Europe’s financial system needs to take its debt medicine: Gottliebsen

Last night’s fall on Wall Street and the decline of the euro were highly significant. The global stock market is going to force Europe to recognise its banking problem and take the necessary medicine. But, as Icelandic banks found out, that medicine will be harsh. Australia may be affected because it could become tougher for our banks to borrow on international markets.

Last night’s fall shows that world stock markets have not yet priced in the inevitable fate of those banks that have been stupid enough to play the “high yield” game by investing depositors and shareholders money in European countries that face bankruptcy. It was a high-reward, high-risk game which went wrong and the banks have only themselves to blame.

Iceland has shown that there is only one way out of the problem – the banks have to take their losses by marking to market their poor investments, and then some of them will be recapitalised via the injection of new share capital.

The alternative system of endless European rescue packages to give the banks time to earn enough money to cover their losses will impoverish Europe for a decade and, as we are seeing in Greece, will spark revolutions.

Earlier this month, two events underlined where we are headed. Iceland made its first international bond issue since its 2008 collapse and it was subscribed at a respectable yield of around 5%.

By contrast, at the same time, the giant Spanish bank Santander had to rely on underwriters to make a $1.4 billion issue. Those underwriters will now be licking their wounds because they clearly did not understand what was ahead.

Because so many European banks are withholding their exposure to the effective bankrupt countries no one knows which banks to trust. We saw a similar situation in the sub-prime crisis. It was unsustainable then and it will be unsustainable again. It’s simply a matter of time before the truth comes out. Markets tend to be impatient.

In the case of Iceland, the situation was helped by the fall in the currency. The populations in countries like Greece, Portugal, Ireland and even Spain should be able to take some of the pain via a lower currency, but at the moment that natural process is blocked because they are tied to the same currency as Germany – the euro.

Naturally we are seeing the euro fall sharply under the weight of the problem, which greatly enhances the position of German exporters. Just as the banks must face the music so in time the world can’t have effectively bankrupt countries in a common currency with solvent countries.

The issue is not whether these events will come to pass but when.

This article first appeared on Business Spectator.


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