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Macro: European Banks Have More Holes Than Swiss Cheese

Show me the money!

This has been a tremendously poor week for the european banking community: Credit Suisse settled criminal charges with the US Dept. of Justice over decades-long tax evasion practices and Portugal's largest bank, Espirito Santo International, was found to be in a "serious financial position" by KPMG.

This argument is not meant to re-hash the facts or opinions presented by the media related to these headlines, but rather to draw big-picture conclusions about the structure, enforcement and culture of european banking as a whole.

What regulatory body can effectively regulate and oversee european banking operations? In the US we have an alphabet soup of agencies fighting over regulatory authority for each individual operating segment (e.g. OCC, SEC, FINRA, PCAOB etc.) Europe's decentralization does not lend itself to facilitated oversight. Once you get past the multitude of languages, ERP systems and work hour expectations, what incentives or punishments actually prevent illegal or unethical behavior?

Lets take this one step further: Why are European banks allowed to be so levered? European banks give out 150% to 300% as many loans as deposits held while US banks (even those with european operations) distribute a mere 50% to 80% of deposits in the form of loans. During a global catastrophe, these banks would be completely underwater and bankrupt if it weren't for the implicit guarantees and support from their respective sovereign national funds. Naturally, the countrie's wealthiest individuals have an interest in keeping the largest banks afloat and have strong ties to the ruling government party. A bailout is inevitable.

But then what happens to the sovereign debt of that european nation?

It's hard for Americans to truly understand this concept because of how unusually flexible the US dollar can be. The sheer number of dollars in circulation and the global implications of trade in dollars protects it from undesirable value fluctuations that would be reflected by Treasury or Federal Reserve monetary expansion policies (e.g. QE- infitity).

European countries are tied to the Euro and cannot simply print endless amounts of currency to fund government salaries, stimulus and tax incentives, or even infrastructure projects. Most other countries can't really print endless amounts either because their currency will be tremendously devalued, damaging the economy nearly beyond repair (e.g. Zimbabwe & Argentina). European countries must live within their means or ask for an ECB bailout. Inevitably, jobs have been offshored and GDP of european nations has fallen (especially in eastern and southern nations where intellectual property development and technological productivity is severely lacking). European sovereign governments inevitably get stuck with the bill & have no way of paying it, even if they have the next 20-40 years to do so.

Bottom line: there will be some significant regulatory, monetary and economic challenges in the euro zone in the future... keep clear of the fan folks