As we enter 2012, hope abounds. U.S. stocks have rallied almost 20% from their October lows and there is optimism that the Euro debt crisis won’t be the unrelenting distraction it was in 2012, especially now that the European Central Bank (ECB) has injected $489 billion euro into the continent’s banking system. Presumably, the ECB felt that because the U.S. bank bailout (of which the major part is known as TARP) was so “successful”, a European version would be similarly desirable.
However, by most measures, it is hard to classify TARP a success. The stated goal of TARP was to get lending flowing in the economy again, yet bank loans to businesses are still down around 20% from their 2008 peak. The real economy benefited little from TARP because instead of re-lending the money, U.S. banks just sat on it, so as to prop up their rickety balance sheets. Over three years later, many ‘too big to fail’ banks are still just a recession away from collapse and their stock prices are still getting pummeled. European banks are responding similarly to the ECB bailout of last December. Most of that $489 billion bailout was almost immediately parked on deposit back with the ECB again. There are several reasons to expect that the European bailout will be even less “successful” than TARP was.
First, European banks are much more highly levered than U.S. banks were. By some conservative estimates, they owe 30 euro in debt for every euro in equity they own. U.S. banks are estimated to be only half as indebted by this measure. Because of leverage like this, several of core Europe’s largest banks seem set to follow Belgium’s largest bank, Dexia into bankruptcy.
Second, European banks rely greatly on short term funding from the wholesale banking market. This means they are at almost constant risk of credit being denied to them. This is currently the case, as European inter-bank lending has ground almost to a standstill. Core European banks need to roll over 30% or more of their total debt in 2012. Many of Europe’s governments need to roll national debt equivalent to 20% or more of their GDP this year. Who is going to buy all this debt?
Finally, because Europe has no central fiscal authority, capital flight from one country to another is an ever-present risk. Greece and Ireland have lost as much as 20% of their bank deposits base as their citizens wisely move their deposits to relative safety in Germany, the U.K. or elsewhere. Unless these countries soon default, devalue and impose capital controls, they risk losing almost all their deposits, much of which may never be repatriated. TARP and the ECB bailouts did nothing to provide for infrastructure, education or new technologies that would fuel economic growth. The ECB bailout does nothing to address the key cause of the euro crisis - the gap in trade competitiveness between northern and southern Europe. At this point, only a return to the drachma, peseta, punt and escudo is likely to restore their competitiveness.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.