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European Banks on the Brink


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

While the TCE has obviously been rising and taking total leverage to rather lofty levels in the mid-40s, banks are raising capital. Over time, leverage will come back down. It helps if you can borrow money at almost nothing and lend it out at much higher rates.

Now, let's turn to the United Kingdom. This is uglier.

Regulators in the UK allowed 20:1 leverage on a regular basis. It's now almost 40: and TCE is around 55. The assets of UK banks are about 5 times as large as UK GDP. By comparison, for the US the ratio is barely 2:1.

Think about that for a second. The UK has banking assets that are 5 times as large as the annual domestic output of the country. They also had a housing bubble. They have their own bailouts to deal with -- which are massive and will potentially get much larger -- but at least they have a central bank and government that can try to fix the problems.

But wait, there's more! Let's look at the Eurozone.

Leverage is now 35:1 and TCE is almost 55. How did 35:1 work out for the US? Given the massive credit problems Eurozone banks have with emerging markets (plus Spain's housing bubble, which is every bit as bad as that of the US), won't this end up in wailing and weeping?

Too Big to Save

And here's the real issue. They have no Paulson or Bernanke. Some of my Austrian economist friends say, "Good. They should all be allowed to die." But that's a very cavalier attitude when you start talking about actually increasing the unemployment rate to something like 20%. I agree that management should be changed, as well as the regulators (35:1 to 1 -- what were they thinking?), and shareholders should be wiped out. But I don't want the system to collapse. And this is a global risk, not just localized to Ireland, Spain or Austria. Sure, the pain might be worse in the local region, but we'll all end up feeling it.

The European Central Bank, at least as of now, can't step in and start saving individual banks. How do you save a Spanish bank and not an Austrian bank? Austria's banks have made large loans to Eastern Europe in euros and Swiss francs, and are going to have large losses -- far more than 3%, which would wipe out their capital. But bank assets in Austria are 4 times GDP. What we have are banks that are too big to save for relatively small Austria. And that goes for Italy, Spain, Greece, et al. More about this below, but for now, let's turn our eyes to Switzerland.
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