For quite some time, both on this blog and off, the Economic Maverick has maintained that the Greece (and broader periphery European) “debt crisis” was really a French/German banking crisis in waiting, which itself could escalate into a broader global banking crisis, as the potential of contagion existed from cascading defaults driven by broad and wide balance sheet exposures across a wide collection of financial institutions. We have wondered at what point would the dominant media narrative switch from “Greek/European Debt crisis” to “global banking crisis”. We believe that in the last 3 weeks - in spite of the market rebound the last few days - said turning point has arrived. The dominant media narrative has moved away from reports on sovereign debt issues of EU member nations to difficulties of financial institutions that have balance sheet
exposures from problematic sovereign debt.While French banks have borne the brunt of the unfolding crisis, the second-order effects have been significant, as non-French financial institutions (including the US TBTFs) that are suspected of having exposure to the French banks are also facing stress. Until recently, it appeared that the stress has been limited to falling equity prices, but as of the last week, reports have surfaced that some French bank(s) (perhaps Society Generale?) are also facing “funding issues” on the short term / overnight markets. It will be interesting to see if funding problems spread beyond French banks to other, especially US TBTF banks. Bank of America seems particularly vulnerable, as the Treasury's "regulatory forbearance" regime runs its course. Furthermore, a sharp sustained drop in equity prices can itself precipitate funding issues, as equity investors bid down the price of a bank's stock under the belief that its assets are worth less (or worthless) than was previously assessed, which itself can push money market funds and other banks to pull debt funding on the overnight and short term markets, which in turn makes their cost of funds increase, which make the institution less profitable and therefore further drives down equity prices, which makes it more expensive to raise equity-capital, in a classic self-reinforcing feedback loop. As it stands now, Bank of America trades at a market cap of $65B, even though its book value of common equity is $215B - meaning that the market (very roughly) estimates the assets on BofA's balance sheet are worth $150B less than they are officially marked at. In fact, all of the large US banks are trading at a discount to their book value. Ultimately, we are still in Financial Zombieland, where the most astute observers have noted that very little structural change to the banking system has occurred since the 2008 financial crisis, as the system has been kept alive on artificial life support.
What the future holds is as much a political risk forecast as it is an economic/financial one, particularly in the short term. Questions may remain - what kind of support will governments be able to provide this time if the banks start to see their short-term funding severely dry up? In the US, the FDIC resolution authority mechanism for SIFI's (Systemically Important Financial Institutions) in last year's Dodd-Frank legislation supposedly makes future bailouts more difficult and not necessary in order to prevent a systemic crisis. Though many thought leaders like Simon Johnson and Yves Smith remain skeptical, former FDIC chair Sheila Bair is confident that the resolution authority is game-ready. Additionally, the public's revulsion of the 2008 "bailouts without restructure" giving us "socialized losses with privatized profits" has made the political cost exceptionally high of a future bailout, or certainly one that is not on the "stealth".
Whatever the future may hold, one thing is clear: We are now in "Financial Crisis 2.0"
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