In Follow The Money: Behind Europe's Debt Crisis Lurks Another Giant Bailout Of Wall Street, former Clinton Labor Secretary Robert Reich lays out a scary scenario in which a Greek default leads to a Lehman Brothers-style crisis on Wall Street.
Today Ben Bernanke added his voice to those who are worried about Europe’s debt crisis...
If you want the real reason, follow the money. A Greek (or Irish or Spanish or Italian or Portugese) default would have roughly the same effect on our financial system as the implosion of Lehman Brothers in 2008.
Investors are already getting the scent. Stocks slumped to 13-month low on Monday as investors dumped Wall Street bank shares.
The Street has lent only about $7 billion to Greece, as of the end of last year, according to the Bank for International Settlements. That’s no big deal.
But a default by Greece or any other of Europe’s debt-burdened nations could easily pummel German and French banks, which have lent Greece (and the other wobbly European countries) far more.
That’s where Wall Street comes in. Big Wall Street banks have lent German and French banks a bundle.
The Street’s total exposure to the euro zone totals about $2.7 trillion. Its exposure to to France and Germany accounts for nearly half the total.
I do not know where Reich got that total—$2.7 trillion. A little investigation turned up nothing. That's a big number. You would think a number that big would be all over the news. As Reich goes on to explain, the problem is not with direct exposure (loans) to financially shaky countries. The problem is with derivatives.
And it’s not just Wall Street’s loans to German and French banks that are worrisome. Wall Street has also insured or bet on all sorts of derivatives emanating from Europe – on energy, currency, interest rates, and foreign exchange swaps. If a German or French bank goes down, the ripple effects are incalculable.
Get it? Follow the money: If Greece goes down, investors start fleeing Ireland, Spain, Italy, and Portugal as well. All of this sends big French and German banks reeling. If one of these banks collapses, or show signs of major strain, Wall Street is in big trouble. Possibly even bigger trouble than it was in after Lehman Brothers went down.
That’s why shares of the biggest U.S. banks have been falling for the past month. Morgan Stanley closed Monday at its lowest since December 2008 – and the cost of insuring Morgan’s debt has jumped to levels not seen since November 2008.
It’s rumored that Morgan could lose as much as $30 billion if some French and German banks fail. (That’s from Federal Financial Institutions Examination Council, which tracks all cross-border exposure of major banks.)
$30 billion is roughly $2 billion more than the assets Morgan owns (in terms of current market capitalization.)
But Morgan says its exposure to French banks is zero. Why the discrepancy? Morgan has probably taken out insurance against its loans to European banks, as well as collateral from them. So Morgan feels as if it’s not exposed.
But does anyone remember something spelled AIG? That was the giant insurance firm that went bust when Wall Street began going under. Wall Street thought it had insured its bets with AIG. Turned out, AIG couldn’t pay up.
Haven’t we been here before?
Back in June, CNN Money's Colin Barr attempted to see where the banks stood in Sizing up the Greek risk to U.S. Banks.
... no one can safely predict that a Greek default would be contained. For this we can thank the risk-hiding magic of derivatives, which were so instrumental in the AIG fiasco, and the hair-pulling disclosure practices of the banking industry.
You might hope the banks won't lightly repeat the credit bust by again betting the house that financial gravity no longer applies. But times are sort of desperate for the banks, whose profits are being squeezed and their stock prices slammed. Show some bonus-obsessed traders a bet that looks like a sure thing and who knows what kind of hijinks might ensue...
We do know that the big U.S. banks are huge players in derivatives – largely in foreign exchange and currency bets, but also to a lesser extent in credit derivatives such as credit default swaps, which enable users to bet a debt issuer will fail to make payments on time.
Even if derivatives don't match the damage they wrought in the last meltdown, they still pose an enormous threat to the financial system. JPMorgan Chase, Citi, Goldman Sachs and Morgan Stanley together had $288 billion of derivative liabilities at year-end [see chart, above left], a measure of systemic risk reflecting the payments they are due to hand over when those contracts end. They have that much and a bit more in derivative assets, reflecting payments they stand to receive when other contracts end.
We know too that lots of wagers are being made on possible defaults in Greece, Portugal and Ireland...
We simply have no idea what the true exposure of banks like Morgan Stanley really is. When Reich says Morgan has probably taken out insurance against its loans to European banks, as well as collateral from them, we don't know what forms those "hedges" take. It's all about counter-party risk. A credit default swap is not really insurance. The counter-party is not obliged to have cash on hand to pay up if they lose the bet, as happened with AIG. (The counterparty Goldman Sachs got their $13 billion.) Hence, Reich foresees another bailout. Lots of wagers have been made on possible defaults in Greece, Portugal and Ireland, and probably Italy and Spain as well. We don't know how many bets have been made, what the terms of those bets are, and how large they are.
As usual, when it comes to the global financial system, we are completely in the dark. Reich's point is that the Dodd-Frank financial "reform" legislation didn't go far enough in reining in derivatives trading. Obviously not.
But the biggest unknown, the one that really counts, is what effect another Lehman Brothers-style collapse would have on the "real" economy, the one where you and I live. God help us, because it's become all too obvious that we can not help ourselves.
Related Posts
Derivatives Craziness And The Next Bailout
Derivatives Craziness And Political Corruption
The Derivatives Shell Game
Bonus Video — from the Wall Street Journal's Bank Stocks Fall on European Exposure Fears (10/3/2011)
"But the biggest unknown, the one that really counts, is what effect another Lehman Brothers-style collapse would have on the "real" economy, the one where you and I live."
In 2008, this was the big argument FOR the bailout. The scenario painted by corrupt banksters, politicians and corporatists was that if we let the "too big to fail" actually fail, it would be the absolute ruin for ALL of us. Well, we fell for that and time has proven that the little guys got hurt, but not the corrupt government, banks and corporations that got us into this mess in the first place.
For all our sakes LET THEM FAIL! It's the only way to break up the monopolies. Let them FEEL THE PAIN and lose THEIR MONEY and thus their power. Us little guys will ride it out and be the stronger for it.
Posted by: gg | 10/07/2011 at 05:02 PM