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Opinion

Macaskill on markets: A Greek default could be Europe’s Lehman crisis

Growing concern in the US that a Greek default could prove to be Europe’s equivalent of the Lehman Brothers collapse threatens to exacerbate trans-Atlantic tensions and spoil trading prospects for global investment banks.

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

There are eerie similarities between the prelude to the last credit crisis and events in the past month – including the way that relatively obscure short-term financing arrangements are bubbling to the top of investor concerns.

European bank reliance on short-term financing from US money-market funds has previously been uncontroversial, for example.

An estimate by Credit Suisse analyst Daniel Davies that European banks were borrowing more than $1 trillion by the beginning of June from US money-market funds, much of it on a daily rollover basis, drew attention to the scale of the funding. Deutsche Bank led the list of European borrowers from the top-five US money-market funds, at almost $20 billion, according to Credit Suisse, followed by the big French banks.

Credit Suisse pointed out that much of this investment constitutes a supply push by funds looking for a small pick-up on domestic yields, while investing in the strongest European financial credits, rather than demand from the banks themselves. But money-market funds are risk-averse and could turn off the tap on this financing overnight at a hint of concern from their regulators about the strength of the big European banks.

Hints duly started to come soon after the Credit Suisse report, both in the form of news reports sourced to unnamed SEC and Federal Reserve officials, and from politicians who convened a Congressional hearing on mutual-fund risks.

European Central Bank president Jean-Claude Trichet did nothing to calm jittery markets when he said that risk signals in the euro area were flashing red. Bank of England governor Mervyn King – increasingly resembling the PG Wodehouse character who once missed a very important train and vowed never to repeat the experience – then weighed in with a warning that UK banks were seriously exposed to problems in the peripheral eurozone area, even if only in the form of counterparty exposure to other banks.

Risk barometers such as the basis between Euribor and US dollar Libor duly widened sharply and bank stock prices fell. US money-market funds that were identified as having exposure to European banks started to see withdrawals in the last week of June and many are likely to cut their lending to Europe simply to avoid having to answer questions from investors.

The big European banks face no immediate funding pressure. Most of them pre-funded a large amount of their medium-term to long-term financing needs for 2011 when the debt markets were rallying in the first four months of the year. And their credit default swap spreads remain tight.

But indications of trans-Atlantic strains as the Greek crisis moves into a new phase threaten the fragile balance between cheap funding and active markets that investment banks rely upon.

Markets have already slowed down, as the commodity price plunge of May was followed by a fall in equity prices and a rise in credit spreads. Weak results from Jefferies, a small dealer that reports using the old US investment bank calendar, caused analysts to downgrade their predictions for the second-quarter earnings that will be announced by bigger banks in July and August.

The announcement of details of the planned capital regime for global systemically important banks that was outlined by the Basle Committee on June 25 will also affect longer-term earnings prospects, although perhaps with some unintended consequences.

The use of buckets to determine the capital surcharge for important institutions could create arbitrage opportunities, for example. The big three US universal banks will certainly be in the top bucket because of their combination of size and inter-connectedness. BNP Paribas and Deutsche Bank are also likely to be in this bucket, along with the three biggest UK banks. These firms can expect a capital charge in excess of core tier 1 requirements of 2.5%. The next bucket could include Goldman Sachs, Morgan Stanley, the two big Swiss banks, Crédit Agricole and Société Générale, and perhaps UniCredit. These banks are widely viewed as national champions that would be bailed out by their sovereigns in the event of distress, so a capital surcharge that is lower than for similar firms in the higher bucket amounts to a theoretical financing advantage. This advantage will not be on offer in practice for Credit Suisse and UBS, which already face a ‘Swiss finish’ of even higher capital requirements from their domestic regulator. But Goldman Sachs could receive a minor boost at the margin in its battle with JPMorgan for the mantle of leading global investment bank.

While that battle plays out in markets around the world, Goldman and JPMorgan can be expected to form an uneasy alliance in trying to head off US regulations that could place them at a competitive disadvantage to European rivals in such areas as derivatives trading.

Goldman has traditionally expended the most energy and money among banks lobbying in Washington, in the highly effective campaigning that gained it the nickname Government Sachs. But its brand is now so toxic in certain quarters that it has scaled back its efforts recently, or at least tried to lower its public profile. This has left JPMorgan to shoulder the task of leading the opposition to the aspects of regulatory reform that dealers think will hit their margins hardest.

JPMorgan chief executive Jamie Dimon increased the pressure on regulators in early June by upbraiding Federal Reserve chairman Ben Bernanke in a public meeting about the potential effect of higher capital requirements on lending by US banks. Then Barry Zubrow, JPMorgan’s chief risk officer, warned the House Financial Services Committee that a broad interpretation of derivatives margin collection rules in implementation of the Dodd-Frank Act passed last year would drive international swap business away from US banks.

JPMorgan is playing a risky game with its increasingly assertive opposition to aspects of regulatory reform and thinly veiled accusations of potential abuses by European rivals. In Congressional testimony on June 16, Federal Reserve Board governor Daniel Tarullo picked up on a point made earlier by Dimon by asserting that there was a surprising discrepancy in the way big European and US banks have been reporting risk-weighted asset calculations.

If JPMorgan’s lobbying results in US regulators making public remarks that undermine investor confidence in the big European banks – just as sovereign debt concerns are intensifying – another financial crisis could move a step closer. That certainly would not work in the interests of big US banks that are reliant on investment banking revenues – even ones that think they can shelter behind a fortress balance sheet, such as JPMorgan.

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