Tuesday, October 11, 2011

Massive Bank Bailouts in Western Europe and China

Bank bailouts are sweeping the world — and on a scale that could make 2008 seem like a mere fire hose. In Europe, Dexia is getting a Citibank-style deal, while in China, there are widespread problems with speculative municipal real estate projects that threaten the financial system.

Dexia, based on Belgium and France and a major presence in Luxembourg, is a multinational bank with a scale and complexity comparable to the Citibank of 1998, and word is trickling in of a bailout similar in scale to the Citibank bailout of 2008. The deal involves about €90 billion in government guarantees for parts of its loan portfolio for the next 10 years. At the same time, the biggest operating divisions of the bank will be sold off. In particular, the Belgian government is buying Dexia Bank Belgium with its €80 billion in deposits.

Observers assume similar deals will follow for other European banks, including one or more in Germany, as various classes of assets lose liquidity in the coming weeks. Most large European banks got high marks in recent stress tests, but then so did Dexia, as the tests failed to consider the possibility of any decline in liquidity for most kinds of bank assets.

In China, the central government’s sovereign wealth fund is seeking to prop up the stock market by purchasing shares in the major banks there. The stock purchases Monday were only perhaps $50 million and didn’t move the market, but that may be the point. If the stock purchases continue through next year as planned, they may stave off or slow down a stock market collapse.

Banks in China hold huge portfolios of distressed real estate loans for projects ranging from railroads and dams to shopping districts and suburban housing developments. These projects were mainly directed by local governments, not independent private developers and builders, but other than that detail, the situation has a striking similarity to the real estate bubble that continues to weigh on the economies of Western countries such as the United States, Ireland, and Spain. Recognizing the situation, banking regulators in China are directing banks to lend less on real estate projects. Meanwhile, the central bank and other government entities are taking steps to keep the banks solvent. But the scale of the loans is such that no one knows whether such a plan can work. In any event, it will be a bumpy ride for the Chinese economy, where development projects were said to account for most of last year’s GDP. If the pace of new projects is cut back by half, it could be a hard landing for the national economy, but if the development projects are not reined in, the results could be worse.