European Banking Crisis Spins Out Of Control – Officials Have No Solutions

The European banking crisis intensified as the threat of debt default contagion spread across Europe.  What was once a “Greek” problem has quickly overwhelmed all of Europe, resulting in a broad sell of equities and frozen credit markets.  Bloomberg reports that European banks are now being valued at levels last seen during the worst of the 2008 financial crisis.

A Bloomberg index shows 46 lenders trading at 0.56 times book value, the cheapest since the post-Lehman lows of March 2009, signaling investors estimate their net assets are worth less than the companies claim and are demanding discounts for perceived risks. Valuations reflect the impact of a potential sovereign default for some banks, according to Barclays Capital analysts led by Jeremy Sigee.

Group of Seven finance chiefs meeting in Marseille, France, over the weekend vowed to support banks amid growing concern that the debt crisis is morphing into a banking crisis. As doubts linger about the ability of some European lenders to withstand a Greek default and its ripple effects, the cost of insuring their debt rose to records, while a measure of their reluctance to lend to each other climbed to a 2 1/2-year high.

“Politicians need to get their heads together and deal with the inevitable: a Greek default and recapitalization of some banks,” said Peter Thorne, a London-based analyst at Helvea Ltd. “You have to make the banks look financially stable and secure so that people are prepared to deposit money with them for more than 24 hours.”

Deutsche Bank AG (DBK) Chief Executive Officer Josef Ackermann said on Sept. 5 that market conditions remind him of late 2008, and urged lawmakers to act to avoid a repeat of the financial crisis, which spawned the worst global recession since the Great Depression.

The 90 banks that underwent European stress tests would face an estimated capital shortfall of 350 billion euros if Greek, Portuguese, Irish, Italian and Spanish government bonds were written down to market values, according to Nomura analysts led by Jon Peace. No “practical” amount of capital can prepare them for a large sovereign debt impairment or default, Nomura said in a note on Sept. 7.

Meanwhile, bickering and political brinkmanship has prevented the European Union from effectively dealing with the debt crisis, causing a loss of confidence in the banking system.  The interbank lending market in Europe has frozen with banks refusing to lend to each other, leaving the European Central Bank as the lender of last resort.  Credit default swap prices on Europe’s banks have soared, indicating that investors are expecting wide spread banking failures.

The New York Times summarized the catastrophic losses on major banking stocks – many of them have sold off beyond levels seen in 2008, just prior to the collapse of Lehman Brothers.  Bank of America, the biggest bank in the U.S., has seen its stock price collapse, a blunt warning from investors that they don’t expect the Bank to survive.

Courtesy yahoo finance

The promised second phase of the Greek bailout by the European Union has been delayed by by demands for collateral by Finland, the inability of Greece to comply with new austerity measures and swelling opposition to additional bailouts by citizens of Germany and other countries of the EU.  The surprise resignation of Germany’s Jurgen Stark from the European Central Bank over his opposition to EU Central Bank purchases of the sovereign debt of Spain and Italy caused a huge market sell off last Friday.  In addition, a ruling by the German Courts further complicated the funding of the European Financial Stability Fund (EFSF) by Germany.  The EFSF was supposed to be Europe’s “shock and awe” answer to containing the debt crisis.

German officials continue to argue over funding additional bailouts and German Economy Minister Philipp Rosler said that an “orderly default” for Greece was no longer out of the question.  The rate on short debt Greek debt climbed to over 100% today, indicating that a default by Greece on its sovereign debt is inevitable.   Greece reportedly has only enough cash to last another three weeks without further bailout funds from the EU.

In another dramatic and worrisome sign of the spreading debt contagion, Moody’s Investor Service will reportedly cut the credit ratings of major French banks due to looming large losses by the banks on their holdings of Greek debt.  European bank stocks, which have collapsed over the past several months, continued to spiral downwards today as politicians appear helpless to contain the rapidly expanding debt crisis. The stock prices of U.S. banking stocks have been sold off relentlessly as well  due to American bank holdings of European bank debt.  The entire banking system is inexorable intertwined – the failure of one large institution could easily be the trigger that sets off a cascade of bank failures.

A crash in bank stocks was the harbinger for the financial collapses seen in 1929 and again in 2008.  The reason why this time could be worse is the inability of already heavily indebted governments to bail out the system.  A global financial crisis is upon us again and the nightmare scenario is that this time the crisis cannot be contained.