European bank stocks continued to take a beating on Tuesday following a series of ad hoc steps by national governments to try to shore up confidence in financial institutions. By the day's close, Britain's troubled HBOS was down 41.5%, and the Royal Bank of Scotland's shares had lost 39% of their value; Germany's Commerzbank fell 14%, and Deutsche Bank was down 8.9%. The pummeling followed a black Monday in which stock exchanges across Europe dropped as much as 9%, suggesting that the markets were casting a doleful eye on the $700 billion U.S. bailout package passed by Congress on Friday.
Europe was looking askance not just at the U.S., but also at tiny Iceland, whose government on Monday completed what amounts to an emergency seizure of its oversized banking sector. Prime Minister Geir Haarde went on television Monday night to warn his compatriots that "the Icelandic economy, in the worst case, could be sucked with the banks into the whirlpool, and the result could be bankruptcy." That's not just talk: Iceland's GDP amounts to less than one-tenth of the total assets of its three biggest banks, all of which are in trouble. British financial authorities warned on Tuesday that Icesave, a subsidiary of Landsbanki, Iceland's second biggest bank, might not be able to pay out the estimated $7.8 billion in deposits of some 300,000 British customers, who would then have to file claims to deposit guarantees set by Iceland and Britain, which would cover up to $87,000 of an individual's savings. One London-based customer said she had tried over a week ago to withdraw her money from Icesave but was told she could not. "I didn't think it was exposed to the mortgage market," she says. "Where did all that money go?"
But scary conditions elsewhere hardly drew attention away from the underlying weakness in Europe's own supervision of its financial institutions. Most of the continent is conjoined into a political union of 27 countries, 15 of which use the euro under the monetary authority of the European Central Bank. But as the recent days' fraught activity has proved, coordination between governments on fiscal and supervisory measures remains strictly voluntary.
Europe's bank-by-bank, country-by-country fixes of its endangered banks have so far failed to bolster the confidence of investors and depositors. "Europe must prepare to put in place a collective line of defense," Dominique Strauss-Kahn, director-general of the International Monetary Fund, said in a speech in Paris on Monday. "The stability of the world economy is at stake."
European governments can certainly talk the talk of coordination. Following a meeting with Italian Prime Minister Silvio Berlusconi in Berlin yesterday, German Chancellor Angela Merkel said, "We both agree that Europeans of course need to display a coherent course of action." President Nicolas Sarkozy of France, which currently holds the rotating E.U. presidency, read on television a common statement from all 27 members pledging to adopt "all necessary measures to protect the stability of the financial system."
But those words have been notably lacking in any concrete policy to back them up, particularly with the crisis moving so rapidly. "Uncoordinated rescue operations, far from restoring confidence, are further fueling fears among savers and investors," said Daniel Gros, director of the Center for European Studies in Brussels. Such actions are pushing Europe "toward a full-fledged banking crisis," he said, with the "likelihood of a serious economic downturn [looming] ever larger."
There was a modicum of cooperation on Tuesday, when E.U. finance ministers, meeting in Luxembourg, agreed to increase the minimum value of deposits guaranteed by member states to $68,000, from a previous floor of $20,000. But beyond that, there appeared little movement toward international coordination. On Monday Germany reaffirmed its determination not to participate in France's plan for a Europe-wide bank bailout plan, modeled on the U.S.'s $700 billion effort. Without Germany's participation, no such plan can proceed. "The Chancellor and I reject a European shield," German Social Democrat Finance Minister Peer Steinbruck told German radio on Monday in reference to the plan, "because we as Germans do not want to pay into a big pot where we do not have control and where we do not know where German money might be used."
The comments came a day after Merkel befuddled her neighbors by announcing a guarantee on 100% of all private deposits the largest such guarantee in history, according to one leading banking expert. The fact that Ireland had previously issued an even more sweeping guarantee hardly shielded Germany from criticism: as Europe's biggest economy, it sets a massive precedent. Indeed, since Merkel's announcement, Denmark, Sweden and Austria have taken steps to offer stronger guarantees to their depositors. Spain is reportedly considering a move to follow suit, and British politicians were in talks with banks on Monday night about a stopgap measure to inject government funds into selected institutions.
German officials say the guarantee was necessary to shore up confidence, not least because Germans hold a higher proportion of their savings in banks than citizens in many industrialized nations and they still harbor a deep collective memory of the perils of economic uncertainty from the interwar years of the Weimar Republic. "We had to do it," says Reinhard Schmidt, a professor of international banking and finance at Goethe University in Frankfurt. "I have friends. I have neighbors. I have family. You wouldn't believe how many people have been calling me to ask about their deposits. The fears are extremely strong now."
Germany's refusal to sign on to a Continent-wide bailout plan was no less necessary, says Schmidt. Such a plan would have triggered a backlash in Germany against the E.U., egged on by the ready arguments of the anti-Europe German press that Germans were paying to bail out other Europeans, he says. "It would have destroyed the idea of European integration," he says.
Which still leaves the problem of how to address the broader crisis now that the country-by-country approach appears to be failing. Gros recommends a common European scheme to shore up capital of distressed banks and the establishment of a "clear center of joint responsibility for the supervision and liquidity support of cross-border European banks," which he says should be housed in the European Central Bank. (At present, the chief tool available to the ECB is lowering interest rates.)
If a shock is what is needed to restructure the banking rules in Europe, one may be underway. Economists are warning that the Continent is facing its biggest crisis since the Depression when Europeans also first mistakenly thought the problem would remain confined to the U.S. One leading German politician, Interior Minister Wolfgang Schauble, even raised the specter of the kind of longer term economic dislocation that led to the rise of Adolf Hitler. "Four months ago," says economist Schmidt, "I might have said that it may not get worse. But we have not seen anything like this before. I cannot say that we have reached the bottom. I am afraid that may not be the case." With reporting by Catherine Mayer / London