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Europe Beginning to Realize Its Lenders Share in the Blame

By Craig Whitlock and Edward Cody
Washington Post Foreign Service
Thursday, October 2, 2008

BERLIN, Oct. 1 -- Europe moved to shore up more teetering banks Wednesday, as officials struggled to answer a basic question: How did their highly regulated banks, many of them state-owned, get suckered by the same speculative investments that have flattened Wall Street?

In Italy, officials suspended trading in Unicredit -- the country's biggest bank, with more than $1.4 trillion in assets -- after its stock price lost almost a quarter of its value. Italian regulators banned short-selling of financial stocks. "I won't permit speculative attacks on our banks," Prime Minister Silvio Berlusconi said.

In Germany, officials fretted over the health of a subsidiary of Commerzbank as well as several state-owned regional banks that have posted heavy losses.

As European taxpayers absorbed the rapidly escalating expense of bank bailouts, lawmakers on the continent toned down their criticism of Wall Street as the origin of the problem and started to blame their own lenders for gorging on subprime loans and other risky investments.

"What were they doing screwing around in the United States?" French President Nicolas Sarkozy reportedly asked his aides after he was forced to negotiate a $9.2 billion emergency bailout Monday for Dexia, the troubled Franco-Belgian bank.

He has invited the leaders of Germany, Britain, Italy and Luxembourg for an emergency meeting in Paris this weekend. Feuding is already starting to break out in the 27-nation European Union over the best course to take. British bankers on Wednesday called Ireland's surprise step to guarantee bank deposits an unfair competitive step; signs emerged, too, of German-French disagreements on bailout strategy.

Until recently, officials in many European countries bragged that they were relatively well insulated from the global credit crisis by what they described as superior regulatory oversight. But with a string of banks pleading for rescues in the past week, officials have begun to acknowledge that their rules were insufficient.

In Germany, most of the banks that have teetered on insolvency in recent months have been state-owned regional institutions. Duesseldorf-based WestLB, for instance, received a $7.8 billion bailout in April. On Wednesday, E.U. regulators said they would review that rescue to ensure it did not give the bank unfair competitive advantages.

Although Germany's state-owned banks have suffered for years from other problems, the credit crisis has exposed the degree to which they willingly made risky bets outside the country.

"Regulations on this side of the Atlantic have not been perfect," said Reinhard Buetikofer, co-chairman of the Greens, a German opposition party. "For a while, a large segment of the public considered all this as innocent German banks caught in an American mess. . . . Only recently has the public started to understand how much we are involved, and how much of this has been our doing, too."

Two weeks ago, the board of directors of KfW, a major commercial lender owned by the German government, suspended two top managers after the bank accidentally wired a $500 million payment to Lehman Brothers hours before the New York investment bank declared bankruptcy.

"We not only have what is clearly a failure on the part of the banking regulators, but also a failure in the political system in Germany," said Stephan Paul, a professor of finance at the University of Bochum. "Indeed, the politicians are the supervisors of these state banks."

Other German banks have gotten into trouble by opening offshore subsidiaries in the Cayman Islands and Ireland, enabling them to avoid regulatory oversight back home. Hypo Real Estate Holding AG, Germany's second-biggest commercial lender, nearly collapsed last weekend because of problems at a subsidiary in Ireland, where a construction boom has deflated.

Similarly, the run on Dexia's stock last week was ignited by reports of liquidity problems following a large cash infusion into the bank's U.S.-based bond insurance subsidiary. Dexia, which counted the French government among its stockholders, had previously traded on its reputation as a conservative lender that focused on aiding municipalities in France and Belgium.

Partly in response, Sarkozy has stressed that European banks should refocus their energy on traditional domestic financial activities, such as business credit and consumer savings, rather than the type of foreign operations that contributed to Wall Street's meltdown.

In the same vein, Sarkozy lectured nine of France's top banking executives this week at the presidential Elysee Palace, saying they should avoid the loosely governed and often thinly guaranteed trading that French commentators have called "Anglo-Saxon banking practices."

"Return to your profession as deposit banks," Sarkozy told the bankers, according to an account provided to French journalists. "Reassure your clients."

Sarkozy said in a speech last week that banks also should adopt new compensation rules, arguing that current practices in France and other countries encourage traders and executives to take undue risks. If French banks fail to do so by the end of the year, he added, the government will do it for them.

In Britain, the government is preparing a banking overhaul bill that Prime Minister Gordon Brown said would include new regulations to end "the age of irresponsibility."

Previously, Brown had said the crisis "started in America." But other British officials and analysts cited growing recognition that the problems are largely homegrown.

In their view, British banks, like those in the United States, took on too much risk. "Toxic assets are the root cause," said Alex Potter, a banking analyst at Collins Stewart investment banking group in London. "The U.S., U.K., Spain and Ireland all have massively overvalued housing markets. When the bad debt comes through, that's massively magnified in fear. The U.K. housing market is going down in a way that the U.S. housing market is going down."

Although there has been a call for increased regulation of British banking, some people are worried that the restrictions could strangle the financial services industry, which has brought enormous wealth to the country.

"Of course there has been greed," said London Mayor Boris Johnson. But the financial sector "is a great British industry, and the last thing we want to do now is throw the baby out with the bathwater with some form of excessive regulation."

Cody reported from Paris. Correspondent Mary Jordan in London contributed to this report.

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