility at present. Italy also announced an unlimited plan to guarantee bank debt, but a finance ministry spokeswoman said the government doesn't expect any banks to tap it in the near future.
Global investors issued a vote of confidence in the plans Monday, pushing European stocks sharply upward. The Dow Jones Stoxx 600 index, which tracks European shares, closed up 9.9%, before the U.S. Dow Jones Industrial Average closed up by more than 10%.
In one early sign that the measures might be working, short-term interest rates fell slightly as banks became a bit more comfortable about lending to one another. The three-month dollar London interbank offered rate, a benchmark that is meant to reflect banks' borrowing costs, fell to 4.7525% Monday from 4.81875% Friday. The three-month Sterling rate fell to 5.60% from 5.8125% Friday.
But the cost of insuring against debt defaults rose for a number of European countries, reflecting rising concerns about how the plans will affect governments' finances. The cost of insuring against a default on £10 million in U.K. government debt for five years, for example, rose Monday to £47,000 annually, from £41,000 Friday. The cost of five-year default insurance on €10 million in German debt jumped to €27,000 Monday from €23,000 Friday. A higher cost of default insurance translates into higher borrowing costs for governments, and more budget money spent on paying interest.
"You cannot issue this amount of debt in a short amount of time without having to" pay more for it, said Stuart Thomson, a fixed-income-fund manager and economist at Resolution Asset Management in Glasgow.
For the most part, Europe's larger governments are in a position to absorb even extreme bank losses. In Germany, a theoretical loss of all of the €480 billion in capital injections and guarantees would raise the country's net national debt to around 75% of gross domestic product, from around 56% now.
Countries whose public debts already exceed 100% of GDP, such as Italy, might have bigger problems coping with such losses, Mr. Gros said. Smaller countries that are home to large banks could also face difficulties. Switzerland, for example, is home to one of Europe's largest banks, UBS AG, which has already suffered some $42 billion in write-downs on bad investments.
Banks that participate in the plans won't get a free ride. Governments intend to charge participating banks for the guarantees, and will also have a say in dividend policies and executive pay. Germany, for example, will charge a fee of at least 2% annually of the amount guaranteed. The U.K. will charge 0.50% plus the cost of default insurance on a bank's debt.
Executive heads are also likely to roll. On Monday, RBS confirmed that Fred Goodwin, the bank's chief executive for the past eight years, would be succeeded by Stephen Hester, most recently chief executive of real-estate trust British Land Company PLC. (See related article.)
—Neil Shah, Alistair MacDonald, Davide Berretta, Stacy Meichtry and Thomas Catan contributed to this article.
