A cold wind is blowing from the City of London to the shores of Frankfurt's Main River—and it has nothing to do with winter. Instead, the chill sweeping across the Continent's financial capitals owes to Europe's worsening economy, as analysts and policymakers revise downward their estimates for 2009 and banks come under renewed suspicion over the health of their balance sheets.
The devastation in just the past few days—especially in Britain—has been nothing short of breathtaking. On Jan. 19, British Prime Minister Gordon Brown unveiled a new program to provide banks with unlimited insurance against further multibillion-pound losses and a 50 billion ($73 billion) fund to buy high-quality but illiquid securities. Yet if anything, the latest bailout plan seems only to have made investors more skittish: Shares in giants such as Barclays (BCS) and the "new" Lloyds (LLOY.L), formed by the government-engineered merger of Lloyds TSB and Halifax Bank of Scotland (HBOS), have since tumbled by 40% and 56%, respectively.
Financial institutions on the Continent are also suffering from increased investor anxiety. Germany's stalwart Deutsche Bank (DB) is off more than 27% since it announced on Jan. 14 that it would post an unexpected 2008 loss of $6.3 billion from winding down exposure to risky financial investments. France's top bank, BNP Paribas (BNPP.PA), is down nearly 30% over the same period. And even Spain's thriving Santander (STD) is off 12% in the past week.
The common theme provoking the banking meltdown is increased worry over the European and global economy. To be sure, there are still concerns over exposure to bad American debt—everything from risky hedge funds to monies parked in the alleged pyramid scheme run by banker Bernie Madoff. But now, with European gross domestic product in decline, unemployment rising, and market sentiment on the skids, investors are increasingly nervous about homegrown issues: the danger of local loan defaults, asset writedowns, and continued sluggish lending.Not Near the End
"Last year, it was the banks that almost brought down the economy. Now, it's the economy that's threatening the banks," says Pete Hahn, a fellow at City University's Cass Business School in London and a former managing director at Citigroup (C). "We are no way near the bottom of this problem yet."
Nowhere is the situation worse than in Britain. Last October, British banks got a 50 billion (now $69 billion) cash injection from the government. But now the country is entering its third consecutive quarter of negative growth and most economists expect GDP to contract by at least 2% this year. Unemployment has jumped by two percentage points, to 6.1%, over the last 18 months, home prices fell 16% in 2008, and consumer confidence is at a 30-year low.