October 1, 2008


THE GLOBAL CREDIT CRISIS
AND THE GLOBAL RESPONSE

US DEVELOPMENTS

In a dramatic vote taken this evening, and less than 36 hours after the rejection by the US House of Representatives of a similar bill, the
US Senate passed The Emergency Economic Stabilization Act of
2008 (H.R. 1424), by a vote of 74 to 25.

Voting in favor of this legislation were 40 Democrats, 33 Republicans and one Independent. The legislation now returns to the House of Representatives, where another vote is expected later this week.

The economic stabilization provisions of the bill as approved by the Senate are fundamentally the same as the provisions contained in the bill previously considered by the House, save for the addition of a provision that increases the amount of applicable coverage by the Federal Deposit Insurance Corporation to $250,000 per insured account. The Senate bill is substantially more voluminous, because the economic stabilization provisions were grafted onto a much larger bill containing numerous unrelated provisions on the development of alternative energy, mental health coverage parity and natural disaster recovery. In an effort to garner additional votes, the Senate bill also provides for tax relief by amending the provisions of the alternative minimum tax. This bill was designed to relieve an estimated 24 million households from the burdens of approximately $65 billion in taxes. To read our summary of the original bill, please click here.

In the regulatory area, the Securities and Exchange Commission announced additional guidance on mark-to-market accounting standards, in an effort to address concerns about the implementation of this regime and its impact on the financial services industry. It is expected that this topic will be one of extended debate in the weeks to come, as the goals advanced by such accounting treatment, providing for greater clarity and transparency in the valuation of assets, are outweighed by the difficulties of determining accurate values at times when market prices for such assets may be impossible to obtain in a deteriorating market. The global nature of these problems was stressed by French president Nicolas Sarkozy in his remarks today calling for a more gradual implementation of mark-to-market accounting and a greater understanding of the difficulties involved for financial institutions.

The SEC guidance, which is seen as another example of regulators attempting to provide flexibility in the face of the emerging credit crisis, may be read here.


EUROPEAN DEVELOPMENTS

As we noted earlier this week, the governments of Belgium, Netherlands and Luxembourg intervened last weekend to rescue troubled banking giant Fortis, S.A. Since then, deteriorating financial, credit and liquidity events in the US have had an impact on European markets. A number of adverse developments in Europe have caused further concern for the region’s banking sector:

On Monday of this week, the UK government announced that it was taking control of the £50 billion mortgages and loans portfolio of another
well-known financial institution, Bradford & Bingley, while its £20 billion savings arm is being bought by Abbey.

The Bradford & Bingley intervention caused other banks’ shares to decline sharply. For example, HBOS, Lloyds TSB and Royal Bank of Scotland all experienced significant losses, which contributed to the FTSE 100 index’s biggest one-day fall since January — down 5.3 percent to 4,818 points at close on Monday. Shares in HBOS, the UK’s biggest mortgage lender, sank almost 14 percent yesterday on market speculation that Lloyds TSB could renegotiate its takeover deal.

Bradford & Bingley is simply the latest bank that has needed rescuing in a turbulent period for British financial institutions. Two weeks ago, it was announced that HBOS is being bought by Lloyds TSB. The Financial Services Authority, which supervises British banks, concluded on Saturday, September 27, that Bradford & Bingley no longer met
threshold conditions for operating as a deposit taker. Loss of confidence by investors and lenders was blamed.

Ireland announced that it was guaranteeing not only the deposits of its financial institutions, but also its loans. The Irish government announced yesterday that it would guarantee all deposits in six of its main savings institutions for two years. Despite pressure on the UK government, Prime Minister Gordon Brown last night confirmed that he was not prepared to match the Irish guarantee. The European Commission is currently investigating whether the Irish arrangement falls afoul of EC state aid rules by giving competitive advantages to Irish banks.

Prime Minister Brown did, however, indicate that the UK government plans to increase the level at which savers’ deposits is guaranteed from the current £35,000 to £50,000. David Cameron, the Conservative Party leader, also pledged to support this increase, telling his party that political leaders must work together in tackling the current crisis.

The actions by the UK government coincided with the intervention by the French and Belgian governments with respect to Dexia, the banking entity prominent in that regional sector, as well as the Icelandic government’s bailout of local bank Glitnir.

The dislocations in the capital markets in the United States and in Europe, and the bailouts resulting from the crisis, caused LIBOR to ascend dramatically yesterday, adding to the credit and liquidity burdens of the financial system. In some cases, borrowers found that LIBOR spreads more than doubled, as lenders passed on their increased funding costs under “market disruption” clauses in applicable credit agreements.

Concerns continued to develop about the extent of these credit disruptions, and the potential difficulties that Europe’s national insurance regimes, with limited resources at their disposal, might have in implementing an effective bailout of a major banking entity in any specific jurisdiction. European leaders continue to insist on the necessity and importance of an effective solution to the US troubled asset crisis. As a precondition to any attempt by the European Union and its constituent states to come to terms with their own analogous domestic burdens, they insist that the US must take the lead in crafting an effective response to this critical problem.

The level of concern about resources available for such bailouts may have been the cause of the French proposal, announced today, to establish, under the auspices of the European Union, a €300 billion rescue fund for European banks operating in this region. Representing the equivalent of almost $500 billion in effective funding, if put into operation this fund would represent a massive commitment of support by the member states of the European Union. When aggregated to President Sarkozy’s comments on mark-to-market accounting, this proposal may also be heralded as a harbinger of the issues and problems we may expect will accelerate in the European financial services community.

Please click on these links to read our earlier comments on the
financial crisis:

September 29, 2008

September 26, 2008

September 24, 2008

September 22, 2008

September 21, 2008