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European Banks on the Brink

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Continent faces bigger losses than the US -- with less money.

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And here's the problem: Europe's banking system is in far worse shape than that of the US. The losses may be bigger, and their capital to meet those losses is certainly less. Let's look at some charts. (Pour yourself an adult beverage.)

As I noted last week, one of the real benefits of writing this letter is that I get to see a lot of really interesting information from readers and meet with very savvy investment professionals. I recently had the privilege of sitting with a team of analysts from Hayman Capital here in Dallas. Hayman runs a global macro hedge fund, so they spend a lot of time thinking about how all the different aspects of the global markets fit together. This week we look again at some of their analyses.

There was a lot of work (as in months of it) done here. And Kyle Bass, the founder of the firm, graciously allowed me to share some of it (and kudos to Wes Swank, who pulled this together). The graphs are theirs, and though my discussion about them is certainly informed by our meeting, I'm using the material as a launching point. Hayman Capital isn't responsible for my conclusions and interpretations.

And Then There Was Leverage

In the first few years of the G.W. Bush administration, the banking authorities decided it would be okay to allow 5 banks to increase their leverage from 12:1 up to 30:1. Those included: Bear Stearns, Lehman (now absorbed into Barclays (BCS)), Merrill Lynch, JPMorgan (JPM), and Goldman Sachs (GS). Just 5 years later, 3 are gone and 2 survived with large dollops of taxpayer money.

(As a quick aside, is it really any surprise that Goldman and JPMorgan are making record profits on the underwriting and trading side of the business? Hell, if I could eliminate 50% of my competition, my profits would grow too! JPMorgan's consumer credit, credit card, and other business groups are losing money, big-time.)

Thirty times leverage means that if you lose 3.3%, you wipe out all your capital. And we watched as banks too big to fail were bailed out with taxpayer dollars. Slowly, banks are buying time, writing down assets. Remember: This month is the second anniversary of the onset of the credit crisis. I wrote back then that the strategy would be to stretch this out as long as possible. Time heals a lot of bad debts -- especially at a 0% Fed Funds rate.

Banks that are reporting so far this quarter seem to be saying that the write-offs will start to level off in about 2 quarters, although banking expert Chris Whalen says that the level may stay higher than we think for longer than we think. There are a lot of assets to write off, and they're just now getting to the commercial real estate problems. This is going to take time. (For an interesting interview on CNBC with Whalen, click here.)
No positions in stocks mentioned.

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