An Epidemic of Eurojitters

All the strains on the U.S. banking system are being duplicated, and then some, in Europe. There too inflation roars ahead at a double-digit pace, and interest rates are hitting unprecedented peaks. In addition, the large multinational banks operating in Europe are being asked to "recycle" part of the estimated $60 billion in oil producers' surpluses. This involves accepting the money in the form of deposits and lending it to countries that, like Britain and Italy, cannot meet their oil bills. Finally, though banks on both sides of the Atlantic have gotten burned speculating in foreign currencies, the losses have been much worse in Europe. In the U.S., Franklin National Bank lost $63.6 million in the first five months of this year, largely because of currency trading; in Germany, Westdeutsche Landesbank Girozentrale dropped more than $100 million, and Bankhaus I.D. Herstatt lost so much that it folded in late June (TIME, July 8). U.S. banking authorities expect no more Franklin National cases, but European financiers are nervously awaiting more collapses of the Herstatt type.

The jitters were high on the agenda of government bankers from the U.S., Western Europe and Japan when they gathered in Basel, Switzerland, last week for a meeting at the Bank for International Settlements, a sort of central bankers' central bank. The central bankers reportedly agreed "in principle" to lend money to bail out private banks caught in a liquidity squeeze just as the U.S. Federal Reserve has kept Franklin National in business by lending it more than $1 billion. However, they specifically ruled out aid for banks caught in "irresponsible" foreign exchange dealings. The decision was no comfort to Herstatt depositors and creditors, who still stand to lose up to a staggering $1.4 billion, but it might help to calm the Continent's financial markets.

Those markets could stand some calming. In recent weeks foreign-currency trading in the huge Frankfurt center has slowed to a crawl, a situation that could eventually impede world trade. Currency dealers are afraid to accept orders forwarded by banks for fear that they might be dealing with another Herstatt. When Herstatt was ordered to close by the West German government, it left currency transactions with a number of other banks uncompleted. For example, Seattle-First National Bank sold $22.5 million worth of marks to Herstatt for dollars; it delivered the marks just before the collapse and is still waiting for the dollars.

Reluctant Leaders. Even if foreign-exchange dealings were to return to normal, international bankers face another major problem: stagnation in the "Eurocurrency" market. This is a giant, unregulated pool of dollars, pounds, marks and other currencies that has been deposited in banks outside the country of issuance. Companies and even governments have been able to tap the market freely for loans that played a major role in financing trade. The currency pool is continuing to grow in size (see chart following page) but nervous investors these days are making only short-term deposits; the banks are reluctant to make any long-term Eurocurrency loans. Thus a major source of European financing is drying up.

Now some investors are shunning the Eurocurrency market altogether. Among them are the Arabs, who are putting their oil dollars and pounds in safer havens like New York. Some Continental bankers are just as glad. They fear that massive deposits from a single source would make them vulnerable to sudden withdrawals that could lead to more bank failures.

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