UPDATE: Lack Of EU Cooperation Worsens Turmoil: Economists

By William L. Watts

LONDON (Dow Jones) -- Even a watered-down pledge by the European Union's top leaders to "coordinate" individual efforts to shore up the troubled banking sector proved overly ambitious, undercutting the euro and exacerbating losses across European equity markets on Monday, economists said.

The hastily-called Paris meeting Saturday of top E.U. leaders -- French President Nicolas Sarkozy, German Chancellor Angela Merkel, British Prime Minister Gordon Brown and Italian Prime Minister Silvio Berlusconi -- offered no pan-European plan for dealing with troubled banks.

"Each government will act in its own way, but will have to coordinate with others," Sarkozy said at a news conference following the meeting Saturday.

The leaders also agreed to take steps to strengthen regulation and to call for more leeway under the EU's growth and stability pact, which requires annual deficits to remain below 3% of gross domestic product and public debt to remain below 60% of GDP.

But with the ink on the leaders' joint statement barely dry, the unspooling of a German rescue plan for troubled property lender Hypo Real Estate prompted Berlin to indicate it would guarantee all personal deposits in the German banking system -- echoing controversial and much-criticized moves by Ireland and Greece last week.

Fearing a massive outflow of deposits to nations with full guarantees, Denmark followed suit. And France and Great Britain were seen under pressure to do the same. Meanwhile, confusion reigned over the exact terms of the German pledge.

As a result, European governments appear "dazed and confused," said Jim Reid, a strategist at Deutsche Bank. "And this isn't helping confidence and will probably end up costing them more in the long run."

While Germany moved to shore up the Hypo Real Estate rescue, problems cropped up elsewhere.

French banking giant BNP Paribas moved to take control of troubled Belgian-Dutch lender Fortis' operations in Belgium and Luxembourg as well as international banking franchises in a 14.5 billion ($19.7 billion) cash and shares transaction.

Outside the euro zone, British Chancellor of the Exchequer Alistair Darling was reportedly weighing a plan that would call on U.K. taxpayers to recapitalize British banks. The measure would likely see taxpayers receive preferred share or warrants in troubled banks, which could pay significant dividends in the future, the Financial Times reported.

European equities fell sharply, led down by banking shares.

The euro dropped to a new 13-month low against the U.S. dollar and its lowest level against the Japanese yen in more than two years.

In the end, it's almost certain that euro-zone members will follow Germany's lead in guaranteeing deposits, said Simon Derrick, chief currency strategist at Bank of New York Mellon. And that's not good news for the euro, he said.

"Although the move to provide such guarantees is undoubtedly better than the highly destabilizing alternative, this will raise questions about how these guarantees would be funded were they to be called upon," Derrick said, in a research note.

Moreover, recent developments leave the impression that politicians are responding to domestic events and have no overriding plan to deal with the crisis -- an impression that won't help the euro.

"In the circumstances, it would not be surprising if investors decided to exit the euro and instead seek the security of a currency where just one government is responsible for financial policy," Derrick said.

The weekend meeting also heightened worries over the fiscal picture, said Marco Annunziata, global chief economist at UniCredit MIB.

"Most concerning is the statement that competition rules and fiscal limits should be interpreted with greater flexibility: this means governments are getting ready to exceed the [stability pact] limits and bail out or nationalize individual banks as necessary," he said. "In other words, less coordination, not more."

Economists at BNP Paribas said turmoil is unlikely to abate until officials take steps to address the root cause of the crisis by providing explicit guarantees for bank liabilities. European banks have virtually stopped lending money to each other due to fears of further bank failures.

"We think this is just the beginning of the European financial storm and European governments will need to be more forthcoming in their rescue plans in order to prevent outright euro selling," they wrote.

(END) Dow Jones Newswires

October 06, 2008 08:14 ET (12:14 GMT)


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