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The EU agrees to guarantee bank borrowing

The European Union has finally shown that it can get Europe-wide crisis initiatives of significance passed. Not only many EU countries guarantee bank deposits, but now bank borrowing has been backstopped as well. At first blush, this looks like a measure that has teeth to it, but we will have to read the fine print to see whether this is the right solution and whether it does have teeth.

I am less than enthusiastic about general bank debt guarantees as a way to stop a financial crisis. Preferable is this lender of last resort role in the interbank lending markets. I would like to see something done in the commercial paper market as well. But, I will reserve judgment until I hear more.

European leaders agreed to guarantee bank borrowing and use government money to prevent big lenders from going under, trying to stop the financial hemorrhage and stave off a recession.

At a summit chaired by French President Nicolas Sarkozy, leaders of the 15 countries using the euro offered their most detailed battle plan yet for bandaging the crippled credit markets and halting panic among investors.

“We need concrete measures, we need unity, which is what we achieved today,” Sarkozy told a press conference at the Elysee Palace in Paris. “None of our countries acting alone could end this crisis.”

As they improvised a response to the banking calamity that started on Wall Street, Europe’s leaders sought to go beyond pledges made by the Group of Seven and to deflect criticism that they are taking scattershot country-by-country steps without a credible joint strategy.

The key measures announced today are: a pledge to guarantee new bank debt issuance until the end of 2009; permission for governments to shore up banks by buying preferred shares; and a commitment to recapitalize any “systemically” critical banks in distress.

France, Germany, Italy and other countries will announce national measures tomorrow, Sarkozy said.

“I don’t even want to imagine what might happen” if the markets react negatively, Klaus-Peter Mueller, head of the German banking association, said earlier today in Washington before the blueprint was unveiled. The market response may be something “we haven’t seen at any stage in our lifetimes.”

A communiqu gave no indication of how much governments are willing to spend or the size of bank assets deemed at risk, leaving unclear the ultimate cost to the taxpayer.

-Bloomberg News

UPDATE – The BBC reports the following:

French President Nicolas Sarkozy said they were taking unprecedented steps.

World governments have been racing to throw banks a lifeline before the major markets re-open on Monday.

News of the rescue plan came from Mr Sarkozy – whose country currently holds the rotating presidency of the EU – after talks between leaders of the 15 countries in the euro currency zone.

UK Prime Minister Gordon Brown – not a member of the eurozone club – attended parts of the talks.

Britain announced a similar plan last week.

Mr Sarkozy said leaders had agreed a framework in which individual countries would be able to inject capital into their own banks by means of preference shares.

He said governments in Germany, France and Italy among others would be presenting their individual plans on Monday, within the agreed framework.
-BBC News

This BBC report makes it clear that the EU plans to do the following:

  1. Backstop inter-bank lending
  2. Provide bank deposit guarantees where necessary
  3. Inject preference share capital directly into banks where necessary.

This is the right solution and I commend these steps. This counts as three of the four steps that I recommended last Sunday.

Related post
The Europeanisation of the Credit Crisis

Foreign-language sources
Euro-Gipfel spannt Schirm über gesamtes Banksystem – FTD
Euro-Gipfel beschließt Krisenhilfe für Banken – Spiegel

Sources
European banks rescue plan agreed – BBC News

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.