European Banks: Too Big to Rescue?

After Iceland collapsed and went into Depression, there were a number of analyses in the press regarding countries with outsized financial sectors. The worry was that the collapse of Iceland was not an isolated incident, but rather a harbinger of things to come for smaller countries with large financial sectors. I wrote a post in November called "Iceland: a cautionary tale for small nations" which pointed to a number of countries that I considered vulnerable including Austria, Denmark, Ireland, Sweden and Switzerland. Even the United Kingdom has been a concern.

Those worries are still with us three months later. And with good reason as many countries in Eastern Europe are in or headed for Depression, Latvia being the most obvious example.

Here is the crux of the matter: there are a number of banks which are very large in relation to the size of their domestic economies. In the past, that has meant that they are too big to fail. Citigroup (C) is a prime example of banks that fall into this category.

But, there are also a number of banks with an asset base that is disproportionately large mainly due to many overseas assets. I have pointed to Royal Bank of Scotland (RBS) as a prime example. What this means is that the governments where these banks are domiciled cannot make credible guarantees regarding the institutions in question.

If we suffer a crisis of confidence and these banks come under attack, they become literally too big to rescue.

To give you a few numbers, I will give you some examples in no particular order.

• Denmark - GDP: $312 billion; Danske Bank (DNSKY.PK) - Assets: $615 billion (197% of GDP)
• United Kingdom - GDP: $2.8 trillion; RBS - Assets: $3.8 trillion or 136% of GDP (with HSBC (HBC) and Barclays (BCS) this rises to $8.6 trillion or 226% of GDP)
• Switzerland - GDP: $492 billion; UBS (UBS) and Credit Suisse (CS) - Assets: $3 trillion (658% of GDP)
• France - GDP: $2.6 trillion; BNP Paribas (BNPQY.PK), Agricole, SocGen (SCGLY.PK), and Dexia - Assets ($6.7 trillion or 259% of GDP)
• Netherlands - GDP: $777 billion; ING (ING) - Assets: $1.8 trillion or 231% of GDP (with Fortis this rises to $2.9 trillion 385% of GDP)
• Germany - GDP: $3.3 trillion; Deutsche Bank (DB)- Assets: $2.7 trillion (83% of GDP)

This list is far from comprehensive -- it does not include Sweden, Ireland or Austria and it does not include other non-bank financial companies like Hypo Real Estate (HREHY.PK) or Allianz (AZ). Germany is the best of the bunch, largely due to the size of its economy. But if you add in Commerzbank (CRZBY.PK) (incl. Dresdner), Postbank, WestLB, and the Landesbanks of Baden Wuerttemberg and Bavaria, you have a problem there too. And many of these German institutions are already having problems.

The data all comes from Data Monitor and the IMF via Wikipedia.

The long and short of it is: many countries in Western Europe have weak financial sectors with high systemic risk. The concern here deals mostly with the theory of reflexivity, popularized in finance by George Soros. Wikipedia has a decent definition:

In sociology, reflexivity is an act of self-reference where examination or action 'bends back on', refers to, and affects the entity instigating the action or examination. In brief, reflexivity refers to circular relationships between cause and effect. A reflexive relationship is bidirectional; with both the cause and the effect affecting one another in a situation that renders both functions causes and effects. Reflexivity is related to the concept of feedback and positive feedback in particular.

An example is the interaction between beliefs and observations in a marketplace: if traders believe that prices will fall, they will sell - thus driving down prices, whereas if they believe prices will rise, they will buy - thereby driving prices up.

Whilst we have beaten back the panic which surfaced after Lehman Brothers collapsed, there are still nagging doubts about the health of the global financial system. And in a world of reflexivity, it does not take much for these doubts to manifest themselves in self-reinforcing panic and collapse. Paul Krugman says this is the key lesson from the Asian Crisis of 1997-1998 in his book The Return of Depression Economics.

Looking at today's crisis, the datapoints I have just provided demand an aggressive policy response in order to eliminate worst-case outcomes. This is, in the main, the problem I have with the policy response to date in Europe and the United States. Hypothetically speaking, if we were to face a crisis where GM (GM) credit default swaps are triggered by bankruptcy or where Bank of America (BAC) collapses, where the Austrian banking system required EU support or UBS faced bankruptcy -- in these scenarios, is the present policy response sufficient to deal with the volatility that would result?

My answer is no.

Comments

[User 357727:]

nothing new or original in this article

the financial sector has always been founded upon confidence and trust from the public sector, the population and the investor community - altho the amount of asset exposure in relation to their home country GDP was never really this large

important points to remember:

for every asset, there is a liability - this potentially could be unwound/sold (maybe not in the short term which is where the complication lies) or would have some kind of financial return to service the portfolio exposure - so looking at total assets in isolation is a misleading and quite unsophisticated way of judging the health of financial institutions

secondly - if you pursue this argument further, you are undermining the 'trust' we have built up for the financial system. this system never functioned without this trust, and admittedly the last 18 months have been adequate to shatter most guages of trust, but once you undermine the trust for the general public (in spite of most governments guaranteeing deposits for developed country customers) then it becomes a self-fulfilling destructive cycle

Worst case scenario - the governments print more money - which is what the bank deposit guarantee would oblige - but this was triggered by your superficial analysis that criticized this 'trust mechanism'

Feb 16 05:28 AM

[Roger Knights:]

Attn. author: Please change the subtitle to:
"Too Big to Bail?"

That's much catchier.

Feb 16 07:41 AM

[Dave Wrixon:]

Take the Plank out of your own eye :)

Feb 16 02:00 PM

[mkreisel:]

When the tide finally went out after Lehman's collapse, it turned out that European banks were far more greedier than their American counterparts, and thus swimming more naked.

I also saw numbers that Austrian Banks' loans to Eastern Europe alone make up to 85% of the country's GDP.

Total assets at American depository institutions amount to $12 trillion, about 90% of the GDP.

Feb 16 03:50 PM

[theobannion:]

Excellent article. The idea that we allowed banks and companies in other industries to get "too big to tail" gives me vertigo. And anyone who doesn't question the dynamics of our so-called democracy is either in a deep coma or brain-dead.

Your article puts the problem in much needed perspective. Ours isn't the first era in which private interests were allowed to grow more powerful financially than the coffers of monarchs. Recall that the Fuggers lent money to kings and that DuPont & Morgan interests got away with attempting a coup d'etat against FDR. Too big to fail, to prosecute, and if your analysis is correct, to save.

Best,
SOB.

Feb 16 04:49 PM

[User 358179:]

See also this article written last September:
www.voxeu.org/index.ph...

Feb 16 06:35 PM

[imyoung:]

It is the Landesbank of Baden-Wuerttemberg (not -burg)
en.wikipedia.org/wiki/...-Württemberg

Feb 16 06:52 PM

[lenczner:]

Excellent material v.Ambrose Evan-Pritchard of the Telegraph.uk who excells telling the world that Euro world is bad ,very bad and even nearly collapsing this in order to cover England worst situation :"...The UK Independent reported: “Britain is facing its worst financial crisis for more than a century, surpassing even the Great Depression of the 1930s, one of Gordon Brown's most senior ministers and confidants has admitted. In an extraordinary admission about the severity of the economic downturn, Ed Balls even predicted that its effects would still be felt 15 years from now. … He warned that events worldwide were moving at a "speed, pace and ferocity which none of us have seen before" and banks were losing cash on a “scale that nobody believed possible.”..."
www.writingshop.ws/htm...
[e-mail]

May 16 04:53 PM

[lenczner:]

'European banks too big to rescue ?' can you believe this by Michael Hudson :"...Bad mortgage lending led to the failure first of Northern Rock and then the Royal Bank of Scotland...the world's largest bank. At $3.8 trillion before it collapsed, it was nearly twice the size of Britain's $2.1 trillion gross domestic product (GDP)..."
a quote from M.Hudson in :The IMF Collects Debts on Behalf of the World's Largest Banks

on this matter commented Edward Harrison here:
seekingalpha.com/artic...

May 16 04:56 PM