Saturday, February 21, 2009

"While Rome Burns"

John Mauldin's latest Thoughts from the Frontline newsletter, "While Rome Burns", includes the graphic above1, from BCA Research. The column consists mainly of two sorts of gloom. The second sort, about the negative prospects for buy-and-hold stock investing when earnings are dropping faster than stock prices, so P/E ratios are high despite the recent market action, is generic enough that I won't excerpt it here. The first bit of gloom concerns the banking situation in Europe. From the newsletter,

Austrian banks have lent $289 billion (230 billion euros) to Eastern Europe. That is 70% of Austrian GDP. Much of it is in Swiss francs they borrowed from Swiss banks. Even a 10% impairment (highly optimistic) would bankrupt the Austrian financial system, says the Austrian finance minister, Joseph Proll. In the US we speak of banks that are too big to be allowed to fail. But the reality is that we could nationalize them if we needed to do so. (And for the record, I favor nationalization and swift privatization. We cannot afford a repeat of Japan's zombie banks.)

The problem is that in Europe there are many banks that are simply too big to save. The size of the banks in terms of the GDP of the country in which they are domiciled is all out of proportion. For my American readers, it would be as if the bank bailout package were in excess of $14 trillion (give or take a few trillion). In essence, there are small countries which have very large banks (relatively speaking) that have gone outside their own borders to make loans and have done so at levels of leverage which are far in excess of the most leveraged US banks. The ability of the "host" countries to nationalize their banks is simply not there. They are going to have to have help from larger countries. But as we will see below, that help is problematical.

Western European banks have been very aggressive in lending to emerging market countries worldwide. Almost 75% of an estimated $4.9 trillion of loans outstanding are to countries that are in deep recessions. Plus, according to the IMF, they are 50% more leveraged than US banks.

1The low ranking here of Australia is surprising to me, considering that up until last year the country had no net federal debt. It looks like the Australian government will run fiscal deficits in the short-term, as it attempts to stimulate its economy, but how that is supposed to make its sovereign debt risk higher than that over already heavily-indebted countries, I don't know. Given what Mauldin has written about Austria above (with public debt equal to about 59% of GDP, according to the CIA World Fact Book), for example, I'm surprised that Austria is considered less of a sovereign credit risk than Australia by BCA.


Hillary Clinton said...

Comrade Obama is content to see America burn if it means he'll be re-elected in 2012.


Paul Price said...

May be Christine can help, you know!