Could Europe be on the cusp of a Lehman moment?

August 23, 2011

By Kathleen Brooks. The opinions expressed are her own.

The euro zone debt crisis has now spread from the sovereigns – after the ECB came in and purchased Italian and Spanish debt – to the banking sector. Although the EU authorities put in place a short-selling ban, which has another week to run, the banking sector is back at the pre-ban levels or in some cases even lower.

Europe’s banks are by and large less capitalised than their U.S. peers. They are also exposed to Europe’s sovereign debt and European loan books. Even if a member state manages to avoid a default, growth is now slowing and we could be in line for another recession that would most likely increase bad debts and further erode banks’ profits.

As if that wasn’t enough, German Chancellor Merkel and French President Sarkozy announced a proposal for a financial transactions tax – a Tobin tax – to pay for bailouts to Greece, Portugal and Ireland. This will be discussed at the next EU summit in September, and if implemented would only make it harder for banks’ to boost their capital bases going forward.

The Basel three global regulatory standards for bank capital adequacy requires the world’s largest banks to boost their Tier 1 capital ratios and to hold higher quality capital as a buffer in case of financial shocks in future. These rules were introduced this year and since then Europe’s banks have been in a rush to raise capital. Pressure was ramped up after stress tests that were released in June showed that 24 banks needed to raise extra capital. Eight banks failed the test, while 16 had core tier 1 capital ratios below the 6 percent threshold.

So the banking sector in Europe was already exposed even before growth started to slow and the sovereign crisis spread to Italy and Spain. If markets get a hint of trouble in the banking sector the rumour mill can go into overdrive. This has driven stocks like Unicredit and Societe Generale lower by 30 percent and 40 percent respectively since the start of August.

Earlier this week there were rumours that some banks had to borrow dollar-based funds from the U.S. Federal Reserve’s swap facilities for foreign banks. This is considered the lender of last resort when you can’t raise money from the inter-bank market. The sums were fairly minimal – EUR500mn and EUR200mn – however, they suggest that some European banks are in trouble and a liquidity crunch could be in the wings.

Rumours and a sharp deterioration in sentiment led to the collapse of Lehman Brothers in 2008, so if the current conditions persist it is not a major stretch of the imagination to see a European financial institution go the same way.

However, we need to keep things in perspective. Back in 2008 Euribor –the inter-bank lending rate – spiked higher threatening to bring down the global financial system. Although the Euribor rate has been rising recently it remains well below the peak of three years ago.

So we may be some way off a full blown liquidity shock in Europe’s banking sector, but the current environment is worrying. The banking sector is the glue that holds an economy together; if it starts to come unstuck the consequences can be severe, as we found out in 2008.

Image — Chocolate bars in Euro banknote design are on display at a candy shop in Vienna, August 19, 2011. REUTERS/Heinz-Peter Bader

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Any five-year old child knows that if you put ten marbles into a tin can, you can only take ten marbles back out. No amount of wishful thinking, dreaming, or praying, will yield that eleventh marble from inside that can. That eleventh marble does not exist. It never did, and it never will. All discussions about the eleventh marble are the product of imagination. The eleventh marble is a fantasy.

Private central bankers issuing the public currency as interest-bearing loans operate on the belief that they can put ten marbles (dollars) into a tin can (the world) and magically get 11 marbles back out. Thus, we may conclude that the bankers are dumber than five-year old children! But unlike five-year old children, the bankers will take your home, your business, and your nation when they don’t get that eleventh marble! The spoiled child may cry and throw a tantrum, but that will be the end of their upset. The spoiled banker, however, in his or her arrogant rage that they cannot have the eleventh marble their imagination says must still be in that tin can, may start a war before they will admit that eleventh marble was never really there.

Economies are like tin cans. Before you can take a marble out, you must have put a marble in. Nobody can give you a marble that does not exist, yet this simple reality is lost to the priests of that fantastic religion called banking in that unholiest of temples called the IMF. Their religious doctrine seems to be that there must always be an eleventh marble inside the tin can, and that the tin can unfairly withholds that eleventh marble, indeed cheats them of their right to the eleventh marble, purely out of spite. That faith in the existence of the eleventh marble, unseen and improvable, is the article of faith the religion of banking rests on. It is far easier to burn the heretics than to question the dogma.

Today we see the bankers, having already retrieved their ten marbles from the tin can, flogging the world for that missing eleventh marble. Greece does not have that eleventh marble, so they turn to Germany and ask, “Do you have an eleventh marble”, and Germany replies, “Sorry, but the bankers already took the ten marbles they put in our tin can, and we are searching for an eleventh marble ourselves. Try the Americans.” The Americans, of course, have only just surrendered the last of their ten marbles back to the bankers and are looking under seat cushions for that missing eleventh marble nobody seems able to find.

But the eleventh marble will never be found. After all that mayhem brought down on the tin can there still will be no eleventh marble. It does not exist. It never did, and it never will.

The problem with all modern reserve banking systems is that the moment the first bank note goes into circulation as the proceed of a loan at interest, more money is owed to the banks than actually exists. Ten marbles have been put into the tin can, but the bankers see 11 marbles owed back to them. Sooner or later the non-existence of that eleventh marble will create a crises of faith. People will stop believing in the religion called private central banking, and that crisis of faith will bring the system crashing down, as did the Temple of Baal in ancient times when the Syrians saw through the priests’ trickery. This evil magic of creating money out of debt was a fraud all along, as fraudulent and silly as the idea that one can put ten marbles into a tin can, and take out eleven.

In ages to come economists will look back at this failed experiment in debt-based currency, and dump it into the same category of human folly as Tulip mania, The Nation of Poyais, Credit Mobilier, the Great South Seas Company, and Mortgage-Backed Securities.

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