Wednesday, February 18, 2009

European Banking & Deposit Guarantees

There is justifiable discussion surrounding the Irish (and other EU members) banking industry and the government guarantees supporting customer deposits. 

This is a very important issue for Intrade.  It is one that we monitor closely on a daily basis. We do not take risks with customer funds.  We have diversified the institutions where we hold segregated customer funds and the underlying government guarantees are not all from Ireland. 

In the unlikely event of a single bank where we maintain funds defaulting and the government (Irish, Danish, UK or wherever) who has guaranteed those funds being unable to honor its guarantees (including an inability to access national reserve fund assets, support from the markets, from fellow members of the EU or the ECB itself etc) it is theoretically possible that all funds we have placed on deposit would not be easily accessible. In such a remote eventuality then the company from its own capital base (held at various institutions) would cover any theoretical shortfall. 

While I appreciate the above is hypothetical, and I believe highly remote, on a far more practical level let me make a very respectful suggestion, one that I do not make facetiously or glibly. For anyone who is seriously worried about the full recoverability of their funds at any institution, Intrade included, they should periodically test the institution in question by seeking a withdrawal in whole or part. 

Perhaps the above comment may be taken and reported on as a recommendation to withdrawal funds from Intrade or other institution, but my motivation is not to cause withdrawals but to encourage the people who have understandable concerns to remove those concerns by considering risk reduction actions. 

As additional information becomes available I will post it here. 

Personal note:  I personally bank at the retail level the same banks where Intrade segregated customer funds are maintained at the corporate level. I do not believe the banks where Intrade segregated customer funds are maintained have any material default risk although I do believe further recapitalizations will be required. Furthermore I do not believe the Irish government will be unable to access additional funds to finance our growing deficit but I am aware that Irish credit default swaps.  

The following article from Bloomberg this morning is insightful. 

Germany and France may be forced to contemplate the bailout of entire nations rather than just individual banks as European government budgets buckle under the weight of recession.

German Finance Minister Peer Steinbrueck became the first senior policy maker to broach the topic this week, saying some of the 16 euro nations are “getting into difficulties” and may need help. French officials are also concerned about market tensions as the cost of insuring Irish, Greek and Spanish debt against default rises to records and bond spreads widen.

The nightmare for Angela Merkel and Nicolas Sarkozy is that widening deficits will prompt investors to shun the debt of some countries, sparking a region-wide crisis. While few investors are yet forecasting any defaults, the mere risk of it may prompt the bloc’s two richest economies to ignore the European Central Bank and announce their willingness to come to the rescue.

“When push comes to shove Germany, France, the larger players will bail out those smaller peripheral players,” said Alex Allen, chief investment officer of Eddington Capital Management. “You can’t let one part of the system fail because it leads to failure of the whole system.”
Allen’s betting that the risk at least one nation will leave the bloc is higher than the market currently expects.

Swelling Deficits
European deficits have ballooned as governments from Berlin to Dublin committed more than 1.2 trillion euros ($1.5 trillion) to save their banking systems from collapse. The situation will be underscored by the European Commission today, when it publishes a progress report on budget policies at 11.15 a.m. in Brussels.

The European Union’s executive arm forecasts a deficit of 11 percent in Ireland, 6.2 percent in Spain and 4.6 percent in Portugal this year. The euro region’s average budget gap was just 0.6 percent in 2007.

European officials have already expressed concern that their bond market could potentially face a crisis similar to that unleashed by the collapse of Lehman Brothers Holdings Inc. in September. ECB board member Lorenzo Bini Smaghi said Feb. 12 there’s a “risk that the mistrust that there is today in financial markets” is “transformed into mistrust in states.”

“I would be very reluctant to say: ‘O.K., let Ireland or Greece default, the market will sort it out, punish them for their irresponsibility of the past,’” said Thomas Mayer, co-head of global economics at Deutsche Bank AG in London. “They tried it with Lehman and realized that was not a good idea.”

Bond Spreads
The gap between the interest rates Greece, Austria and Spain must pay investors to borrow for 10 years and the rate charged Germany yesterday rose to the widest since before they adopted the euro. Credit-default swaps on Ireland rose to a record on Feb. 16, climbing to 378.4 points.
Greek credit-default swaps, 270 points on Feb. 16, show a 4.5 percent chance that the country will default in the next 12 months, according to ING Bank NV.

Eddington Capital’s Allen, who runs a fund of hedge funds, says the market currently “vastly underestimates” the risks and expects credit-default swaps for Greece, Italy, Spain and Portugal to double in the next 12 months.

Any state-funded rescues may meet with opposition from the ECB, which has repeatedly said the Maastricht Treaty forbids bailouts.

“The no bailout rule is an important pillar on which the European Union was founded,” says ECB Executive Board Juergen Stark, who helped draw up the fiscal rules underpinning the euro.

No Bailout?
At the same time, the treaty says that EU nations can grant financial assistance to a member state if a country is “threatened with severe difficulties” caused by “exceptional occurrences beyond its control.”

“The member countries are working hard on a ‘pre-emptive de facto bailout’ to prevent the test of the ‘‘no bailout’’ clause,” said Juergen Michels, an economist at Citigroup Inc. in London.
Part of the problem policy makers now face stems from the fact the currency union does not have a single treasury and relies on the Stability and Growth Pact, which has been breached in the past, to keep budgets in check. Billionaire investor George Soros said yesterday the region’s economy must confront the problem posed by the lack of a Europe-wide finance ministry.
For now, finance officials say that market concerns are not justified. ECB President Jean-Claude Trichet said in Rome on Feb. 14 he’s confident countries will work towards sustainable public finances.

State Rescue
Greek Finance Minister Ioannis Papathanasiou said three days earlier the extra interest rates on his country’s debt were unjustified. Spain’s Deputy Finance Minister Carlos Ocana categorically ruled out a default on Feb. 16, and the Irish Finance Ministry warned yesterday against drawing conclusions about public finances from the CDS market.
Steinbrueck’s comments nevertheless suggest that views in Berlin are shifting as the financial crisis worsens.

“In reality the other states would have to rescue those running into difficulties,” he said Feb. 16. Steinbrueck said that Ireland was in a “very difficult situation.”

“There will have to be some kind of support package for some of the smaller economies to avoid the tension and speculation about breakup,” said Ken Wattret, senior economist at BNP Paribas SA in London. “The bigger national governments will say this isn’t our problem. But when push comes to shove they might need to provide some kind of financial support.”

To contact the reporter on this story: Emma Ross-Thomas in Madrid