Iceland Crisis: Panic Spreads

That’s why the European markets, largely treading water this morning, are now on hold, as if satiated for the moment after yesterday’s bloodbath (though as I write the London and Frankfurt exchanges, Europe’s two biggest bourses, are still slipping south—there is certainly no upward momentum). The Bank of England is under increasing pressure to cut interest rates on Thursday, European finance ministers gathered in Luxembourg this morning want the European Central Bank to do the same (though they can’t say so out loud) and the word from Washington is that the Fed is also inclined that way.

Interest rate cuts are now taking centre-stage because yesterday’s lifeline—the Bush $700bn bank bailout—doesn’t seem to be having much effect. This morning’s New York Times says that, three days old, it “looks like a pebble tossed into a churning sea...a stopgap for the United States alone. With Europe showing few signs of developing a coordinated response to the crisis, there is very little on the horizon to calm rattled investors.”

The Times is right: the Paulson plan does half the job—buying up the banks’ toxic waste—but it doesn’t do the other vital half: recapitalising the banks’ balance sheets so that they have the strength to start lending again. That’s the big issue in London this morning and will soon be heading across the Atlantic.

It has emerged that the CEO’s of three of Britain’s biggest banks—Royal Bank of Scotland (fifth largest in the world, with huge holdings—Mellon, Citizens—in America), Barclays and Lloyds TSB—had secret meetings with Britain’s Chancellor of the Exchequer (finance minister) yesterday. Top of the agenda: the government (ie taxpayer) pumping $100bn into their balance sheets in return for a temporary equity stake. Prime Minister Gordon Brown is still dithering over this plan (as he’s inclined to do on all big issues). While he ponders, Royal Bank of Scotland shares, already in the dirt, lost another 30% in morning trading. Most of the other big British beasts of the banking world are also taking a battering.

As it dawns on Wall Street that the Paulson plan is not all it was cracked up to be, expect this issue of a government recapitalisation of the banks’ balance sheets to hit the headlines in America too. If President Bush thinks he’s done with bank nationalisation he could have another think coming.

The only man who can afford a smile is Senator Obama. The latest WSJ/NBC poll gives him a six-point lead (49% to 43%) over Senator McCain, which seems pretty decisive to me. The smile will be wiped from his face, however, when he looks at the continuing financial crisis that will be his inheritance.