Banking Crisis: Europe Banks the next to fail en masse

European banks are in a freefall similar to what happened to US banks.  We saw this coming months ago when I wrote in a blog post about the state of US, Europe and Canadian Banks.  I said that of the three, I worried most about the European banks because asset prices had not fallen like they had in the states, and that the debt level of German and UK banks could precipitate another crisis.  There are some very concerning things happening now in European Banks. 

The market is discounting them as practically insolvent.  And even worse, there is some real problems with what is happening in state insured banks like West LB which has been bailed out and is state owned.  It would be the same if the markets charged Fannie Mae the subprime borrowing rates they deserve.  Fannie Mae's cost of funds is below any private bank simply because they are considered part of the treasury.  In fact, because it is guaranteed, if their borrowing costs were too high, one could buy Fannie Mae bonds, sell gov't bonds and make a risk free spread. 

Well, that is exactly what is happening at West LB.  "WestLB AG, the German state-owned lender bailed out during the financial crisis, is among banks paying the most to borrow for three months in euros, dollars and pounds, according to data from the British Bankers’ Association."  So one could technically buy short term debt from West LB and Sell German bonds for a risk free return.  Its a no brainer... or is it?

It could be just a technical phenomenon, i.e. collateral damage, or the market is spooked that either the gov't is not going to honor its guarantee.  The third and most scary possibility is that the Sovereign debt crisis is going to suck Germany in whole.  While I would not subscribe to that theory, it is enough to make one wonder.  The leverage on Germany's banks would make any American bank blush, and if there were banks to fall under pressure, they would likely not be able survive with such debt loads. 

More on European debt via Bloomberg:

European banks at risk of writedowns from the sovereign debt crisis face a funding squeeze that may depress earnings, curb lending and imperil economic recovery in the region.

Investors are shunning bank securities on concern Greek, Portuguese and Spanish bonds held by the lenders will plunge in value. Bank bond sales slowed in May to the lowest since Lehman Brothers Holdings Inc.’s failure in 2008 as the extra yield buyers demand to hold the securities over government debt soared to the highest this year. Firms are wary of lending to each other, depositing record funds with the European Central Bank.

The cost of insuring bank debt from default rose close to a record last week. The Markit iTraxx Financial Index of swaps on 25 European banks and insurers climbed to 208 basis points on June 8, approaching the all-time high of 210 basis points set in March 2009, JPMorgan Chase & Co. prices show.


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