Sunday, July 4, 2010

European Bank Catastrophe

First and foremost, today is the 4th of July.. a day meant to celebrate our Independence from the British Empire. For those who's history is a tad shady, it was nothing short of a remarkable feat.. a rag tag (literally rags) collection of colonial farmers, fisherman and merchants with help from France intent on liberating themselves from the unjust taxes imposed on them by the world's greatest superpower of the day, the British Empire. Today's equivalent would be California defeating the United States, with the aid of Mexico, and secured by a crushing defeat of the United States Army by Californian rebels at a battle (Yorktown). The odds against this were literally incalculable. Their bravery and improbable victory, at a very high cost in lives, should never be forgotten. It's more than BBQ's and fireworks, folks.

On to today's subject.. the catastrophic state of European banks. Throughout most of the 20th Century, US banks were leveraged at 10-1 (that is, ten dollars in loans for every dollar in the vault). Therefore, if one tenth of the bank's loans went belly up, the bank is toast. In the 1980s, with the benign neglect of Alan Greedspan, banks leveraged themselves ever upward.. resulting in a leverage ratio at some big banks at 25-1.. and this ratio did not include the credit default swaps they had written. This led to mortgages and credit cards being handed out to anyone with a pulse.. with predictiable results. Sept 2008 nearly crashed the US banking system, thanks to this wreckless lending.

The European banks, not to be outdone by their Yankee cousins across the pond, leveraged themselves up even further.. in some cases sixty and seventy to one, nevermind credit default swaps. Worse, much of these loans ($1.7 trillion) were to Eastern European countries, who's political and economic stability were shaky. Worst of all, were also given to loaning huge sums of money to other EU banks, thus ensuring that should one go down, it would very likely take down others with them because of these loans as well as CDS's. For example, America's largest bank, Citibank, has roughly $2.2 trillion in assets. Britain, one sixth the size of the US, has three banks larger than this; France has two.

As the EU countries slowly begin to implode.. Greece is but the first of many.. the security of the banking system comes increasingly into question. Perhipery nations, to whom EU banks have loaned hundreds of billions, are also very shaky.. Rumania and Hungary in the last few weeks look pretty grim. Today, Ambrose's article is about Spain and their $1.1 trillion of external debt and how they are likely to need the EU/IMF bailout by summer's end. Already EU banks have essentially stopped loaning to each other, a sign of fear.. and rightly so. Only the ECB loans to EU banks.. this is a very bad sign.

Over a long enough period of time, this ends in one of two ways.. both of which lead to grinding Depressions on the Olde Continent. The first is hyperinflation in order to save the banks. The second is complete and utter collapse of the financial system and repudiation of debt. Anybody buying the official line "the economy continues to recover" are utter fools. This is coming.. my guess is that they'll hold it together this year, but 2011 is my guess for the financial apocalypse.

Here's an excellent graph on this:

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