The banks' version of the Spanish flu epidemic


I heard a joke the other day that seems very pertinent to the current situation.
“A Greek, a Portuguese and an Irishmen go into a bar.” The punchline is.... “It’s the German who pays!”

It really comes home when a statistic provided recently stated that one sixth of the US population lives below the poverty line and 25% of the US salaried workforce is just one month away from living in a cardboard box, as they have absolutely nothing in reserve. But perhaps we should not be poking fun at these economies, because we are actually in the same damaged boat as them. The hole may be at their end of the boat but the result will be the same for all of us.

History recounts that, immediately after the Great War, a major Spanish flu epidemic swept the world, taking with it more victims than the War itself. Are we now entering into a banking contagion on a similar scale? It has been known for a while that a good many world banks are still barely clinging on to life and the sound of them slipping is like fingernails scraping down a blackboard. The screeching sound only makes matters worse because confidence is a major factor in this crisis. As the screeching increases and confidence wanes, the banks may even cease to have contact with the blackboard and may go into free fall. 

It seems that short-term cash positions are being covered by the European Central Bank. It is the longer term capitalisation that is causing concern. And the horror doesn’t lie just with the Franco-Belgian Dexias of this world. Yesterday I even heard Deutsche Bank’s name mentioned in the context of their inability to get their hands on long-term funds. At this point what starts as a governmental problem becomes a world problem as the contagion of no confidence spreads.
Add to this dynamic the position with credit default swaps. To explain these I will have to go off on bit of a tangent and will compare them with the humble straw basket. Straw baskets are extremely strong. However, an individual piece of straw is quite weak. When straws are woven together the effect is of hugely increased strength. Credit default swaps are similar. They are the structure by which world banks are interlinked and provide support to each other. If only one bank is weakened the rest can still support the structure, but when all become affected simultaneously the combined strength of the structure starts to break down.
As the credit default swaps are traded, the lack of cashflow supply to affected banks becomes apparent. Those banks then find it hard to raise capital, increasing the seriousness of the situation. In short, it is as if the bank has caught the Spanish flu.
The problem lies with the marketplace trying to guess which banks have the most sovereign debt, that is to say monies lent to foreign governments. Add to this the problem of overweight commercial debt in national economies that are already having problems, and you have a recipe for true disaster.
Without doubt, bank capitalisation in both the UK and Scandinavia is more robust than it is in Europe, Japan and the USA. Some see this as a kind of protection against the contagion. However, it only takes an economy like Ireland to follow Greece off a cliff and it will bring a world of troubles onto British banks. Everything is interlinked and nobody can isolate themselves and escape.
This contagion of confidence is unique as there is nothing that the banks themselves can do about it, except possibly to look to be shored up by IMF capital.
In reality, the halting of the contagion is down to European governments reaching an agreement with each other. They need to ensure that the follow on from Greece is not Italy, Spain, Portugal and Ireland. Perhaps it would help if Italian politicians could remember to keep their trousers on and do more about running their country than their libido. It would also be beneficial if major and minor political parties in Slovakia could stop trying to point score off each other and ratify the support package for Greece.
Shedding a light on this in commercial broker terms, I think that, until this is sorted out banks’ pockets will get longer but their arms will get shorter. In other words they will think of every reason to extend out the credit process and not complete on deals in the short to medium term, as they cannot be seen to be committing to large tranches of long term debt.
Things on the street may get a lot tougher for all of us. The only ray of light is that advance fee fraud was highlighted nationally on the news yesterday. It was in part vigilance in our own community that brought this to court.
It only remains for us to hope that politicians across the world can come up with a strong combined position, based not on individual interest but on the greater good.