Although financial authorities in the US and other countries are now criticised for treating the crisis that emerged in July/August 2007 as primarily a crisis of liquidity – with which they dealt well – whereas important systemic solvency issues underlay it, there is no doubt that action to deal with the particular banks that came under particular pressure was in general prompt and decisive.
Thus, that governments in Europe and the US were not slow to contain emergent solvency problems at specific banks from the start of the crisis in July/August 2007 is evident from the treatment of such entities as Sachsen Bank, IKB bank, and Northern Rock in July-September 2007, Bear Stearns in March 2008, Indymac, Roskilde Bank, Freddie Mac and Fannie Mae in June-September 2008, among others. But not before September 2008 was there a full recognition that solvency problems could be broad-based.
The much-discussed events of the middle weekend on September 2008 culminated in the bankruptcy of Lehman Brothers on Monday, 15 September. The decision not to save Lehman Brothers now appears to be regretted by most of those concerned, though the decision to allow the failure had its defenders at the time, given the moral hazard of repeated bail-outs, and the fact that Lehman Brothers was an investment bank – not an insured bank.
Following this shocking event – the largest bankruptcy in history – containment measures by the authorities gathered momentum. In particular, the two weeks before the introduction of the Irish guarantee saw an accelerating trend of bank rescue actions by governments to contain emergent problems and try to prevent the spread of the crisis.
This started in the US, which was already exploring system-wide interventions, but by the weekend of 25 September had spread to Europe where some large individual banks had to be dealt with.
First, the large US insurance company AIG, which had been a key player in providing credit insurance products to large commercial and investment banks, was nationalised and recapitalised on 16 September. The announcement on Tuesday 16 September that
the net asset value per share of a sizeable, famous and long-established US money market mutual fund, Reserve Primary, had fallen below the target floor of $1 (―breaking the buck‖), as a result of losses on Lehman-related assets, prompted huge withdrawals – amounting to 5 per cent of the total – from other money market mutual funds. This prompted the US Treasury to introduce, on Friday, 19 September, a $50 billion insurance programme allowing money market funds to insure themselves (for a fee) against ―breaking the buck‖. The program stabilised the liquidity of the money market segment.
That same day (19 September), the US Treasury Secretary initially recommended to Congress the creation of a very large program, eventually called TARP, to stabilise the banking system. The initial design envisaged that the funds would be used to buy up toxic and hard-to-value mortgage-backed securities from troubled banks (though in the end the funds were used in a quite different manner). The rejection by Congress of this proposal on Monday, 28 September, was a destabilising factor for the markets.167 The 7th largest US bank Washington Mutual (WaMu) was intervened by the FDIC on Thursday evening 25th September following deposit withdrawals totalling $17 billion in the previous 10 days. Its mortgage book and deposits were sold to JP Morgan, but its debt (senior and subordinated) with a face value of $23 billion was left to recover what it could in the bankruptcy.
UK mortgage lender Bradford and Bingley was also nationalised and the retail business sold to the Spanish bank Santander over that weekend, following downgrades by rating agencies and withdrawal of its license on Saturday 26th by the FSA with the shares being suspended as from the opening of business on the Monday. The UK Government promised to repay all outstanding unsubordinated wholesale deposits and borrowings when due, and to continue this guarantee for a period of six months.
In a complicated three-government rescue, Fortis was part-nationalised over the weekend and supported with promised injections of capital and, as was subsequently made public, a massive ELA line of credit. This was not sufficient to restore market confidence however, and the bank‘s share price fell sharply on Monday and it continued to suffer outflows for the rest of the week until a revised package was announced the following weekend.
167 The scheme was eventually approved in modified form on 3 October.
The Fortis Case
Fortis was structurally a liquidity-deficit bank. Because of a capital weakness following its over-ambitious participation in the purchase of ABN-AMRO (a purchase designed in part to strengthen its structural liquidity position), it was, from June 2008,168 seen as a vulnerable bank and began to lose liquidity rapidly at end-September. By Friday 26th it suffered a silent run (unable to raise its usual €15to €20 billion in the overnight interbank market) and started to lose institutional and retail deposits. That day it resorted to the ECB‘s standing Marginal Lending Facility (MLF) in the amount of €5 billion to meet its immediate liquidity needs. It was clear that it would not be able to get through Monday without defaulting, having exhausted its ECB-eligible collateral. A complicated three-government capital injection deal was negotiated over the weekend, with Belgian, Dutch and Luxembourg Governments announcing that they would inject a total of €11.2 billion between them to acquire 49.9% of the group. ELA was also authorised (but not announced at the time).
Despite being described by the Dutch Ministry of Finance in a statement as offering a
‗solid guarantee‘ to ensure financial stability and protect the interests of account holders at Fortis and ABN AMRO, these measures were insufficient to boost market confidence on Monday. Indeed, the bank was downgraded and its share price fell sharply on Monday.
By Friday October 3rd, according to the Shareholder Circular and the Panel of Experts‘
report (p. 49), ELA drawdown reached €61 billion, out of €65 billion that had been authorised (€58 billion from the Belgian National Bank and €7 billion from the Netherlands Bank – in addition to classic ECB funding and drawings on the MLF and the US Federal Reserve‘s discount window). At this point a second round of equity acquisitions and capital injections from governments was undertaken, leaving the Netherlands subsidiary wholly in the hands of the Dutch government and with the French bank BNP acquiring most of the remainder of the banking assets. (The Dutch government statement did not provide a general explicit guarantee.169 However, it did guarantee the long-term debt of the Dutch subsidiary to the Belgian parent in the amount of €16 billion). After that weekend, ELA declined speedily with the payment of €51 billion from the Netherlands government and with additional funding from BNP. (The use of ELA had fallen to €6 billion already by 9 October).
The German bank Hypo RE, which had acquired Irish-based DePfa in 2007, was bailed out early in the morning of Monday, 29 September, by a consortium of German banks and the Federal Government, reflecting the funding difficulties of the highly leveraged DePfa (as well as – it later proved – solvency issues in the parent). (This particular deal fell through but was replaced on 4 October by another deal involving banks and the Bundesbank). Total funding required was €50 billion.
Dexia hit problems on Monday, 29 September, with a sharp fall in its share price. The following day Moodys downgraded its intrinsic strength to C-. Expected losses from
168 When a capital need of €8.3 billion was announced.
169 It stated: ―This provides a strong safeguard for all those involved in these institutions and for the stability of the Dutch financial system. Under the current exceptional circumstances, the interests of account holders and other parties concerned must be safeguarded.‖
its US subsidiary and a large loan to DePfa were mentioned as causes. Rescue measures involving a capital injection of €6 billion and a government guarantee covering new borrowings,170 plus ELA from BNB, were announced on 30 September.
Intervention by FDIC and the sale of the 6th largest US bank Wachovia to CitiGroup was announced Monday, 29 September. (The deal was subsequently renegotiated with Wells Fargo as the buyer – at no cost to the FDIC). This followed withdrawals of €26 billion by corporate depositors, or one quarter of their total, mainly in the last days of September.
Bearing in mind the Congressional rejection of the first version of the US TARP plan that day also, this, then was the state of play on the evening the Irish authorities faced the decision to introduce its blanket guarantee. The crisis continued to deepen over the following days with, for example, the UK starting, without publicity, to extend ELA facilities to HBOS (from Wednesday 1st October) and RBS171 (six days later), before the summit meetings later in the month that led to the coordinated cross-country announcement of huge rescue packages – not all of which were subsequently drawn down.
While the range of containment measures finally adopted was wide, including equity, preference share and hybrid capital injections, asset insurance and loss-sharing agreements, assisted and encouraged mergers, asset purchase programmes, guarantees for depositors and other creditors, and emergency liquidity provision, it is worth noting that most, if not all, of these had already been employed in the period from August 2007 to the day of the Irish guarantee.
170 The guarantee covered Dexia's liabilities towards credit institutions and institutional counterparties, as well as bonds and other debt securities issued for the same counterparties, provided that these liabilities, bonds or securities were falling due before 31 October 2011 and had been contracted, issued or renewed between 9 October 2008 and 31 October 2009.
171 The peak drawings from the two banks totalled £62 billion by mid-November, and HBOS had not fully repaid it until mid-January 2009.
ANNEX 4: DEPOSITS, BONDS, SUBORDINATED DEBT, AND THEIR