9/12/2011 7:53 PM ET
European leaders may stave off a banking crisis for a few more weeks. Markets may even stage a relief rally as Greek debt worries abate. But make no mistake -- a deeper crisis in foreign banks is coming.
Financial markets are behaving as if they expect a European banking crisis that would require the bailout or nationalization of some European banks. That would feel like a replay of the financial crisis that followed the bankruptcy of Lehman Brothers in the fall of 2008. Only this time, the epicenter would be Europe instead of the United States, and the ripples would expand from the eurozone outward into global financial markets.
How realistic is that fear? Very, I'm afraid. European banks are facing a very real liquidity and capital crisis that could lead to the need for a government rescue of some globally significant banks.
But the crisis isn't an exact replay of the 2008 crisis. The effects of the crisis would not be limited to Europe, but the likelihood that a European crisis would take down a major U.S. bank -- in a mirror image of the 2008 crisis where problems originating in the United States did lead to the bailouts of banks in the United Kingdom, Germany and Belgium -- is relatively small. On the other hand, the crisis is potentially worse this time around because the European Central Bank is much less able to intervene as a lender of last resort than the U.S. Federal Reserve was in 2008.
The current European banking crisis is rooted in the Greek, Italian, Spanish, Portuguese and Irish debt crises. But the repeated collapse-bailout-collapse-again pattern of the prices of bonds of those countries wouldn't have produced the current mess without a series of missteps by banks, bank regulators and central banks.
Jim Jubak
European banks hold a huge amount of government debt from the countries involved in the crisis. German banks, for example, held $22 billion in Greek government debt at the end of 2010, according to the Bank for International Settlements. If you add holdings of Greek government debt to holdings of private-sector Greek debt, the exposure gets much higher. For example, in May, Fitch Ratings said that French bank Credit Agricole (CRARY, news) had $35 billion in exposure to Greek government and private debt. BNP Paribas (BNPQY, news) and Société Générale (SCGLY, news) had exposure of about $11 billion each.
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The exposure of European banks to Greece, however, is small souvlaki compared with exposure to the much larger Italian economy. BNP Paribas, for example, has an estimated $31 billion in exposure to Italian government and private-sector debt. Even where the total for Italy is not as high as for Greece, the additional exposure is big enough to add to worries. Credit Agricole has an estimated $17 billion in Italian exposure.
But the current banking crisis owes as much to the reaction of banks and bank regulators to the problem as to the size of this exposure. Nobody now expects that Greece will be able to avoid a default in the end. Even Sunday's announcement of new measures to close a $3 billion budget gap just served to convince financial markets that the more Greece cuts, the more the economy will slow, and the fewer taxes the government will collect. Like last year's rescue package, this year's deal, if ultimately approved, only buys time.
But instead of using that time to get Europe's financial house in order, banks and bank regulators have spent the time dreaming that everything would somehow turn out all right. So, for example, banks have avoided marking to market their portfolios of Greek, Italian and other troubled debt securities.
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The arguments have been varied and ingenious. Banks have argued that since the Greek II rescue package asked bondholders to take a 21% haircut on the value of their bonds, banks should value their debt at that same 21% discount -- even though the debt instruments were trading much lower. Banks have also argued that since it has become difficult to trade some of this debt, there is no market price that they can use to value it. Instead, they're marking this debt to the values calculated by financial models. Remember how well that turned out in the financial crisis of 2008?
And regulators, especially those in France, have let them get away with it. Regulators have pointed to the latest bank stress test and said, "See, our banks passed." But having a 6.5% Tier 1 capital ratio when 5% was the benchmark to earn a pass in the test was not enough. A 6.5% shouldn't earn applause when many countries are urging their banks toward a 10% standard.
You can probably predict the reaction in the financial markets. Because non-European banks can't trust the books at European banks to accurately state risk, they've stopped lending to European banks.
U.S. money market funds, a key source of short-term capital for European banks, have cut back their short-term lending. An August survey by Fitch Ratings found that 43% of the total prime money market funds reduced their exposure to European banks by 9% or more. Where money market funds have kept lending, they've cut the length of their loans. Fitch found that 20% of the money market fund lending to French banks was for maturities of a week or less. That's three times greater than just a month earlier. Money market fund exposure to Spanish and Italian banks has fallen even faster. It was effectively zero, Fitch found, by the end of July.
Markets don't trust the banksThis is a big deal, especially for French banks, which are particularly reliant on short-term funds from wholesale sources, such as money market funds. For example, French banks rely on short-term funding even for long-term lending. Credit Agricole, for instance, relies on short-term funding for 23% of lending for long-term mortgages. A reliance on short-term funding makes a bank extremely vulnerable to exactly the kind of squeeze that threatened the banking system after the collapse of Lehman Brothers.
Latest news on European debt crisis
And in the current market there's not a whole lot of long-term capital looking for a home at a European bank. Across the eurozone, banks have managed to sell $4.5 billion in debt this year, but almost all of that came in the first half of the year. For the past three months, banks have redeemed more in maturing debt than they've managed to sell in new debt.
According to Dealogic, net issues of bank debt in the region -- excluding covered bonds, which are secured against pools of existing loans -- are a negative $41 billion. Covered bonds can't fill the gap indefinitely, because new issues face limits imposed by the need to find existing loans to use as collateral and by national banking regulations. And it's not as if these banks can go to the equity markets to raise capital, except at a crushing cost. Shares of Société Générale are down 55% since June 15, and shares of Credit Agricole are down 45%.
The math gets pretty daunting if you look at the amount of debt that eurozone banks need to roll over in the next few years. And that doesn't even consider any new money they need to raise to expand their business (in case their economies have, you know, ideas about growing), or to meet new capital requirements. According to Deutsche Bank, eurozone banks need to finance nearly $2 trillion over the next five years.
Where will that money come from? Nowhere, without some kind of guarantee from either national governments or the European Central Bank. The ECB has done an astounding job of eating into its own credibility over the past year and of convincing everyone that its policies are as steady as the wind in Pomerania. Nobody is absolutely certain that the central bank stands ready to supply all the liquidity that eurozone banks might need. The past year has also highlighted the ECB's limitations as a lender of last resort. The ECB is dependent on member central banks for its funding, and it's by no means clear that those banks stand behind the eurozone banking system as a whole.
In fact, one big fear is that some national governments may be preparing to save their own banks while letting those in the rest of the eurozone twist in the wind. So, for example, when the rumors swept through the financial markets last week that Germany was preparing contingency plans to support its banks in the event of a Greek default, the market as a whole found the news chilling.
Continued: What will Germany do?Single page12Next >RELATED ARTICLESJubak on video: We aren't Japan . . . yetThe week ahead: Fasten your seatbeltsIs the market closer to a bottom than a top?10 ways to survive a zombie economy - stocks investing - MSN MoneyChina crash coming? 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Advise for the middle class? Well first of all there isn't much left of the middle class, but here is some advise anyway. Invest in guns, ammo, and canned and freeze dried foods. 2 0ReportSpamJenBritq1 hour agoMy friend just met a millionàire man on ḾillionáireƑriends.CoM, it's where for men and women looking for companionship for a fabulous lifestyle, maybe you want to try out :)Bernankie's made-up half a trillion to support his make work pals 2 1ReportSpamtruthhurts4022 hours agoHow's that 401K working for you that your employer forced you on after abolishing your retirement account. VOTE UNION..... 4 2ReportSpamsbnets2 hours ago"O" wants to spend broke-**** Bernankie's made-up half a trillion to support his make work pals, while BofA is laying off how many thousands? Lots of new taxes & "socially responsible" Big Brother regulations coming at us soon too. Euro & the US $$ couldn't head for the glorious OneWorld bankster monetary/credit enslavement system any faster. Better load up comrades, because they stopped listening to us a long time ago. 8 0ReportSpamcragig3 hours agoYou know what Greece needs right now? That's right, a cash for clunkers program. Hey it worked here, right?
Should work just as good there as it did here..
3 2ReportSpamgnostic truthsayer3 hours agomoney money money money money, if every banks computers were wiped and all currency burned, then everyone still went to their jobs and perpetuated society. Went to stores and took only what they NEEDED and invested time in research ONLY in things that SOLVE the inequalities of the world, instead of market research to boost profits. the world would still go on... money DOES NOT EXIST, IT IS REPRESENTATION OF TIME. IT IS PAPER and 1's and 0's in computers. Here's a thought. Outlaw Profit in business. Change all personal income to an equal share in the companies' earnings you work with. Then a true renaissance of society and thought can take place. Then and only then will time vouchers serve people not the other way around.
3 10ReportSpamIntotheknown4 hours agoSocialism has brought Europe to the brink of bankruptcy. The U.S. will be brought to the brink by it next. 16 8ReportSpampocketprotector5 hours agoJim Jubak----smartest guy in the room, baby. 10 2ReportSpamVincent Homer (Teakwood) 5 hours agoOK, I get it! Bad news, it's all going in the dumper-again. I have read hundreds of these articles in the last few years and none have any advice for the middle income, W-2 reporting person with a few dollars saved. What are we to do to weather this next calamity? The government's only solution seems to be to spend more of our present and future money on projects and programs that don't help. Can you imagine what would have happened to the economy if the stimulus moneys had been distributed directly in the form or personal income tax refunds? I know I've got several "shovel ready" projects that I'd love to get windfall financing for. 19 0ReportSpamwyman4165 hours agoThey don't know anything,selling fear to get people to read this crap. 5 8ReportSpamFred13135 hours agoHas anyone in this country ever read Atlas Shrugged, by Ayn Rand? 9 5ReportSpampapa tiger6 hours agoAnd " O " wants how much, oh thats right 450 Billion to prop up the exposed US Banks again to French and other Euro Zone Banks. A convient way is to claim to go for a works, jobs bill, when it is really just a Big Bank Bill again. More Red ink and poor obamaeconomics ( OCON's ). When will the give away stop. When will Congress act for the American People and not the Wealthy. Jobs can't happen in this Climate of OCON with these Nancy's. Bank America is allready cutting its fat payroll by 30,000 jobs, and how many more to follow from City Bank. 18 15ReportSpamzeke16 hours ago
If I understand correctly, American banks are sitting on mountains of debt that the Fed is not requiring mark to market. If the US wasn't the world's reserve currency, we'd have been down the tubes long ago.
As far as negative news, reality is a bitch which is why, almost, all US news is "happy news". Don't want to alarm the masses. Why do you think the banks were bailed out, nearly zero interest rates, cash for clunkers and all the other "save the country" programs. All of which were done with borrowed money which we are so graciously leaving to our children to pay off. There's nothing like leaving your off spring something to remember you by.
For those of you who like only "happy news", avoid reading or listening to anything you don't like.
30 3ReportSpamGreener Oregon7 hours agoDanny - I DO blame the messenger for a HUGE part of this mess........ their negativity sells and that is all they are interested in........... Godforbid they would cast a positive light on ANYTHING......... 6 11ReportSpamA Leg Up7 hours agoIt's about time, the whole shabang needs to be redone! We've been running on about 5 out of 8 cylinders for too d**n long now! This is what happens when fratarded people are put in positions of power!...................................................................................................GOD SPEED! 26 1ReportSpamdannylv237 hours agoGreener- don't blame the messenger.
Jetfly- free up cash and short the s&p and short financials
5 2ReportSpamGreener Oregon7 hours agoOnce again - the GLOOM and DOOM of the media is a HUGE factor in driving the economies up or down - where is THEIR RESPONSIBILITY......... they HIDE behind FREEDOM of SPEECH ......... and the well-being of the economy BE DAMNED...... 9 24ReportSpamSomeone8 hours agoThe truth hurts. The debt is real, the size of a mountain range, and ultimately belongs to someone. Thanks to the centralization and interlinking of world economies, currencies, and banking, that someone is all of us. No matter how we keep trying to pass the blame and hot potato to the next guy, it keeps coming back at us. The frantic behavior of the markets in response is no surprise. Major market indices are swinging wildly (2-5% in less than an hour) on rumors, hearsay, and sweeping comments by central banking and finance elite. Entire markets are freezing up with no liquidity whatsoever for hours and days. This is not market capitulation, floor building, or strengthening of any kind. This is like a bird that’s been hit by a car flapping its broken wings, still thinking it will eventually fly again. It’s painful, even when watching from a safe distance. Wait a minute, is that a bus I hear behind m……….
52 0ReportSpamJoshiDC8 hours ago Bull Rider you had me laughing so hard. 1 0ReportSpam12 Add a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.CategoriesSpamChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatThreats of suicideOtherAdditional comments(optional) 100 character limitAre you sure you want to delete this comment?jQuery.async('scp', function () { jQuery.scp.comments({"partnerId":"e70689f0-2848-458a-b8ae-965c0aac79c8","jsUrl":"http://us.social.s-msn.com/s/js/16.5/ue.min.js","strings":{"lc_shw":"true","lc_dtf":"%M/dd/yyyy %h:mm tt","lc_dtf2":"ddd %h:mm tt","lc_gmt":"-4","lc_erg":"Comments are currently unavailable. 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