Jean-Claude Trichet - World Economic Forum Annual Meeting Davos 2010

Jean-Claude Trichet

Stocks are closed in the US today, but they are falling precipitously in Europe, as the continent continues to struggle. European leaders still cling to the fallacy that they are in the midst of a debt crisis, when a bank crisis is more to the point. An austerity crisis, too.

But the elites still demand more beatings. The head of the European Central Bank, Jean-Claude Trichet, warned Italy that they must soldier on with austerity measures, after their Parliament failed to pass legislation to that effect. The ECB basically threatened to slow down or stop its purchases of Italian debt if the austerity programs aren’t put into place, which would raise borrowing costs for Italy to unsustainable levels. But this is akin to the ECB putting a gun to its own head. European banks would suffer if Italy faced a Greek-style collapse, and they cannot afford any kind of losses at this point. Bank stocks are the ones taking the brunt of the pain right now:

Financial shares led the declines. Royal Bank of Scotland gave up more than 10 percent, while Barclays, Deutsche Bank, BNP Paribas and Société Générale all fell more than 6 percent.

“The banking sector is at the center of this turmoil,” Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets in Brussels, said. Flows of speculative money into bank shares are exacerbating the volatility of the stocks, he noted.

In addition to growing expectations that many financial institutions will need to raise capital — as the head of the International Monetary Fund, Christine Lagarde, suggested last month — banks have also been hit by a lawsuit filed by the U.S. authorities against 17 financial institutions that sold the mortgage giants Fannie Mae and Freddie Mac nearly $200 billion in mortgage-backed securities that later soured.

The European Commission is putting on a brave face, saying there will be no return to recession. But John Lanchester has this pegged right: a lack of growth means that Eurozone countries will have problems paying their debts, and as a result the European banks, which are in horrendous shape, will falter.

It’s lucky I’m not a trader actively involved in the financial markets, because if I were, I would have permanently lost my shirt – I would have ‘blown up’, as traders call it – in 2009, betting everything I own against the euro, on the basis that its banks were just as broke as the ‘Anglo-Saxon’ ones, with the only difference being that they hadn’t admitted it yet. They still haven’t admitted it. [...]

In the case of the current euro crisis, hedge funds are shorting specific banks, principally European ones, which they believe to be undercapitalised, as per Gordon Brown above. (Just because they’re evil doesn’t mean they’re wrong on the substantive point.) The European governments reacted in the way they tend to do, by issuing a temporary ban on short-selling in France, Belgium, Italy and Spain – a not-so-subtle clue as to the location of the targeted banks. Crying ‘foul’ in this manner doesn’t impress the markets much, and the banks’ predicament worsened. The European Central Bank figures tell the story: in a single week, they provided €22 billion in emergency funding. The total amount of support to one (unnamed) bank amounted to $500 million. ECB lending on that scale can’t be kept up, but numbers that big are necessary because other banks had stopped lending to the endangered banks – and banks being scared to lend to other banks is the exact formula which didn’t just cause the credit crunch, it was the credit crunch.

There are options for Europe. They could sell eurobonds to ward off the rapacious markets from the PIIGS countries and put the entire Eurozone behind the debt. They could break up the euro and allow the countries in trouble to deflate their currency. They could end this austerity that is killing economic growth and increasing deficits. It’s a sad commentary that the European country with one of the larger increases in GDP was Belgium, which has had no functioning government for 15 months, and as such has not instituted austerity measures, keeping government spending relatively high.

Finally, as Lanchester writes, the entire world, Europe and the US as well, could stop the madness of the financial sector driving policy decisions, and instead regulate the banks as a public utility. European too-big-to-fail banks are clearly the impetus for the austerity fever that has gripped the continent. The developing world is marked for a decade of pain where deleveraging occurs and banks are shoveled money to grow their way out of their problems. But when the finance sector must grow, countries have to take a back seat. And even then, they are simply too indebted, too troubled, to follow this plan. Big Shitpile still follows the banks wherever they go, and they cannot escape.

But we’re not going to do any of these things, Lanchester concludes, and I agree with him. “I fear that the grip of anti-spending ideology is so strong throughout the West, and the politicians’ fear of the banks is so entrenched, that the ten-year slog looks more likely.” What year are we in now, so I can set my calendar?

Photo by Monika Flueckiger for World Economic Forum swiss-image.ch under Creative Commons license