Tags: Euro | Banks | Chaos | debt

Euro Banks Dwarf Lehman and Threaten to Unleash Chaos

By Michael Carr   |   Wednesday, 16 May 2012 10:29 AM

After becoming overleveraged, Lehman Brothers collapsed in September 2008 and plunged the global financial system into turmoil.

Recovery seems to have erased the memory of that painful experience and European banks are now approaching the amount of leverage that took down Lehman, Bear Stearns before that, and a number of hedge funds during the last 15 years.

Europe’s banks have more than $55 trillion in assets, according to the European Banking Federation. They are four times larger than the U.S. banking system which has assets of only about $14 trillion, according to Federal Reserve data.

European banks are more than three times as large as the eurozone economy, which has a GDP of about $17 trillion. For comparison, the size of the U.S. economy is about $15 trillion.

Size alone isn't a guarantee of problems. Leverage, the use of borrowed money, has been the trigger for crisis.

When banks or hedge funds have used leverage that is about 30 times more than their assets, trouble has followed. With that much borrowed money at work, a 3.3 percent market decline wipes out all of the equity.

With leverage of 26 to 1, European banks have redefined too big to fail. The European Central Bank can't bail them out with the resources that are available, but it can't allow them to fail.

The only long-term solution seems to be printing money and giving it to the banks who can then give it to their governments so that deficit spending can continue.

After a time, the central banks around the world can agree to drop zeros from their currencies. Turning a trillion dollars into a billion by dropping three zeros has been the traditional way that central banks address hyperinflation, and that seems to be the only way out for banks.


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