Uncovering the Darkest Secret of the Financial System
Interest-Rates / Eurozone Debt Crisis Jul 27, 2012 - 07:30 AM GMTBy: Graham_Summers
As noted in yesterday’s piece concerning how and why Europe could bring about systemic risk, EU banks are likely leveraged at much, much more than 26 to 1.
Indeed, considering how leveraged and toxic US banks’ (especially the investment banks’) balance sheets became from the US housing bubble, the chart I showed you should give everyone pause when they consider the TRUE state of EU bank balance sheets.
This fact in of itself makes the possibility of a systemic collapse of the EU banking system relatively high. Let me give you an example to illustrate this point.
Let’s assume Bank XYZ in Europe has a loan portfolio of €300 million Euros and equity of €30 million Euros. This means the bank is “officially” leveraged at 10 to 1 (this would be a great leverage ratio for a European bank as most of them are leveraged to at least 26 to 1 or worse).
So… let’s say that 10% of the bank’s loans (read: assets) are in fact worth 50% of the value that the bank claims they’re worth (not unlikely if you’re talking about a PIIGS bank). This means that the bank’s actual loan portfolio is worth €285 million (10% of 300 is 30 and 50% of 30 is 15).
With equity of only €30 million, the bank, at some point, will have to take writedowns or one time charges on its loan portfolio that would erase HALF of its equity. At this point, the bank becomes leveraged at 19 to 1 (€285 million in assets on €15 million in equity).
This announcement would result in:
1) Depositors pulling their funds from the bank (thereby rendering it even more insolvent)
2) The bank’s shares plunging on the market (raising its leverage levels even higher as equity falls further).
Thus, at a leverage ratio of 10 to 1, even a 50% hit on 10% of a bank’s loan portfolio can result in the bank needing a bailout or even collapsing.
Now, what if that €300 million in loans is actually the amount the bank’s in-house risk models believe to be “at risk” and the REAL loan portfolio is around €800 million?
Immediately, we realize that the bank is in fact leveraged at 26 to 1. At this level even a 4% drop in asset prices erases ALL equity rendering the bank insolvent.
And yet, based on Basel II requirements, this bank can claim in all public disclosures that it is only leveraged at 10 to 1. With this in mind, you should understand why the banks lobbied so hard against a rapid implementation of Basel III capital requirements (which would require equity and capital equal to 10.5% of all of risk-weighted assets.)
Indeed, Basel III requirements which were meant to go in effect at the end of 2012 will now gradually begin to be implemented in 2013. And banks will have until 2015 to adjust to the new capital requirements and until 2019 conservation buffers in place.
With that in mind, take my XYZ bank example, apply it to all of Europe, assume leverage ratios of 26 to 1 at the very minimum (Lehman blew up when it was leveraged at 30 to 1), and take another look at the housing bubbles in the above chart.
In simple terms Europe’s entire €46 trillion banking system is in far worse shape than even the US investment banks were going into 2008. And this is based on their leverage ratios alone.
However, even this analysis doesn’t go deep enough to explain how and why Europe will implode. Indeed, I’ve spent the last six months digging as deep as I can into the financial system to find the unquantifiable risks that aren’t being discussed by the financial industry.
I’ve found them. And they are worse than anything I expected to find. Indeed, what I’ve discovered is more horrifying than I’d care to admit. And I would very much like to share this information with you.
The only problem is that my private clients are paying me to provide them with this information. So as much as I think people need to hear it, I have to honor their trust and their confidence and not make this information free.
Those investors looking for actionable investment ideas could also consider our Private Wealth Advisory newsletter: a bi-weekly detailed investment advisory service that distills the most important geopolitical, economic, and financial developments in the markets into concise investment strategies for individual investors.
To learn more about Private Wealth Advisory… and how it can help you navigate the markets successfully…Graham Summers
Chief Market Strategist
Good Investing!
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I call it The Financial Crisis “Round Two” Survival Kit. And its 17 pages contain a wealth of information about portfolio protection, which investments to own and how to take out Catastrophe Insurance on the stock market (this “insurance” paid out triple digit gains in the Autumn of 2008).
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Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.
Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.
© 2012 Copyright Graham Summers - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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