Europe: The Ice(land) Man Cometh

By Peter Atwater  JUN 14, 2012 10:20 AM

What's troubling is how policymakers and pundits could have missed the important messages from Iceland.

 


MINYANVILLE ORIGINAL In a recent article in the Wall Street Journal, a very worried David Wessel offers, “The biggest threat to the survival of the euro may not be a Greek exit.  It may be the Balkanization of Europe’s banking system.”

He, like many other pundits and policymakers, is worried that the “decadelong cross-border integration of European banks” is “fraying.”  And with news reports of France’s Credit Agricole (ACA.PA) preparing to walk away from its Greek affiliate, he has good reason.

At the risk of dog-piling Mr. Wessel, who I genuinely respect, the fact that he is now suddenly worried saddens me.  As I’ll discuss in moment, no one should be at all surprised at what is now unfolding.  But I’d also offer that it is not just the “Balkanization of Europe’s banking system” that Mr. Wessel should be worried about. 

If mood deteriorates further, the Balkanization of Europe, if not the entire global economy, may be ahead.

To my first point, what we are seeing within the European banking sector should have been expected.  As I discuss in my upcoming book, Moods and Markets (to be released in August), when mood deteriorates, what is local takes clear priority.  But in the specific case of Europe, what I am afraid that Mr. Wessel and others missed were the clear signals offered in 2010 during Iceland’s banking crisis. 

From my perspective, when major Icelandic banks walked away from their UK and Dutch affiliates, they set a very troubling precedent.   In fact, it was so troubling to me at the time that not only did I raise concerns about Greek subsidiaries of European banks, but on March 10, 2010, I also offered this to my clients:

With Iceland in mind, let me now share the same ratings information … for the US subsidiaries of foreign banks operating subject to “parental support”:



While to date none of the corporate parents of these banks has in any way displayed an unwillingness to support their US operations, the significant ratings differentials between “stand alone” and “supported” suggest to me that if push came to shove, support could be in doubt.  Even worse, while the parent banks could be willing, their home country regulators might not be, particularly if support here in the US means less capital for the home market.

To be clear, I am not today suggesting specific concerns regarding any of the banks above.  My point then and now is that the actions taken in Iceland over two years ago were game changing.  If need be, banks would walk away from their foreign operations.   

But to me, the message from Iceland was even more significant than that.  Not only did that country’s banks walk away, but the Icelandic electorate affirmed the action near-unanimously through a public referendum.

On March 3, 2010 following Iceland’s initial referendum on its banking crisis, I posted this comment on Minyanville's Buzz & Banter (subscription required):

...what is going on between Iceland, the UK and The Netherlands matters.  The notion that a country can put out to public referendum whether to honor its existing contractual obligations is at a minimum deeply troubling.   And in a world filled with [unfunded] guarantees I think it is important that [readers] realize that we have crossed the point where it is not only financial ability to honor guarantees that matters, but now also willingness.  And if Iceland is any indication, public opinion is now going to drive willingness. …The financial pundits are likely to discount the message’s significance as it is coming from a small country most couldn’t find on a map. But I would not. To me the message from Iceland is really a message to all elected world leaders: “You had better think twice about helping those outside of your borders."

And that brings me to my more worrisome second point.  What I see unfolding in Europe today is not just the Balkanization of European banks, it is the Balkanization of the entire region.  From my perspective, as the industry most vulnerable to deteriorating social mood, banks are merely the canary in a much bigger coal mine.

This morning the Slovak prime minister said that if Greece fails to meet commitments, Slovakia will demand its exit. Yesterday, Finnish Finance Minister Jutta Urpilainen had to rebuff calls for her country’s exit from the euro.

Unless mood improves, I am afraid that national self-interest will take greater and greater precedence over pan-European solutions.   As I have offered repeatedly, generosity is a function of the confidence of the donor, not the need of the recipient.  Should mood drop further, the willingness of stronger European countries to support the weak will be tested.  And as we have already seen in Iceland, the willingness of the weak to support their external creditors will be non-existent.

But for those who continue to see the events in Europe as an intra-regional problem, I would note that there are already signs of global Balkanization afoot.  Some Washington policymakers have already raised concerns about the Federal Reserve’s commitment to support foreign banks during the 2008 banking crisis.  And I have already seen ads from the two US presidential candidates that emphasize domestic jobs and paint China as an adversary.

As offered above, when the going gets tough, we all go local.

That a major French bank is considering walking away from its Greek affiliate should not have been a surprise.  The precedent was set more than two years ago. 

But I would pay attention to the other messages from Iceland.  If unconfident voters are given a choice between national, regional, or even international interests, they will always choose local.  And should mood around the globe drop further, I'm afraid we will see just how true that is.
Position in SH and JPM

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