Before we get too euphoric over the European Union’s $1 trillion rescue plan, take a look at these names. They’re distressingly familiar.
Fortis (FORSY). Dexia (DXBGY). Societe Generale (SCGLY). BNP Paribas (BNPQF). ING (ING). Barclays (BCS). Deutsche Bank (DB).
Remember them? They were so neck-deep in the Lehman/American International Group/mortgage-backed assets debacle that they required government bailouts. (Deutsche Bank may quibble. It got its cash from American International Group (AIG), so technically I suppose it didn’t get government money, but since the AIG payout used cash from a government bailout of that company, I think it’s a distinction without a difference.)
And now? Well, they all make the short list of European banks most at risk in the Greek debt crisis.
Still. Even after the $1 trillion rescue.
The plan announced by European Union politicians over the weekend is a bailout plan, remember. That implies that there are banks they might be in need of rescue. The plan really doesn’t change the risky assets on these bank’s balance sheets into gold or German bunds. The hope is that by putting the rescue plan in place, investors won’t sell the bonds of Greece and Spain and Portugal and push banks loaded up with these bonds into deeper trouble.
But it’s only a hope. And if you want to understand why European leaders were so anxious to get this deal done before the financial market’s opened on Monday May 10 look at this list.
Want to know how dangerous the Greek (soon to become the Greek/Spanish) crisis is? Look at these banks.(For more on Spain’s progress to crisis see my post https://jubakpicks.com/2010/05/06/spanish-interest-rates-climb-as-the-country-takes-another-step-toward-crisis/ )
Want to understand why this is serious but not a replay of the chaos that followed on the collapse of Lehman Brothers? Look at these banks.
Want to know why investors are right to worry about contagion and the risk that other banks will catch what these banks have? Look at these banks.
Okay, let’s start with the data on how much money is at risk at each bank. (The Financial Times put this all together in a table in their Thursday, May 2010 paper.)
Fortis holds $5 billion in Greek bonds. Dexia holds $4 billion. Societe Generale $5.2 billion. BNP Paribas $8 billion. ING $4.6 billion. Barclays $6 billion. And Deutsche Bank $2.6 billion.
Altogether a hefty $35.4 billion in Greek bonds.
Now I know that seems like a lot of money but in the scale of recent financial crisis it’s not all that much. In fact, if you compare these amounts to what it took to bailout these banks in the aftermath of the Lehman bankruptcy, then $35.4 billion is pocket change.
The governments of Belgium, the Netherlands, and Luxembourg bailed out Fortis to the tune of $16 billion or so The Dutch government injected $13.4 billion into ING. France, Belgium, and Luxembourg put $9 billion into Dexia. France bought $13.9 billion in debt securities from six banks, including Societe Generale and BNP Paribas, and then later lent an additional $7.4 billion to BNP Paribas.
I think you get the idea.
But on another scale these sums seem absolutely large enough to recreate the dynamic that made the post-Lehman crisis so devastating. The basis of the post-Lehman crisis was fear. Banks that had become accustomed to finding their capital in the financial markets by selling short-term commercial paper found themselves forced to borrow for shorter and shorter time periods as buyers of bank debt tried to limit their risk by extending money for as few days as possible. Eventually those few days turned into no days and these banks found themselves unable to get financing at all.
Something similar had started to happen in the European banking sector in the days before the rescue. Banks were increasingly unwilling to lend to each other for any period longer than overnight. Of the almost $600 billion that turns over every day in the Euro zone money market sector 90% was now lent not for 90, 30, 14 or even seven days but overnight.
The fear that’s behind the unwillingness to lend comes from massive uncertainty. Some banks look in trouble even if you look at just Greek debt and use a relatively strict but straight forward measure such as the ratio of Greek debt to tangible net asset value. (Net asset value is the value of a company’s assets that remains after all liabilities have been subtracted. Tangible net asset value excludes intangible assets such as goodwill by assuming that such assets are worthless.) At Fortis Greek debt equals more than 60% of tangible net asset value. At Dexia the ratio is 30%.  Both numbers are high enough to make potential buyers of short-term paper from these banks shy away.
But even banks with much lower ratios such as Societe Generale, BNP Paribas, ING, Barclays, and Deutsche Bank where Greek debt represents from a little more than 10% (at Societe Generale) to just over 5% (at Deutsche Bank aren’t worry free.
Remember that so far I’ve looked only at exposure to Greek debt. Spanish debt is increasingly looking like an asset to avoid—and there’s a lot more of it floating around the European banking system than there is of Greek debt.
French and German banks are the most exposed to the Greek debt crisis of any in Europe. Barclays Capital pegs the total exposure of  banks in those two countries at $103 billion. (Think about that to explain the outrage of German and French taxpayers. They know they’re being asked to bailout their banks–again–in the $1 trillion rescue plan.)
In comparison Spain needs to roll over almost $300 billion in debt just in 2010. And since Spain has a relatively low savings rate and relatively large government and trade deficits about 45% of Spanish debt is held by foreigners. (For more on the relative size of the Spanish and Greek crises, see my post https://jubakpicks.com/2010/04/28/how-much-could-it-cost-to-bailout-greece-portugal-and-spain-would-you-believe-630-billion/ )
If that exposure was spread evenly across the globe or even across Europe, even that amount of debt wouldn’t be nearly so worrisome. But as the Greek numbers show, a few banks can wind up holding a disproportionately heavy part of the bag. The seven banks on my short list hold total Greek debt equal to about 34% of the total debt held by German and French banks.
Some bank or banks could be on the hook for a bigger than average chunk of Spanish debt. If you could figure out who that bank might be, you would certainly avoid doing business with it. And if you can’t pinpoint the risk, the most reasonable option is to act as if everybody were a potential risk and not do business with anyone.
Even if you knew exactly what everybody’s dollar exposure to Greek and Spanish debt was, you still wouldn’t know who had bought hedges on some of that risk—and who had taken on even more risk by selling those hedges. Financial risk insurance, we learned during the Lehman collapse, is only as solid as the company selling it. And since this part of the derivative market is by and large private and opaque, you can’t really know who is hedging and how much and with what counterparties. Refusing to do business with anyone or to buy anyone’s debt, even the shortest term debt, seems like an even better idea.
Which, of course, is why any rescue plan had to guarantee everybody. The only way to remove investors’ and traders’ worries if they can’t be sure who is at risk is to make sure that everyone is part of the bailout. Potentially, at least.
And it’s yet more attractive because it’s not just the aggregate amount of Greek and Spanish debt, and the long or short position after all the hedges are netted out makes the difference between a bank that’s in a painful but survivable jam and one that’s in danger of going under.
Local Spanish banks—not the big players like Banco Santander (STD) but the smaller regional banks—are big owners of Spanish government debt and are now finding it just about impossible to raise capital in the financial markets. But this isn’t as fatal a problem as it might seem because these banks historically have raised much of their capital the old fashioned way—from customers depositing money with the bank. These banks may be sitting on a large pile of Spanish debt relative to their size but their actual risk may well be lower than a bigger institution such as Deutsche Bank that has a relatively weak deposit gathering apparatus. (On the other hand, the big Spanish banks like Banco Santander have been aggressively going after the depositors of these small banks. I told you figuring out who is at risk is complicated.)
Thinking back to the post-Lehman crisis and looking at the current group of seven banks on this short list gives you a way to benchmark this crisis. Remember that several German state banks went under in that crisis but their troubles didn’t threaten the global financial system. Few of the institutions on this list play a big enough role in the global system of parties and counterparties that their troubles would cause a crisis in New York or Tokyo. Two possible exceptions are Societe Generale and Deutsche Bank. The banks were the top two recipients of cash from American International Group (which, of course, got that cash from the federal government, which got it from tax payers) to settle derivative contracts. Societe General received $4.1 billion and Deutsche Bank $2.6 billion, according to documents released by AIG on March 19, 2009. Those payments were larger than the $2.5 billion Goldman Sachs (GS) received from AIG.
So as the European debt crisis moves to its next stage in Spain (yes, inspite of the rescue plan, Spain still needs to figure out how to cut its deficit) , I’d keep an eye on those two banks and on the two big international banks based in Spain, Banco Santander and Grupo BBVA. I think the danger of contagion escaping the Euro zone and infecting other financial markets is limited to just that handful of banks.
 At least until the United Kingdom and the United States face their days of reckoning for their debt.
Full disclosure: I do not own shares of any of the companies mentioned in this post in my personal portfolio.
Jim – I’d appreciate an analysis of HSBC exposure to this Euro bailout debacle.
I was merely commenting on the ORIGINAL comment which did not mention “bums” in private sectors. It does not mean I think private sectors are all “geniuses”. But the difference is that private sectors only make decision for their businesses (though sometime their businesses may effect others if they got too big) while people in government are, by definition, have to take care the entire society or nation as a whole. We better require more qualified people in that position.
yx… I don’t disagree. I don’t see politicians from either party being very fiscally conservative. Well, a few have suddenly seen the light, but where were they the last 5-10 years? This reminds me of a comment I heard somewhere, don’t remember the attribution: We don’t need a 3rd party, we need a second party.
All we need is another massive entitlement in addition to the 2 wars. Taking over more and more private sector will really help us create jobs and wealth.
I guess instead of those from the “ivory tower” we need some of the geniuses from Bear Stearns or AIG. They knew how to make payroll every Friday. Right. There are bums in both the private and public sectors.
And as far as the US spending, maybe if we didn’t have 2 wars to finance we would be better off. Just a thought.
Fiscal conservatism does not have a party boundary.
yx,
That’s one of the reasons I own EUO. 😉
yx,
I agree…that’s part of the problem, perhaps. A lack of the right kind of experience often hampers the well educated. Given the choice between knowledge and wisdom…give me a little knowledge and lean hard on wisdom. Come to think of it, I haven’t seen evidence of it…not in this crisis!
Why not place a hold on interest payments and passing a special regulation to allow these banks to hold Greek debt at face value? Greece would have to use the interest savings to buy back debt on the open market, surely at a significant discount, and could lower their dept:GDP through time. Refi, or roll over, in a year or two at 80 – 90 % of today’s debt level and the situation looks much better. NO BAILOUT NECESSARY!!!
The downside to the banks is NPA’s and they’d lose some margin. However, 1 or 2 % of $35.4 billion is a helluva lot smaller than a trillion. Each country could decide on a relatively small bailout on a case by case basis. Or maybe China would like to buy a couple banks.
Ed:
If Germany leaves EU, then EU and Euro are worthless.
bobisgreen:
“Why highly educated men and women government blundered so badly”? The answer is very simple. None of them ever had to make payroll on Fridays. This is particularly true with the current administration which is full of people who spent their whole lives in ivory tower.
Now for the other side of the euro coin:
http://uk.finance.yahoo.com/news/merkel-s-caution-in-euro-crisis-weakens-germany-in-eu-reuters_molt-8c7c2ac749c9.html?x=0
If Merkel has lost influence in the EU, as well as her own country, this could be an indicator that Germany might eventually pull out of the euro. Granted, we are talking several years from now, unless Germany gets severely frustrated before then.
Keep in mind, if the EU loses Germany, then the euro loses a huge chunk of it’s inherent value as a currency.
The key to this speculation will be inflation in the EU. If inflation starts to get out of control there, expect to see increased political pressure in Germany for leaving the EU.
unrelated, GDX hit 52.08, Jim isn’t that your target for GDX?
in that argument, is it still appropriate to buy stocks (even in the US). in this time and age if china get hurt everything get effected and same for Europe even if nothing is wrong in the US.
good to see HSBC missing in the list
Part of the problem with the EU is how they finance their debt.
The governments sell bonds to banks. The banks turn around and use those bonds as collateral to borrow money from the ECB at 1% interest. In other words, whatever money the government pays the bank above the 1% interest is free money for the bank.
Why would a politician raise taxes when he has an easy credit line like this?
I think the appropriate phrase for this is “moral hazard”…
It’s almost laughable, yet scary at the same time. When you consider the simplicity of the answer to the problems of the Euro – US financial meltdown, it makes you wonder how highly educated men and women in positions of governmental and financial authority can blunder so badly. Of course, some would say my view is over simplistic, but think about this concept: all of us little people (most, well a lot any way) take into account our net income, subtract (and manage, manage being the operative word) our expenses and learn to live on what’s left. We don’t take on personal debt in excess of our means to deal with it. Apply this small scale example to a country like Greece or Spain, and yes, the US. When are educated, experienced people going to wake up and smell the coffee? Don’t know. I only know this; excesses, greed, corruption and the rest of human nature has backed the globe into a corner. A change in behavior, some very hard choices on many levels and common sense are necessary for financial survival. Stuffing your dough in a mattress may not be practical, but attractive options are becoming fewer. Unfortunately, ultimately, we poor tax payors are on the hook. The “hooks” are too big and the effect of being “hooked” makes a small impact on the problem!
After a few more years under Obama, and we become more socialized, and indebted; I can see a similar situation as the Greek riots happening here in the US. There are allready small pockets here and there and are only so called “tea partie”, but it can and probably will escalate. Also, who would have thought two weeks ago, that the markets would drop 10% in just afew minutes. After the Bull euphoria, everyone would say impossible. Can’t happen. Folks…we are living in dangerous times. I can not believe how the average Joe out there has no clue nor interest in whats going on in our world. If you have any assets at all, you must manage it daily, just as if were a second job.
Jim, I have a bad feeling that our European Governments consider the markets as ruled by psychology, and psychology only. They would probably look down to you as a naughty boy for not taking what they say at face value. Unfortunately, I don’t either.
Jim,
This may sound funny, but your post is almost taking the “rosy” view of the scenario.
Let’s consider the worst case scenario under this new bailout. Let’s say a lot of these banks start adding Greek sovereign debt to their portfolios. Now let’s say that Greece falls into anarchy because of the austerity measures being forced onto them. Let’s say Greece decides to secede from the EU, and in the process defaults on their debt.
Suddenly, these banks are sitting on worthless paper as their reserves. Could we see a bank run similar to what happened in the U.S. at the start of the Great Depression? Certainly, and it might not even be limited to the largest banks you mentioned.
Now the governments of the EU could get everyone calmed down, and bailout the banks once more. Unfortunately, this is going to end up putting some severe stress on either the economies of countries like France and Germany, or it could severely inflate the euro as they crank up the printing presses.
Politically speaking, this will give more power to anti-EU forces in Germany and France.
Granted, this is a worst case scenario, and I doubt it will happen this way. However, I do see anti-EU sentiment growing in the stories from Europe. Successful countries don’t want to pay for the leeches, and the leeches want everything the successful countries have.