The chart that frightens

By Buttonwood

FORGET for a moment all the headlines generated by the latest statements from Angela Merkel, Jean-Claude Trichet et al about the best way to stabilize government bond markets. Focus instead on this chart of European bank shares. Things are almost as bad as they were back in late 2008.

Now European politicians and bankers may say that these declines are unwarranted. But banking, like a fiat money system, is a matter of confidence. At one level, it is all about borrowing short and lending long, and the assumption that banks can handle the maturity mismatch. At the moment, the problem is one of capital. Many believe that the banks need to raise more capital, as their British and American counterparts did in 2008 and 2009. If you are a existing shareholder, then you assume that any new equity will come at the expense of diluting your own stake; the more the share price falls, the bigger that dilution is likely to be.

In the end, as Sir Howard Davies suggested on this morning's Today programme (the Radio 4 version, not the Matt Lauer sofa-fest), governments may have to stump up the capital. Again, given the terms governments are likely to demand, shareholders are right to be scared.

In this context, all the talk of Greece's euro exit doesn't help. One might assume that a Greek exit would "lance the boil" and allow the other countries to deal with their own problems. But as Willem Buiter of Citigroup points out in a private research note (hence no link)

Greece's exit would create a powerful and highly visible precedent. As soon as Greece has exited, we expect the markets will focus on the country or countries most likely to exit next from the euro area. Any non-captive/financially sophisticated owner of a deposit account.... will withdraw his deposits from countries deemed at risk - even a small risk - of exit. Any non-captive depositor who fears a non-zero risk of the future introduction of a New Escudo, a New Punt, a New Peseta or a New Lira would withdraw his deposits at the drop of a hat and deposit them in the handful of countries likely to remain in the euro area no matter what - Germany, Luxembourg, the Netherlands, Austria and Finland.

The funding strike and deposit run out of the periphery euro area member states (defined very broadly) would create financial havoc and most likely cause a financial crisis followed by a deep recession in the euro area broad periphery.

These fears clearly lie behind Europe's dismal stockmarket performance (the Dax is down by a third since May. Mind you, it does raise the question of whether shares in non-financial companies, some of which are global brand names, have been oversold, something I hope to discuss in this week's column.