Tuesday, November 22, 2011

US Banks and the Euro Crisis

In a post a short just over two weeks ago, I suggested that the response to the European sovereign debt crisis was in part being influenced by the 'too big to fail' banks, including the large US banks exposed to European debt. As the European crisis lurches forwards, the exposure of the too big to fail banks is starting to see the light of day. For example, the following is a graphic from EconMatters on Business Insider, originally from the New York Times:

From NYT, Oct 23, 2011

It's  great visual illustration of the linkages between the different debtors, though the colour scheme is extremely questionable. The concern has now become concrete, with the following from Reuters:

The U.S. Federal Reserve plans to stress test six large U.S. banks against a hypothetical market shock, including a deterioration of the European debt crisis, as part of an annual review of bank health.
The Fed said it will publish next year the results of the tests for six banks that have large trading operations: Bank of America (BAC.N), Citigroup (C.N), Goldman Sachs (GS.N), JPMorgan Chase (JPM.N), Morgan Stanley (MS.N) and Wells Fargo (WFC.N).

"They are clearly worried about the issue of Europe," said Nancy Bush, a longtime bank analyst and contributing editor at SNL Financial. "In a time of risk aversion and concern, you need transparency."
The Fed said its global market shock test for those banks will be generally based on price and rate movements that occurred in the second half of 2008, and also on "potential sharp market price movements in European sovereign and financial sectors."
Meanwhile, as the Independent newspaper points out, the 'technocrats' and leaders of Europe are being recruited from the alumni of the too big to fail banks:

The ascension of Mario Monti to the Italian prime ministership is remarkable for more reasons than it is possible to count. By replacing the scandal-surfing Silvio Berlusconi, Italy has dislodged the undislodgeable. By imposing rule by unelected technocrats, it has suspended the normal rules of democracy, and maybe democracy itself. And by putting a senior adviser at Goldman Sachs in charge of a Western nation, it has taken to new heights the political power of an investment bank that you might have thought was prohibitively politically toxic.

This is the most remarkable thing of all: a giant leap forward for, or perhaps even the successful culmination of, the Goldman Sachs Project.
It is not just Mr Monti. The European Central Bank, another crucial player in the sovereign debt drama, is under ex-Goldman management, and the investment bank's alumni hold sway in the corridors of power in almost every European nation, as they have done in the US throughout the financial crisis. Until Wednesday, the International Monetary Fund's European division was also run by a Goldman man, Antonio Borges, who just resigned for personal reasons.
Even before the upheaval in Italy, there was no sign of Goldman Sachs living down its nickname as "the Vampire Squid", and now that its tentacles reach to the top of the eurozone, sceptical voices are raising questions over its influence. The political decisions taken in the coming weeks will determine if the eurozone can and will pay its debts – and Goldman's interests are intricately tied up with the answer to that question.

I suggest reading the complete article. As for the stress tests of the too big to fail, the one point of confidence that we might have about such tests is that they will seek to reassure, rather than really test.  The pressure being laid on the Eurozone by both the US and UK are no doubt at least partially driven by the impact of both the direct and indirect exposures of the major banks in these countries. As I pointed out in the earlier post, it seemed odd that the bailout of Greece was being arranged to avoid triggering Credit Default Swaps, which would risk spreading the pain of default into the too big to fail banks. This is my conclusion to the previous post on default exposure:

It is a certainty that central banks and the regulators in the US and Europe have a good idea about the concentrations of risk in the system, and they are no doubt briefing and driving the policy of politicians. This is all so opaque, and one can only suspect that the avoidance of triggering CDSs is yet again about 'too big to fail'. In other words, the world is being moved again by policy to protect large financial institutions and the 'investment-grade global banks' are investment grade only because they are backstopped by governments and central banks.Is this not shabby? 

It is all looking ever more shabby.


  1. Intriguing diagram. (Pity it doesn't show China too!) Is circle size proportional to GDP?
    Not sure that net exposure is what matters: in a complex, opaque system, any exposure might bring vulnerability, even if theoretically offset.
    But, if net exposure is the key point, then: Greece isn't a huge deal; a defaulting Spain or Italy might trigger French default; Britain is a threat to the Eurozone not threatened by it; and a toppling USA could bring the whole system down at once.

  2. I preferred the interactive version the bbc created along the same lines.

    Anyway, I have been reading this blog since 2008, and events are now (finally) catching up with CE's prognosis.

    But what's next?

    I've moved my money to Swedish Krona, because the currency and financial institution I chose there, seem to be solidest available to me.

    Thinking of buying farmland in Ireland if/when the Eurozone fragments.

    But amid all the hysteria I find it hard to picture what the world will look and feel like 3 years from now.

    How apocalyptic will things get?

  3. Lord Sidcup:

    Agreed. I have also been reading the blog since late 2008 and was completely taken in by CE's arguments. It is satisfying - albeit concerning - to see his predictions coming true.

    But attempting to predict in which order things will fall apart seems too difficult as things are so volatile that black swans could appear from any direction.

    Choosing a more sound economy to store your wealth seems sensible and tangible assets also. I like gold, some don't.

    If you have not read Anonymous' (postings from '97), Friend of Anonymous or FOFOA (postings from 2008), then I suggest you do so as IMO it is some of the most interesting writing on the internet.

    Anonymous' postings on Kitco forum start here: http://www.usagold.com/goldtrail/archives/another1.html

    And this is FOFOA's most recent article, a really excellent one in which he debunks MMT:

    Essentially they claim the dollar is finished and all central banks know it.

    They state the inevitable outcome will be hyper-inflation and that physical gold bullion is the best way to transport your wealth to the other side as it is true money as opposed to fiat currency. It is a concept they call Freegold and will lead to gold being revalued into the $10's of thousands per Oz.

    I recall reading somewhere on FOFOA'a blog that a period of currency collapse will last no more than 6 months.

  4. In answer my own question (above), I found this article quite interesting, but not totally persuasive.



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