Bank run in socialist Europe begins

Europe: Annual Budget Deficit as % of GDP
Europe: Annual Budget Deficit as % of GDP

From CNBC.

Excerpt:

Money-market funds in the United States have quite dramatically slammed shut their lending windows to European banks. According to the Economist, Fitch estimates U.S. money market funds have withdrawn 42 percent of their money from European banks in general.

And for France that number is even higher — 69 percent. European money-market funds are also getting in on the act.

Bond issuance by banks has seized up because buyers have gone on strike.

From the Economist’s Free Exchange Blog:

In the third quarter bonds issues by European banks only reached 15 percent of the amount they raised over the same period in the past two years, reckon analysts at Citi Group. It is unlikely that European banks have sold many more bonds since.

Corporate depositors are also pulling their cash.

Free Exchange:

“We are starting to witness signs that corporates are withdrawing deposits from banks in Spain, Italy, France and Belgium,” an analyst at Citi Group wrote in a recent report. “This is a worrying development.”

And there are troubling signs that banks are even running out of collateral to back their borrowings from the European Central Bank .

So far the liquidity of the European Central Bank (ECB) has kept the system alive. Only one large European bank, Dexia, has collapsed because of a funding shortage. Yet what happens if banks run out of collateral to borrow against?

And from the leftist New York Times.

Excerpt:

The flight from European sovereign debt and banks has spanned the globe. European institutions like the Royal Bank of Scotland and pension funds in the Netherlands have been heavy sellers in recent days. And earlier this month, Kokusai Asset Management in Japan unloaded nearly $1 billion in Italian debt.

At the same time, American institutions are pulling back on loans to even the sturdiest banks in Europe. When a $300 million certificate of deposit held by Vanguard’s $114 billion Prime Money Market Fund from Rabobank in the Netherlands came due on Nov. 9, Vanguard decided to let the loan expire and move the money out of Europe. Rabobank enjoys a AAA-credit rating and is considered one of the strongest banks in the world.

American money market funds, long a key supplier of dollars to European banks through short-term loans, have also become nervous. Fund managers have cut their holdings of notes issued by euro zone banks by $261 billion from around its peak in May, a 54 percent drop, according to JPMorgan Chase research.

This is really disturbing. I wonder if any of my economics-minded commenters can explain to me what happens when there is a run on banks. I am guessing that there will be some rioting over benefits as austerity measures are imposed, and interest rates will go up.

5 thoughts on “Bank run in socialist Europe begins”

  1. I wonder if any of my economics-minded commenters can explain to me what happens when there is a run on banks.

    IANAE (that’s “I am not an economist”, cf. IANAL — I am not a lawyer), but here are my guesses.

    Mild: The affected banks can arrange for loans from other banks. Depositors are paid out and go home happy. In the medium term, the situation stabilises, but the affected banks may be obliged to charge higher interest rates on loans, offer lower interest rates to depositors, or charge higher service fees. This makes them less attractive to new customers, and may ultimately force them to the wall, the last remaining investors ending up out of pocket.

    Moderate: The banks are unable to meet their depositors’ demands, and the government is obliged to get involved in order to calm the fears of ordinary people who risk losing their money on deposit. The government offers to guarantee deposits. If they are smart, they in turn impose conditions on the banks, possibly up to and including nationalisation. Since they probably don’t have enough of a budget surplus to cover the shortfall, they must either raise taxes, increase the money supply (the same thing, by stealth), borrow from private lenders or foreign governments (increasing taxes in the medium to long term in order to repay debt), or some combination of all three. The currency drops in value, especially if the money supply is increased. The increased taxes depress economic activity and discourage foreign investment, causing loss of jobs and a further fall in currency value. The only ones really happy are the exporting sector and the tourism industry.

    Severe: The government is unable to secure loans, and must resort to immediate tax hikes or a massive increase in the money supply, the latter triggering significant inflation. Potential investors are seriously frightened, and current investors look for ways to get out. Business activity decreases sharply, and significant numbers of private-sector workers are laid off. Foreign lenders may get involved, but only on condition of significant austerity measures, creating the same circumstances in the public sector. The resulting decrease in consumer spending begins to create a vicious cycle. Both locally-produced and imported goods and services become increasingly unattainable. The standard of living visibly declines, and social conflict arises.

    Catastrophic: Confidence in the money economy is lost, and people pay in kind or by barter. Due to the resulting inefficiencies, economic activity decreases greatly, while the mechanisms for enforcing social order break down as members of the civil service and police force look to their own interests and those of their families and communities. Transport and communication links degrade, and brigandage begins to appear. Communities become self-managing. Eventually, war, famine and disease break out as medical services break down, inefficient farming practices re-emerge and people try to acquire what others possess by force. Great numbers of people perish, and many others are reduced to dire poverty. The country becomes a ripe target for neighbourly aggression.

    What do you think?

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    1. They can’t inflate the currency because it’s the Euro. They would have to drop out and that would be devastating to them. The more likely scenario is bailouts from Germany and France, with accompanying concessions. So far Greece has not laid off a single civil servant.

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      1. You’re right, of course (although I note that Greece was barely mentioned in the sections of the articles that you quoted). In Greece’s case, the inability to devalue their currency could prove to be a real problem, because it limits the available short-term policy responses. In Europe’s case, I see a grave risk that individual countries could take the money, not make the necessary changes to get back on track, and then come back demanding more money on the grounds that Europe dare not let an entire fellow nation come to financial ruin. Thus ultimately escalating the problem into a pan-European one.

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  2. Worse than the that it means the credit supply is choked off, businesses will be denied access to operating loans etc, payrolls won’t be met, job losses will result and the whole shebang spirals downward.

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