The tale of the bank

Once upon a time in Baghdad lived a Caliph and his Vizier. One day, the Vizier came to the Caliph, pale and trembling:
“Pardon my fright, Light of the Believers, but in front of the palace a woman bumped into me in the crowd. I turned around and this woman with pale skin and dark hair, her throat veiled by a red scarf, was Death. When she saw me she beckoned to me. Since Death is looking for me here, Lord, allow me to flee and hide far from here in Samarkand. If I hurry, I can be there before tonight”.
And he galloped away quickly on his horse and disappeared in a cloud of dust to Samarkand. The Caliph went out of the palace and also met Death. He asked:
“Why have you scared my Vizier who is young and well?”
And Death replied:
“I did not want to scare him, but when I saw him in Baghdad I was surprised, since I am expecting him in Samarkand tonight” (1).

Little lies between the inexorability of destiny described in this tale and the turmoil in the banking sector.

After the excessive spreading of toxic assets and the use of over-sized leverage, we all welcomed the return of financial orthodoxy in the sector in 2009 and 2010.

Believing their compliance with this orthodoxy and encouraged by Basel 3 rules, the majority of European banks accumulated government bonds without batting an eye-lid, seeking to shelter themselves from risk.

However, the trend to invest in euro-zone government bonds could prove to be their flight to Samarkand. All European banks are currently struggling with this theoretically risk-free asset. Valuations of government bonds have been brutally thrown into doubt by the market, with the trend measured and amplified by the famous credit default swaps (2), a simple insurance against default risk, which reflect investor concerns to the extreme (to excess). French CDS currently costs double the price of DANONE CDS. Without questioning the solidity of the agri-food group, we ask ourselves if this is really reasonable? In the same vein, the Italian CDS is worth double that of Columbia’s. Do we sleep twice as well in the knowledge that we have loaned money to Columbia rather than to Italy?

In our Arabian tale, Death has only one victim, the Vizier. In the banking world, the victim is DEXIA, and we can but hope it is the only one. However, since incantatory processes are not enough, let us remind our politicians that the destiny of European debt and bank debt is now tied. Contrary to the subprime crisis which was built by banking institutions, the current crisis has primarily stemmed from overly expensive states!

European banks are both actors and victims and need to be “kept at the palace”, provided with liquidity and recapitalised if necessary. Stopping the shilly-shallying and pro-cyclical regulatory adjustments is the only way to stop the stampede and save European government bonds and banks.

Although a rescue operation would be costly and affect growth on a lasting basis, it would be welcome for the economy as a whole and for our favourite companies in particular.

with the collaboration of Marc CRAQUELIN

(1) Tale by Farid Al-Dîn Attar, Persian poet of the early XIIIth century
(2) OTC instrument created in 1994