In the middle of last week, exceptional measures were announced by a coordinated group of six central banks: the Fed, the ECB, the Bank of England, the Bank of Canada, the Bank of Japan and the Swiss National Bank. In effect they agreed to supply virtually unlimited Dollar liquidity to the market. The result has been a sustained market rally over the past few days. However it is only now beginning to sink in what lay behind the central banks' decision and how close the financial system just came to collapse.
It is now clear that the funding cycle, even for the best credits in Europe was getting dangerously short. Whereas a major industrial, like Unilever, could expect to fund US Dollar exposure for at least 30 days, by the beginning of last week, this was down to three days. If it was bad for industrials, it was becoming impossible for banks. US Dollar holders were not prepared to provide funds to several major Euro-zone banks at virtually any price.
They were simply unable to gain access to the US Dollar market.
Although this still has the status of market gossip, it seems all too likely that a significant number of the largest Eurozone banks would have collapsed last week unless the central banks had done what they did. Just to repeat, last week, the Eurozone came close to a multiple collapse of some of its largest brand name banks because they were not able to access funding in Dollars.
So clearly the action of the central banks was critical, but while necessary, it is not sufficient to address the crisis of funding. It is clear that several major houses do not have an independent future. A major banking restructuring is now very much on the cards.
The German government has refused to address the private sector until the Eurozone fiscal/sovereign crisis is stabilized. Last week's near disaster shows how short sighted that policy has been. The fact is that the debt crisis can only be solved by coordinating debt write-downs and restructuring across both public and private credits.
We had a very close shave last week, but while the liquidity issue is addressed, at least for the foreseeable future, the solvency issue is not. I do not think it is a coincidence that Commerzbank is being forced to take immediate remedial action to boost its capital ratios.
Others will follow very shortly. Further retrenchment will follow. So in addition to a major fiscal contraction, the Eurozone must now deal with a large-scale contraction in bank funding.
It is hardly a surprise that S&P has put all of the Eurozone countries on credit watch for immediate down grade.
In the face of the determination of Berlin to impose fiscal control without actually providing credit support, it is a moot point as to whether the price for the Euro is actually worth paying. Even if the Eurozone governments believe it is, the years of recession ahead, amounting, lets face it, to a second Great Depression may see the voters changing their minds rather quickly.
So far the politicians are betting that closer fiscal union will work in the medium term.
Given the odds, that is not a bet I would be taking.