A month ago, the former UK Finance Minister, Alastair Darling, warned that the European Central Bank (ECB) had “to recognise they have to be the lenders of the last resort”.
He added that “This is far worse than the banking crisis of 2008 in its seriousness and, if it is not solved by Christmas, I think the whole of the euro will break up.”
Last Thursday, Darling was proved correct. The ECB provided an unprecedented €489bn ($635bn) in 3 year loans to 500 banks across the region. Otherwise, many of them would have gone bankrupt, and the Eurozone would indeed have broken up.
The reason for the near-disaster goes back to our old friends, greed and stupidity:
• Greed. Eurozone bankers – supported by governments – have maintained the fiction that they have sufficient reserves. This has allowed them to continue to make risky loans to the PIIGS (Portugal, Italy, Ireland, Greece, Spain).
• Stupidity. They seemingly failed to realise their source of deposits was about to dry up. As the above chart from the IMF shows, Eurozone banks have been dependent on the overnight ‘wholesale markets’ for 45% of their deposits, far more than any other region. And they have done little to reduce this risk since the IMF first identified it 3 years ago.
The IMF itself warned in April that they were playing a dangerous game:
“Moreover, a number of euro area banks have substantial short-term wholesale funding requirements. Current market conditions, with low short-term rates and a steep yield curve, may provide incentives for banks to maintain this short-dated funding. But such funding brings additional vulnerabilities given its high rollover rate and quick repricing. Some larger European banks also fund a significant part of their short-term positions in foreign currency, much of which is from U.S. money market funds. But this funding comes with further risks as it could be subject to quick withdrawal by money managers, as has been seen in the past.”
Once US money markets funds realised that Greece was bankrupt, they stopped lending money overnight to Europe. And at that point, the banks were on the road to bankruptcy, just as Darling had warned.
Last week, the ECB finally agreed to become the ‘lender of last resort’. But €489bn is a lot of money. When German and other North European taxpayers find out what has happened, they are unlikely to be pleased.