Last week, part of my emerging “Gruesome Twosome” thesis suggested that the European banking system was next to come under siege, and those problems could become severe, given their high leverage and proportionately large balance sheets relative to their home countries’ wealth.
Just as lawmakers stateside were piecing together a bill to stave off the collapse of the financial system – and that, combined with the takeout of Washington Mutual (WM) on Thursday, seems to have prevented another weekend rescue drama in the US.
The same can’t be said for Europe, however. After extensive pressure on shares of Fortis, Belgium’s largest financial firm, the governments of Belgium, the Netherlands, and Luxembourg teamed up to inject $16.3 billion [USD] into the bank to stabilize it, all while extracting their own pound of flesh between equity stakes and convertible debt. The amount of government money used to shore up Fortis exceeded the company’s existing market capitalization at the most recent market close.
Like most other recent bank failures, the comments mainly center on investor perception that the banks were too highly leveraged at a bad time in the market, and thus their liquidity dried up. Below is a chart from a recent publication highlighting the leverage ratios of several large European banks, with Fortis highlighted in yellow and more highly leveraged companies highlighted in red. Note that Fortis was far from the most extreme example of leveraged balance sheets.
I don’t want to promote panic, but it is difficult to see how Fortis will be the last major bank to fail, especially in Europe where the level of contagion seems to have lagged behind the US. Until there is evidence to the contrary, I’m going to add some weight to my thesis that global deleveraging and financial consolidation is going to be dominant theme, as will central banks’ attempts to inject enough excess liquidity to cause offsetting amounts of inflation – not that the effects will necessarily balance, but they will on a statistical basis.
I also believe that the Euro is a loser against the dollar; the risks to the dollar have relatively more clarity, and it looks like the European Central Bank is going to be forced to cut rates much like Bernanke was last year, even after repeated public worries about inflation.
Disclosure: None
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This article has 3 comments:
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strutzma
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15 Comments
Oct 01 10:27 PMDoesn't it matter more (most?) as to what types of assets are leveraged? Would this explain why a Fortis fell before the other higher-leveraged institutions on this listing? I believe that we all, perhaps yourself included, would love to know which assets are leveraged at all of the large financial institutions. If this information is available, is there a location where it may already be compiled?
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Lilliana
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27 Comments
Oct 02 01:14 PMLloyds bank has been around for over 250 years and has steered clear of the sub-prime mess.
The amalgamation with HBOS is a no cash stock deal.
Actually" Fortis" completely over extended itself on the NV Ambro purchase and lost their posterior.
Understand Leverage, is a normal part of Bank investing and
is well regulated.
Wonder how much this guy got paid for this article.?
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James Cullen
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142 Comments
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Oct 02 05:27 PMAll I'm trying to show is that leverage is high in European banks - this isn't intrinsically bad, but is worth noting... Now, the assets being leveraged absolutely matter, but the idea that a bank won't have problems because it has been around forever is not logical - see also: Barings, mid-1700s to 1995.