The Financial Crisis. Has Europe found the solution to the global financial crisis?
11 / 12 / 2008
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Following Britain’s lead in the recapitalisation and partial nationalisation of banks, the EU countries have far outstripped the much hailed US bail out fund of 700 billion US Dollars approved by the US Congress the last week. What is more significant is that the EU measure seems to have done the trick. While the approval of the US fund was received by Wall Street and other exchanges with indifference, the EU measures approved last week-end have been received with record breaking surges in stocks in all the main stock exchanges of the world.

As early as July of 2007, the first signs of trouble from sub-prime loans started to emerge and banks throughout the world have spent most of the last year coming to terms with the real value of their balance sheets. In the process they have had to admit that a large proportion of their assets are worthless. This in itself was enough to create mistrust amongst banks and the ensuing credit crunch that has worsened over the last twelve months.

When banks do not lend to each other in sufficient quantities, they cannot meet their short term obligations and hence cannot afford to lend money to business and individuals for fear that they may need the cash themselves to keep solvent. The credit crunch, as this is known, then has a domino effect on the whole economy because business cannot function without finance.

What brought the whole matter to a climax was the demise of Lehman Brothers. This important American bank was allowed to go under by the US authorities who did not wish to be associated with bailing out what are seen to be greedy, wealthy institutions that bet other people’s money in risky financial products. This decision, which was probably the right thing to do, was taken, however, at the worst possible moment.

Lehman Brothers was very conspicuous in a specific money market fund. This is the kind of fund used by banks to lend to and borrow from each other. As a consequence of the bankruptcy, this fund “broke the buck” which means that it was unable to fully repay the amounts deposited in it by banks. It was the first time this had happened since the great depression and it was enough to break the little trust banks had left in each other, grinding the money markets to a complete stop.

Because of the huge crippling effect this has had on the global economy, the governments of all the main countries in the world have realised that action had to be taken and had to be taken fast. Vast amounts of money, in Spain 15% of the national wealth, have been applied by governments to fund a cocktail of measures ranging from guaranteeing money markets and deposits to directly investing in banks, effectively nationalising them in the process, with the objective of reinstating trust amongst banks and to get them to lend to each other again.

The recovery of the stock market this week could indicate the end of the financial crisis as far as the banks are concerned. However, much of the damage has been done to the world economies in the broader sense. Businesses are going under in the general slow down and unemployment is rising. The basic remedies are in place but like most medicines, the cure takes a little longer.

Joseph Fay Viota - Partner at UHY Fay & Co

Published in the International Tribune (10/10/2008)

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