The new IMF managing director, Christine Lagarde, has raised doubts about the financial system in Europe. A couple of weeks ago, she said that European banks needed to be recapitalized... Did she talk because she knew what is going on after closely work within the European institutional system before join the IMF? The immediate reaction from European authorities like the ECB was to deny these needs.
Soon after the IMF also advised about the risks of a new recession, something that got an immediate response with the stock markets returning to their free fall, particularly punishing financial institutions. So, what is going on?
The marriage between governments and banks during the crisis has reached a dangerous point of no return. In 2008, faced with the aftermath caused by the collapse of Lehman Brothers, governments quickly came to support and provide help to the financial system. Now is the government debt what is weighing on bank´s balance sheets, on top of a stalled economic recovery. Banks have portfolios full of sovereign debt that could result in huge losses in case any government defaults, a fear we are all feeling when it comes to Greece.
Investors are wondering how far these defaults can go, considering several worst-case scenarios, including euro´s disappearance. As a result, interbank funding is freezing again. And this can be proved by the high amounts of funds deposited in hands of the ECB, since financial institutions prefer to leave their funds under the safety of the Monetary Authority than to borrow them to other banks. At the same time, governments are scratching their pockets, but they can´t find any more capital to prop up the financial system again. So, ? what solution can save the financial troubles of this marriage?
The chairman of Deutsche Bank said yesterday that banks can´t account in their balance sheets the full impact of their exposure to sovereign bonds at current market prices because many would fail and collapse. Joseph Ackermann warned that the situation was too similar to the panic lived in the days after Lehman´s collapse. So some suggest that losses can be slowly recognized. They also think it's unlikely that all the projected losses will materialize, including the IMF figures, that account potential of 200,000 billion dollars. Also, they take in consideration that the ECB provides liquidity to the industry.
However, the problem has moved now to the States and is increasingly growing. The contagion has hit Paris, and Rome is still planning its adjustment programs. At some point, Trichet is not going to be able to provide for everyone that is why Lagarde has called for action, providing liquidity directly into banks, as the US did during the financial crisis. With regard to Spain, Solbes complained that we are still in the first restructuring of our financial system and asked the Bank of Spain to recapitalized as soon as possible.
There is no time to lose. There was an excess of debt that must be digested or removed. We have to clean up and then recapitalize institutions, with the help of the EU´s rescue fund. The ECB may give a temporary solution to deal with the upcoming bond maturities, but Europe needs to realize that this marriage does not work. Its banks are still sick and not receiving any treatment.
