The U.S. stock market surged yesterday on news the European Union (EU) would deploy a two trillion euro rescue fund to help get its sovereign debt crisis under control. This news was so good even battered Bank of America stock jumped more than 10%. Crisis averted? Hold on, not so fast. Some big French banks are in trouble because they are up to their necks with sovereign debt. Naturally, President Nicolas Sarkozy wants action now. Yesterday, the Financial Times (FT.com) reported the French leader said, “. . . an unprecedented financial crisis will lead us to take important, very important decisions in the coming days.” Raising the sense of urgency, the French president added: “Allowing the destruction of the euro is to take the risk of the destruction of Europe. Those who destroy Europe and the euro will bear responsibility for resurgence of conflict and division on our continent.”
Jim Rickards of Tangent Capital says you have to distinguish between the bonds, banks and the euro. He said recently in an interview on King World News, “The bonds are definitely going to crash and burn. The bonds are toast. . . . The banks own the bonds, and if the bonds are toast, the banks are toast. . . . But that doesn’t mean the currency is toast.” Rickards expects the euro currency will survive, but many banks will not.
Reggie Middleton of Boombustblog.com says the reason for the coming bank failures is simple—high debt loads. Middleton says many European banks have 40 to 1 leverage. He recently explained how dangerous this was by saying, “I take a dollar and I borrow $39, and I go out and buy something with it. All you need is a 2% move to totally wipe you out—100%. And we all know a lot of sovereign bonds have moved a whole lot more than 2%.” Middleton is expecting more European bank runs as the crisis picks up speed.
Dr. Martin Weiss of MoneyandMarkets.com is also predicting “European megabanks will collapse.” In a recent post, Dr. Weiss said, “Sovereign debt defaults will trigger more bank failures. More bank failures, in turn, will precipitate more sovereign debt defaults. This vicious cycle will cut off the flow of credit to businesses and households, sink the global economy into a depression, and perpetuate the vicious cycle. Ultimately, we will see an extended period of great economic hardship for billions of people on every continent.”
The risks associated with the European sovereign debt crisis are not overblown. Some of the top government financial officials know all too well the real world consequences of a daisy chain of out-of-control debt defaults. Just last month, Bloomberg reported Treasury Secretary Tim Geithner’s warning to the EU. The report said, “. . . Geithner pressed European policy makers to intensify their efforts to end the 18-month sovereign debt crisis and avoid the “threat of cascading default, bank runs and catastrophic risk.” In his strongest public push yet for Europe to step up its crisis-fighting, Geithner said strains in the euro-area’s budgets and banks are the “most serious risk now confronting the world economy.”
The EU can’t save all the banks, but that is not going to stop them from printing money to pick and prop up winners. As we all know, every bank cannot be a winner. The problem is so big that European banks are allowed to lie about the value of their assets to project the image of solvency. The same is true for American banks. When European banks start failing, there is no way U.S. banks will be able to avoid being sucked into a vortex of default. For anyone who thinks this crisis can be resolved with a pain free plan—forget it. Welcome to the age of bank failures.