But there’s now another problem looming – one that could ultimately weigh down the global financial system.

The problem: Europe’s banks.

As economies slow in other parts of the world, rising joblessness and plunging housing prices and escalating loan losses are putting banks under pressure. That’s especially true in Europe, where consumers and companies are continuing to run into trouble.

Royal Bank of Scotland PLC (NYSE ADR: RBS), now 70% state-owned, fell to a loss in the first quarter and wrote down $3.17 billion in risky assets after its bad debts quadrupled to $4.37 billion.

Bank executives “[expect] a slowdown in financial-market activity compared with the very buoyant conditions seen in Q1,” Chief Executive Officer Stephen Hester told Reuters.

In Germany, Commerzbank AG (OTC ADR: CRZBY) had to take a $1.61 billion charge from its investment bank and a $72.38 million charge from commercial real estate initiatives, resulting in a $1.2 billion loss for the quarter.

In late December, the Institute of International Finance released its global economic outlook for 2009, and estimated that banks around the world had collectively lost nearly $1 trillion – $678 billion from U.S. banks and $300 billion from their European counterparts.

That was in December. We know it got worse – a lot worse – for U.S. banks after that point. Thanks to a mix that included lots of government bailout and an injection of new capital from investors, U.S. banks have experienced an improvement in their outlook.

Indeed, U.S. Federal Researve Chairman Ben S. Bernanke stated that the banks tested are all solvent and the results should provide “considerable comfort about the health of the banking system.”

But in the five months since that Institute of International Finance report was issued, it’s  likely that European banks have experienced a major decline in their fortunes.

Last week’s release of the bank stress tests results removed significant uncertainty about the U.S. banks, since it created a blueprint of what the troubled institutions needed to do to stabilize their finances. Morgan Stanley (NYSE: MS) and Wells Fargo & Co. (NYSE: WFC) have announced plans to raise an aggregate $15 billion in capital. Bank of America Corp. (NYSE: BAC) plans to sell assets and issue more common stock after being told by the federal government that it must raise $33.9 billion to adequately guard against “more adverse” economic conditions.

Bank of America was one of 10 banks told by the government to raise more capital following the so-called stress test. The government concluded that BofA faces a potential $136.6 billion in losses from troubled loans and investments in 2009 and 2010. The bank’s $34 billion capital shortfall was more than twice that of Wells Fargo, which had the second greatest capital need.
Are we destined to see this all play out now in Europe?

Market Matters

Shifting back to autos, General Motors Corp. (NYSE: GM) lost $6 billion in the first quarter and is shopping Saturn to Renault SA of France as it moves closer to its restructuring deadline (and potential bankruptcy). China’s Geely Automobile Holdings Ltd. (PINK: GELYF) has interest in GM’s Saab unit, and Fiat SpA (OTC ADR: FIATY) may look to complement its Chrysler LLC line with the German Opel (also late of GM).  Meanwhile, Ford Motor Co. (NYSE: F) claims to be on track with its restructuring plan and still believes it can manage just fine without any government assistance.  On the earnings’ front, The Walt Disney Co. (NYSE: DIS) and Kraft Foods Inc. (NYSE: KFT) bested estimates, while Cisco offered some mixed results as its better than expected numbers actually prompted some profit-taking among techs.

A poorly received 30-year Treasury auction sent bond prices tumbling as fixed income investors focused on the massive programs the government will need to finance over the next few years.  Oil prices surged above $58 a barrel for the first time in six months as traders seemingly failed to consider rising inventory levels and instead bought on signs (feeble as they are) of an economic recovery that would lead to enhanced energy demand.

The Standard & Poor’s 500 Index pushed beyond the crucial 900 level and ended the week in positive territory for the year.  Techs struggled late as investors realized any economic rebound would not translate into capital expenditures overnight.  Still, the Nasdaq Composite Index has outperformed the other indexes on a year-to-date basis.  With stress tests out of the way, where will the next leaks come from?

Economically Speaking

U.S. retailers released same-store sales data for April and the results were actually quite promising.  As usual, Wal-Mart Stores Inc. (NYSE: WMT) led the charge with a 5% increase in activity, while Children’s Place Retail Stores Inc. (Nasdaq: PLCE), Stage Stores Inc. (NYSE: SSI), Gap Inc. (NYSE: GPS), and The TJX Cos. Inc. (NYSE: TJX) were among those stores that posted better-than-expected results and beat analysts’ expectations.  A late-Easter holiday (April instead of March) helped many retailers as consumers waited until the last minute (as has become the norm) for their related holiday shopping.

On the global front, the European Central Bank dropped its key lending rate by 25 bps to 1%, and initiated other monetary moves to stabilize its (16-country) economy.  Likewise, the Bank of England announced a plan to buy up government and corporate bonds, thus, increasing its money supply.

Speaking of the labor market, the U.S. unemployment rate climbed in April to 8.9%; however, only 539,000 jobs were lost from the economy.  The contraction represented the smallest in six months and was below most analysts’ expectations.  Still, since December 2007, about 5.7 million domestic jobs have disappeared and businesses continue to be slow to hire until they see additional signs of greater stability in the economy.

Construction spending climbed in March after five consecutive monthly declines, though the gains were attributed to non-residential activity and the housing sector remains sluggish at best.  In more promising news, the National Association of Realtors reported a 3.2% increase in pending homes sales, the second straight monthly gain.  Because the release is considered a predictive indicator, analysts took it as a favorable sign that sales activity may pick up in the months ahead.

Weekly Economic Calendar

Source: Are Europe’s Banks Next to be Stressed?

The European Union certainly has a full plate right now. Large portions of the 27-nation bloc are lumbering through the depths of winter without heat, as the Ukraine and Russia continue their row over gas prices. The region is also pressing Israel to end military operations in Gaza, although they’re applying that pressure with little or no help from the United States.

Still, the EU can’t lose sight of its own economic crisis, a crisis of confidence that has emerged from the collapse of the global financial system.

Confidence in the EU economy hit a record low in December, the European Commission said today (Thursday). The Commission’s economic sentiment indicator (ESI) fell 7.0 points to 63.5. The ESI for the Eurozone -the 16 countries that use the euro -fell 7.8 points to 67.1. Both readings are the lowest since the indicator was launched in 1985.

Confidence plummeted across all sectors, which suggests the recession that began in the second quarter of last year.

“December’s EC survey brings more alarming evidence that the recession in the Eurozone is deepening rapidly,” Jennifer McKeown at consultants Capital Economics told the Strait Times.

The Eurozone economy contracted by 0.2% in both the second and third quarters of last year, and most analysts forecast much steeper contractions this year.

Germany’s Ifo, France’s INSEE and Italy’s ISAE slashed their joint estimate for Eurozone growth in the fourth quarter of 2008 to a contraction of 0.6% from an October projection of a flat reading, Thomson Financial reported.

The three think tanks said Eurozone gross domestic product (GDP) will contract by 0.4% in the first quarter of this year, down from a previous prediction of 0.1% growth, and will shrink by 0.2% in the second quarter.

The Organization for Economic Cooperation and Development (OECD) predicts that the Eurozone economy will contract 0.5% in 2009, in line with the International Monetary Fund’s (IMF) most recent forecast.

Solving the region’s economic contraction will not be an easy task. In December, the EU pledged economic-stimulus steps worth $272 billion (200 billion euros), or about 1.5% of GDP, to combat the fallout from the financial crisis. But while some member countries support even more government spending as a remedy to the crisis, others continue to hold the line of fiscal discipline.

“Some say this is a crisis that has to be tackled through expansion,” said Miroslav Kalousek, the Czech Republic’s finance minister.

Others say the crisis should be accompanied by even more rigorous discipline and that, if discipline isn’t adhered to, we’ll have problems refinancing debts,” Kalousek added.

Kalousek, whose country took over the EU’s rotating presidency on Jan. 1, is an advocate of fiscal discipline. That aligns him with the likes of Germany, Poland, and Belgium and sets his position opposite to that of Ireland, Spain, and the United Kingdom, which have been among the hardest hit by the financial crisis so far.

“This world crisis was not triggered by the financial policies of this or that government. It was a total crisis of confidence on the banking and financial markets,” Kalousek told reporters yesterday. “For that reason, I think it’s extremely important that the lack of confidence should not be made even worse by unreliable policies on the part of certain countries.”

Kalousek has vowed to remain impartial and open to compromise with regard to all matters facing the 27-nation European contingent, despite his position. Even so, he speaks openly about his anxiety over mounting debt.

Said Kalousek: “Often I’m woken at night by a nightmare -how am I to refinance the debt?”

Source: Sleepless Nights for Czech Finance Minister as Eurozone Economy Sputters

This from Money Morning:

The leaders of 20 of the world’s most developed nations, the G20, will convene in Washington D.C. on Nov. 15 for an emergency financial summit considered by many to be the 21st century version of the Bretton Woods initiative of 1944. This will be the first chance for European leaders – many of whom blame the current financial contagion on U.S. free market capitalism run – to press for an overhaul of a global financial system the United States has dominated for more than 60 years.

The summit will “seek agreement on principles of reform needed to avoid a repetition of the problems and assure global prosperity in the future,” U.S. President George W. Bush, European Commission President Jose Manuel Barroso and French President Nicolas Sarkozy said in a joint statement.

However, Barroso was more explicit – and less diplomatic – earlier this week when he said that  “we need a new global financial order.”

President Sarkozy has also expressed his desire for a more dramatic remaking of the current financial system, which he says “has distanced itself from the most fundamental values of capitalism.” It was the French president who earlier this week pressed President Bush to call a summit of the G8 and include the developing nations of India and China.

Sarkozy, over the past week, outlined some of the broad principles of reform he hopes to achieve. Specifically he argued that “no bank that works with government money should be allowed to work with tax havens” such as the Cayman Islands. He also raised the issue of curbing executive pay.

“No financial institution should escape regulation,” the French president said, referring to hedge funds and private equity firms. And the world’s most prominent credit agencies – dominated by such U.S. institutions as Moody’s Corp. (MCO), Fitch Ratings Inc., and Standard & Poor’s – should have their role in the global credit market reduced after their “scandalous” behavior.

Sarkozy isn’t alone either. The European Union (EU) is also on board with tougher regulations on hedge funds, limits on executive pay, and new rules for credit rating agencies. And British Prime Minister Gordon Brown, who has been instrumental in pushing for reform, has called for 30 cross-border “colleges of supervisors” to be established by the end of the year to monitor the activities of the world’s 30 biggest banks.

Indeed, the recent rash of criticism from leading politicians is indicative of the prevailing sentiment in Europe that the failure of U.S.-style free market capitalism is most to blame for the credit crisis that has put the world economy at risk of a recession. For Sarkozy, Brown and others, reform will not end with increased oversight of financial institutions but extend to the fabric of the global financial system, as well as the U.S. dominance that lies at its heart.

“Europe wants it. Europe demands it. Europe will get it,” Sarkozy said in reference to global financial reform last Saturday.

And while President Bush has insisted that the United States will seek to preserve the foundations of democratic capitalism – a commitment to free markets, free enterprise, and free trade,” Sarkozy has branded the lax regulation that has become the hallmark of the U.S. economic philosophy as a “betrayal of the spirit of capitalism.”

To Europe, the capital excess that is behind the global financial meltdown epitomizes the behavior of an America that has essentially squandered its role as the standard bearer of global finance.

“We cannot continue accepting the increasing deficit of the world power,” Sarkozy said. “Americans for three decades have been living over their limits.”

Bretton Woods – Then and Now

In 1944, the United Nations Monetary and Financial Conference – a collection of 740 delegates from 44 Allied nations – convened in Bretton Woods, N.H. The goals were to prevent a repeat of the Great Depression and facilitate the reconstruction of Europe following World War II.

After three weeks of deliberation, delegates agreed to a number of principles that established the rules for commercial relations among the world’s major industrial states and served as the foundation for today’s financial system. To this day, that complex plan is known as the “Bretton Woods system of monetary management.”

The nations participating agreed to fix their exchange rates to the dollar. The dollar was, in turn, fixed to gold at a value of $35 per ounce of gold bullion.  The conference also led to the formation of the Bank for Reconstruction and Development, the General Agreement on Tariffs and Trade, and the International Monetary Fund (IMF).

The Bretton Woods system met its demise in 1971 when U.S. President Richard M. Nixon severed the link between the dollar and gold. Most major world economies now float their currencies. However, such Bretton Woods institutions as the Bank for Reconstruction and Development and the General Agreement on Tariffs and Trade (GATT) live on in the form of the World Bank and the World Trade Organization (WTO), respectively. The IMF, meanwhile, is currently negotiating broad-based bailouts for Iceland, Ukraine, Hungary, and Pakistan.

And analysts aren’t confident that the upcoming round of dialogue will produce the “very large and very radical changes,” that British Prime Minister Gordon Brown has called for and Sarkozy has seconded.

The original Bretton Woods conference took years of coordination and planning. It was also a three-week gathering of the world’s foremost economists, including John Maynard Keynes – not an impromptu political salon for world leaders to pontificate on the obvious shortcomings of the current financial system. And as the IMF’s continued intervention in many struggling world economies illustrates, many of the old Bretton Woods Institutions still have value.

“Things like this that produce real results for the world are planned years in advance,” Edwin M. Truman, who was an assistant secretary of the Treasury under U.S. President Bill Clinton, told The New York Times. “The notion that you’re going to have something come out of this in three months is probably naïve.”

The timing of the conference is also precarious, as it will come just 11 days after a new U.S. president is elected and just a few days before President Bush takes his last official trip abroad. The U.S. president will be joining an annual summit of Asian-Pacific leaders in Peru.

The meeting is being planned in such haste that the White House was not yet certain where it will actually be held. And with so many nations participating – not to mention a lame duck U.S. president – it unlikely the November summit will achieve anything substantive.

Still, there remains the hope that at least a framework of discussion – and perhaps even an outline for reform – can be established.

Instead the leaders who attend will be challenged to “agree on a common set of principles for reform,” White House Press Secretary Dana Perino told The Times. It will then be up to financial experts “to put meat on the bones when it comes to fleshing out the principles.”

Source: Will Calls for a “New Global Financial Order” Result in a Second Bretton Woods and the End of U.S. Dominance?