European bourses are booming to record highs for the two oldest reasons in the world: fear and greed

By CHARLES WALLACE /LONDON

t the ripe young age of 33, Stephan Tenhaef, a customer marketing manager in Schwalbach, Germany, already frets about his retirement. "It's too much of a danger to just wake up and find you can't live on your pension," Tenhaef says. Polly Thrasivoulou, a 34-year-old advertising manager in London, faces a similar dilemma. "I worry about state pensions--they don't pay much, never mind when my turn comes," she says. For Lillian Garrin, a 60-year-old Spanish widow, worrying about making ends meet is a problem she confronts not just in the future but every day. "The interest rates paid by my bank have fallen by 5% recently," she laments.

Despite a world of differences, Tenhaef, Thrasivoulou and Garrin all arrived at the same answer to their financial worries. Only a decade ago, their choice would have seemed daring, if not reckless. But like thousands of others in Europe, the three withdrew some of their savings from a bank account and invested in...the stock market. Thanks to the increasing anxiety over pensions among young Europeans--not to mention the baby boomers whose retirements are just over the horizon--and to a refreshing jolt of competition ahead of monetary union next year, a financial revolution is dramatically changing the way Europeans think about money.

Savers are deserting traditional bank accounts and low-yielding government bonds by the thousands and moving en masse into equities. As a result stock markets across Europe have ballooned to record highs. "A wall of money," says Mark Collier, CEO of American discount broker Charles Schwab Europe, is cascading into mutual funds, sweeping away a half-century of conventional wisdom, which held that Germans fear risk more than paltry returns and Italians prefer the granite walls of a bank to the gossamer guarantees of a stock certificate. "A massive reallocation of wealth is taking place," says Marco Pagano, an economist at Italy's University of Salerno. "There is a widespread perception that somehow the pay-as-you-go retirement system is going bankrupt and benefits will be drastically reduced. So people are beginning to save for retirement personally."

The money revolution is leaving its mark everywhere. The net assets of Italian mutual funds soared from $123 billion to $206 billion in the last year alone, while investments in Spanish equity funds tripled and French stock funds climbed 48%, according to Lipper Analytical Services, which tracks fund movements. Virtually all of that money came from bank accounts. Stocks, which represented only 18% of the $5.7 trillion in European household savings as recently as 1992, now account for more than 26%, according to U.S. brokerage Merrill Lynch.

At the same time, Europe's money revolution is overturning decades of tradition in the hidebound financial services industry. Hundreds of inefficient banks are expected to be swallowed up by healthier competitors or disappear entirely. New challengers have emerged offering innovative services such as 24-hour telephone banking and mutual fund sales on the Internet. Supermarkets in Britain offer credit cards and mortgages alongside bins of broccoli. Much of the revolution now underway in Europe echoes what happened in the United States three decades ago, when customers began deserting banks for the higher returns of money market mutual funds. Because of their long head start, U.S. financial companies like Merrill Lynch, Citibank and mutual fund family Franklin Templeton are considered likely to set the pace of change in Europe. "If the Europeans thought monetary union was going to bring about a Fortress Europe, then they're going to find that the single currency is a Trojan Horse," warns Jo Owen, a banking consultant at Andersen Consulting in London: "a Trojan horse full of Americans." With no historic ties to any one European country, American companies have already deployed across European boundaries while many European institutions are only now taking their first tentative steps into foreign markets.

While many of the changes underway in Europe would have happened on their own, the movement toward European Economic and Monetary Union has sharply accelerated the process. Come next Janary, 11 European countries are expected to begin denominating their financial transactions in the single currency called the euro as the first step toward replacing marks, francs and lire with the new European currency in 2002.

One of the earliest repercussions has been a narrowing of the differences among interest rates across Europe. Rates in formerly high-inflation countries like Spain and Italy have fallen rapidly to approach Germany's historically low rates, now just over 5%. Italian savers once were dubbed the BOT people because of their fondness for Italian treasury bills, or buoni ordinari del Tesoro, which until three years ago paid tax-free, double-digit returns. "With interest rates of 14% tax free, you'd be crazy to go look for another type of investment," says Paolo Cantalfamo, managing director of Templeton Italia. But BOTs now yield only 5.5%, a 20-year low, and Italians have moved $113 billion from their bank accounts and treasuries in the last two years. In Spain, where the impact of EMU has sent rates down to levels not seen since the 1960s, $200 billion has deserted bank accounts for mutual funds. Even in countries with low inflation like France and Germany, emu has prompted savers to seek more rewarding long-term investments than bank accounts. The simple reason is fear about old age. While Europeans could once count on a social safety net from their governments to provide for their retirements, state pensions are under double threat--a demographic bulge means that when baby boomers retire, there will be fewer workers paying taxes than demanding benefits. At the same time, governments have pledged to pare down their budget deficits as part of the deal to join monetary union, meaning they will be unable to make up the shortfalls by borrowing money. In Germany, for example, pensioners will double in the next 30 years, while the number of working-age persons will fall by almost one third. The government faces a budget shortfall of 11% of GDP just to pay for pensions. As a result, Germans are making private arrangements to save for their retirement. According to Richard Wastcoat, retail marketing director for Fidelity, the giant U.S. financial services company, German investments in mutual funds have been growing by 20% a year since 1990. Last year, German mutual fund investments reached $285 billion, overtaking Britain as the second-largest mutual fund market in Europe, behind France. Since April, Germans have had the option of a new type of retirement investment called an "old age provision special asset" that will allow them to invest in stocks, bonds and real estate. But the bulk of the new investments will be in equities--a sea change for conservative German investors.

The equity bug is even spreading among the French, historically Europe's most risk-averse investors. Although the French lead the Continent in mutual fund savings, most of those francs are in money market accounts. One reason for the conservative approach has been the attractive alternatives--two-thirds of savers park their money in state-guaranteed bank accounts, the tax-free Livret A or the PEL, where the money is locked in for a minimum of four years. Both accounts pay a relatively modest interest rate and investors are beginning to clamor for better returns. "The appeal of rate-based investment is waning," says Herve Goulletquer, chief economist for Credit Lyonnais in Paris. "This naturally leads toward the stock market."

Remarkably, Europe's newfound love affair with mutual funds is happening without much prodding from governments. Fund managers in the United States look to 1982 as the watershed year for mutual funds, when Washington allowed taxpayers to open tax-sheltered savings plans called Individual Retirement Accounts. But in Europe, only Britain and the Netherlands offer some form of tax-deferred investing in stocks and mutual funds. British savers held $65 billion in tax-free Personal Equity Plans in 1997, compared with $3.8 billion in 1990, according to the Inland Revenue Service. The accounts are so popular that Chancellor of the Exchequer Gordon Brown said in March that tax benefits for equity investments would be preserved under a new system of Individual Savings Accounts to replace PEPs in 1999.

Once-conservative British savers have adapted to the new environment with a vengeance. Half a dozen new personal investment advice magazines have sprung up, and independent financial planners are creating something of a cottage industry. Mutual funds--known as unit trusts--still represent only 4% of British savings, but 10% of new savings are cascading into stock funds. "PEPs have broadened the audience for savings products," says Anne McMeehan, spokeswoman for the Association of Unit Trusts and Investment Funds. "There is a growing awareness that [savers] need to provide for themselves and take responsibility for savings."

Italian investors are equally eager. "They've gone ape" for stocks, says Tim Harris, equity strategist at J.P. Morgan in London. New money flooding into mutual funds was up 340% in the first quarter of 1998 compared to last year. It wasn't government policy. "The average Italian feels richer. There's been a bit of wage growth, the equity culture is taking off and there's a massive bull market," explains Harris.

With a tidal wave of money leaving bank accounts in search of higher returns, it's no surprise that a lot of the money is landing in stock markets, either through direct share purchases or through managed stock funds. "More and more people see the benefits of investing in the stock market rather than leaving spare money in the bank or a building society," says Martin Campbell, product development manager for Virgin Direct, a British investment manager that specializes in retirement accounts. "While a lot are experienced investors, a growing percentage are taking the plunge and investing in the stock market for the first time."

Although stock market investing hasn't become any less risky over the years, savers are beginning to accept the historical evidence that in any five-year period since World War II, with one exception, stocks have produced higher returns than bank accounts, bonds or bullion, says Paul Kaskar, spokesman for Fidelity in London. The charge into equities is becoming a classic case of demand suddenly outpacing supply because the flood of capital is growing far faster than the number of European equities available. The result has been a bull market of record dimensions, as a glance at the financial pages of Europe's newspapers confirms: last year stock markets soared in Germany (up 48%), Italy (99%), Spain (85%) and France (43%). Judging by the first three months of the year, Europe's markets are getting set to repeat the gains again this year.

What's more, in terms of market capitalization as a percentage of national output, Europe's stock markets may still have a long way to grow. For example, in the U.S., stock market capitalization has reached 114% of GDP, but in Germany it's a puny 28% and Italy is only 21%, according to the Organization for Economic Cooperation and Development in Paris. Britain, with a market capitalization of 122% of gdp, is the only country in the European Union to approach the level of U.S. capital markets. "We see a massive undersupply of equities," says Michael J. Marks, chief operating officer of Merrill Lynch Europe, which predicts demand for stocks in Europe will outstrip supply by $1 trillion by 2000. "It's quite dramatic, when you consider all the new money and existing money that will shift from bonds into equity markets."

One reason europeans are losing their entrenched fears about stock market risk is that many governments have been promoting stock ownership as part of the process of privatizing state owned companies. Privatizations in Europe rose to $68 billion last year, up from a mere $15 billion in 1990. Sales of stakes in giant utilities such Telecom Italia, Spain's Telefonica and Deutsche Telekom have helped introduce many first-time investors to the stock market, often with a quick profit. "When Telekom went public it did it with such fanfare that people sat up and started to take notice of the stock exchange," says Bernhard Termuhlen, managing director of German fund manager MLP in Heidelberg.

The pace of privatizations is likely to slow as the number of government-owned companies available for sale dwindles. But new supplies of equities for investors will come from small to medium-sized firms, many family owned, which will seek to cash in on the stock market boom. Their vehicle will be listings, called initial public offerings, under which the owners of privately held companies sell shares of stock to public investors for ipos in the next few years," says the University of Salerno's Pagano.

In Germany, a generational change of historic proportions will further fuel the IPO fire. Control of the country's fabled Mittelstand, prosperous small and medium-sized companies, is shifting from their post-World War II founders to their children. Jorg Sieweck, author of a report on the country's wealth, estimates that between 1987 and 1992 inheritances in Germany totalled $440 billion. Between 1997 and 2002, Siewick projects the amount to soar to more than $1 trillion, in what he calls "the largest and most significant mass exchange of wealth in history." Many of those companies will wind up on the Frankfurt stock exchange, while others will be sold by their new owners and the wealth reinvested in stocks.

Thus far the impact on European financial institutions has been less obvious than it was in the U.S., which saw a rash of mutual fund and discount brokerage companies rise up to challenge banks. This is partially because 20 years ago, American banks were prohibited by law from offering stocks or mutual funds to their customers. With no such regulatory curbs, some European banks have moved quickly into new financial services to ward off upstart competitors.

Thus in Italy, where $113 billion moved out of bank accounts in the last two years, banks control 90% of the mutual fund market, up from only 30% in the early 1990s. As a result, most mutual fund companies market their products through a bank, rather than try to sell directly to the customer. To buy a Templeton fund in Italy, for example, it's necessary to visit a bank. Even Fidelity, the king of direct marketing among fund managers in the United States, sells 90% of its funds in Germany through banks like Bayerische Vereinsbank. "To most Europeans, if you are investing your money, you want to be investing in an institution you've heard of, that you trust, sort of feel it's around the corner," says Angus Hislop, a banking analyst with London's Coopers & Lybrand.

Most of the new institutions that have emerged are competing with traditional banks on their weak points of service and costs. First Direct, an offshoot of Midland Bank in Britain, has attracted 800,000 customers, about 2% of the market, even though it lacks a single branch office. Instead it offers free overdrafts and ATM withdrawals to customers willing to bank by phone. For its telephone banking service, Deutsche Bank created the English-sounding Bank 24, which has 250,000 customers. So far, Bank 24 is confined to Germany but the company plans to offer the service to customers in nearby countries in the coming months.

In Italy, an entrepreneur named Ennio Doriss has built Mediolanum into a huge fund and insurance empire by sending 3,000 door-to-door salesmen to peddle everything from mutual funds to life insurance. "While banks wait for customers to come to their branch office, we took service to our clients' home or office," Doriss says. The result is a resounding success: annual growth has averaged 18% for a decade. Mediolanum has just opened a telephone banking operation modeled on First Direct in Britain, but which also zips your bank statements to a fax machine at the touch of a phone button.

Ironically, the first truly pan-European bank is probably American, with Citibank servicing 8 million customer accounts from 468 branches spread across 11 European countries. Because of its cross-border expertise, Citibank is already the market leader in such wholesale operations as managing companies' cash and is looking to expand that into retail markets by using new technology developed not only for Europe but for global markets. Now that Citibank is merging with Travelers Group, the huge insurance company and owner of stockbroker Salomon Smith Barney, the process is likely to accelerate. "We're not looking to compete with banks on a one-to-one basis," said Michael D. Weitzman, Citibank's director of sales in Europe. "Our view is to use more global platforms to deliver service more efficiently." One result is that Citibank is targeting Europe's "early adopters"--the young, upscale consumers who feel at ease with the latest technology--and offers telephone and Internet banking service virtually everywhere on the Continent.

Citibank and other American firms are hoping to carve a lucrative niche in Europe by promoting credit cards. Apart from institutions in Britain, European banks have never promoted credit cards, which offer revolving balances at upwards of 18% a year interest, preferring instead debit cards that deduct charges from a bank account. American companies are rushing to profit from this oversight: American Express has begun to test-market a new "Blue American Express" card in Italy and Germany.

At the same time, Merrill Lynch, the giant U.S. brokerage, is striving to find a way to appeal to European savers. Unlike in the U.S., where it was known as the broker that brought "Wall Street to Main Street," in Europe Merrill has appealed to especially well-heeled investors. In fact, its private banking unit just upped its minimum account from $100,000 to $250,000. But Ron Carlson, corporate strategist at Merrill Lynch Europe, says the company is considering a radical plan to dispense with its usual reliance on stock brokers and instead offer sophisticated euro-denominated cash management accounts, each with a credit card, a stock portfolio and a checking account, all across Europe by personal computer. Consumers would select their needs without sales pressure, much as discount brokers like Charles Schwab work in the U.S. "No one has a pan-European banking network and no one has this pan-European distribution," Carlson says. "There's a chance of really leap-frogging ahead and delivering this."

Of course, there is no guarantee that stock markets in Europe will keep booming, or that stocks will continue to outperform bonds or real estate. A downturn is a growing possibility, one which would certainly cool Europe's rising equity fever. But the demographics of aging are as immutable as time itself, and that suggests Europe's personal finance revolution has a long way yet to run, driven in large measure by the public's perception of what the future holds.

As Stephan Tenhaef, the nervous young investor from Schwalbach notes, "At least for now I can sleep at night."

--With Reporting by Bruce Crumley /Paris, Nina Planck /London, Peggy Salz-Trautman /Frankfurt and Jane Walker /Madrid