U.S. Missteps Are Evident, but Europe Is Implicated
By NELSON D. SCHWARTZ
Published: October 12, 2008
PARIS — A week ago, European leaders said they knew who was responsible for the global credit crisis.
Silvio Berlusconi, Italy’s prime minister, blamed a “capitalism of adventurers” in the United States, a group that encompassed risk-taking investment bankers and home buyers who borrowed more than they could afford. The British prime minister, Gordon Brown, pointedly noted that the crisis had “come from America.”
But now, after problems at European banks helped set off a global stock market rout and a 20 percent plunge on Wall Street last week, experts say lenders here all too willingly embraced many of the riskiest practices of their American counterparts, bulking up on risky debt and relying on short-term loans, rather than deposits, to finance their operations.
Indeed, even while European leaders continued to point fingers at the United States as they completed their own rescue efforts Sunday, analysts predicted that the eventual cost of the bailout on this side of the Atlantic could soon rival that of the $700 billion American plan.
And that pain won’t be Europe’s alone, as the turmoil here continues to reverberate through the world’s stock markets and make a global recession look more and more likely.
“The same mechanisms that led to the crisis in the United States were operating here,” said Arnoud Boot, a professor of finance and banking at the University of Amsterdam. “It’s totally misplaced for European leaders to put the blame on the Americans.”
While the deposit guarantees and capital injections deployed in Britain and Ireland and across the Continent from France and Belgium all the way to Greece might allay the immediate panic, these steps will not necessarily free up credit for European businesses already hard hit by the global economic slowdown.
In fact, an ocean of short-term debt issued by European banks is set to come due over the next two quarters, with $375 billion maturing in the fourth quarter of 2008 and another $339 billion needing to be refinanced in the first quarter of 2009.
“If the banks do not manage to roll over this debt, we may witness balance sheet contraction with major negative implications for the real economy or more bank failures,” said Vasco Moreno, who tracks European banks for Keefe, Bruyette & Woods, a research firm specializing in financial institutions.
The American subprime loan crisis may have been the trigger, Mr. Boot said, but dangers like too much leverage, too little oversight and an executive-bonus culture that encouraged risk-taking had been building for years in Europe, just as in the United States.
By some measures, in fact, European banks exposed themselves to even higher levels of debt than American banks did. And the after-effects are likely to be felt for years, potentially reducing European demand for American exports, a rare bright spot for domestic companies until recently.
European institutions do not directly face the kind of bad mortgages that brought down Wachovia and Washington Mutual, because local lending standards here never fell as far as they did in the United States. But their own heavy borrowing has made European banks vulnerable now that easy credit is a thing of the past and plunging stock prices make it harder to raise money.
“The market is really efficient in identifying the weakest players in the industry here in Europe,” said Christophe Ricetti, a banking analyst with Natixis.
A glaring example is Hypo Real Estate, Germany’s second largest commercial real estate lender, whose loans exceeded its deposit base by more than eight times.Less than 24 hours after Mr. Berlusconi and Mr. Brown blamed the United States about a week ago for the crisis and offered assurances about Europe’s relative stability, Hypo’s near collapse forced Germany to hastily guarantee all consumer deposits and mount a $67 billion rescue effort to save the stricken bank.
Several days later, British authorities would unveil a $255 billion plan to shore up its own shaky banking system.
Other banks that overreached include the Royal Bank of Scotland and Fortis, a Dutch-Belgian lender, which last year took on huge debt to finance a $100 billion takeover of rival ABN Amro — a deal that had the bad timing to coincide with the market’s peak.
Late Sunday night, the British government appeared poised to take a majority ownership stake in the Royal Bank of Scotland, while Fortis has already been taken over and broken up by the Dutch and Belgian governments.“The high leverage could have been sustainable if the risks were kept under better control,” Mr. Boot said, “but clearly, supervision was insufficient.”
In Ireland, loans at the biggest banks also far outpaced deposits. That led the Irish government to issue a blanket guarantee on private savings accounts on Sept. 30, a move that set off criticism by other European governments — until they found themselves forced to follow suit.
Despite having to take drastic action close to home, in recent days European leaders have continued to focus on the American role in the global economic debacle, especially the decision last month by Federal Reserve and Treasury Department officials to let Lehman Brothers collapse.
“For the equilibrium of the world financial system, this was a genuine error,” Christine Lagarde, the French finance minister, said last week.
And on Sunday, after a conference of European leaders at the Élysée Palace here aimed at easing the panic, President Nicolas Sarkozy of France returned to this theme.
“This crisis was not born in Europe,” Mr. Sarkozy said. “This crisis was born in America. It is now a global crisis.”
But according to one commonly used yardstick to measure borrowing — the ratio of assets to equity — European banks employed more than twice as much leverage as their American counterparts, Mr. Moreno, the analyst, said.
“The banks have a large amount of debt to roll over until the end of 2009,” he said.
To be sure, not all European institutions indulged in risky borrowing and lending, Richard Portes, professor of economics at London Business School, said. Despite a rapidly deflating housing bubble in Ireland, Spain and Britain, the French bank BNP Paribas, Santander of Spain and Britain’s HSBC have emerged largely unscathed, he noted.
Even as excessive debt emerges as the most pressing concern, the decision by other European institutions to wade into the market for complicated, mortgage-backed American securities and other derivatives overhangs the system.
UBS, the Swiss giant, for example, bought tens of billions of dollars in American subprime debt in a bid for higher yields, only to find out too late that it was toxic, generating huge losses at UBS over the last year.
And after Fortis was divided up earlier this month, with the Dutch government nationalizing local operations, and Belgian authorities selling most of the remainder to BNP Paribas, experts found that it owned more than 10 billion euros worth of toxic, illiquid securities. As part of the deal worked out by Belgian authorities, those mostly American asset-backed securities have been placed in a separate “ring-fenced” entity, meant to quarantine them from more valuable holdings. As part of the deal, Belgian taxpayers got stuck with nearly a quarter of this hard-to-sell portfolio.
At Dexia, a French-Belgian lender to municipalities that was saved by a government-led $9.2 billion capital injection in September, the difficulties can also be traced to a similar mix of hazardous American securities and European mishandling of them.
In 2000, Dexia entered the fast-growing market for municipal bond insurance in the United States, acquiring Financial Security Assurance. To lift profits, the unit relied on credit default swaps and other now beaten-down derivatives, ultimately draining Dexia’s capital and forcing the recent government intervention.
“Using credit-default swaps was cheaper, but it was opaque and the board of Dexia couldn’t follow all that,” said one government official who was involved in the rescue. He spoke on condition of anonymity because he was not authorized to discuss internal matters.
Officials from Dexia and Fortis declined to comment.
Even worse, added this official, oversight of Dexia was split between Paris and Brussels. French regulators oversaw the unit of the company that included Financial Security Assurance, while Belgian authorities were responsible for monitoring the entire company.
“Nobody understood it,” the government official said.
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