I realize that the situation in Europe can be very confusing. Aside from the fact that we’re dealing with over 20 different countries all with their own respective economies and debt issues, we also have the European Central Bank and the numerous bailouts and bailout funds (the LTRO 1 and 2, the EFSF, the ESM and now the OMT) to keep track of.
So for clarity’s sake, I’m going to explain Europe’s problems in simple terms.
The first thing you should know is that European banks, taken as a whole, have far more leverage than their US counterparts. According to the IMF, US banks are leveraged at 13 to 1.
European banks are leveraged at 26 to 1. Put another way, they have $26 in assets for every $1 in equity.
Think of it this way, imagine if had $100K in the bank and you borrowed $2.6 million to buy homes and other items. Do you think you would be in a stable financial condition?
That’s Europe’s banks on the whole.
However, we also know that the IMF only reports based on known assets or the asset levels that the banks admit. How many times in the last few years have we found out that banks were being honest and open about their risk levels?
So you should use the 26 to 1 leverage level as the minimum. Reality is likely far worse. Which means… European banks are insolvent.
Outside of this, European nations are also bankrupt. I realize that everyone likes to focus on Debt to GDP levels, but the reality is that European banks owe far more when you account for unfunded liabilities.
I know the same is true for the US, but the US’s unfunded liabilities pale in comparison to Europe’s. As far back as 2004, we know that:
Debt to GDP Including Unfunded Liabilities
EU as a whole
So, we have a bankrupt banking system in bankrupt countries.
Now for the zinger…
This entire financial system is based on the assumption that European sovereign bonds are still are risk free.
So you have bankrupt nations, selling bonds to insolvent banks, which then use these bonds to leverage up to over 26 to 1 (by the way, Lehman was 30 to 1 when it blew up).
And that’s the ENTIRE European financial system.
I hope this clarifies why Europe is doomed. It is absolutely 100% impossible for Europe to get out of this mess unless the entire union suddenly started growing its GDP at over 10% for a decade.
That will never happen.
My advice to everyone: trust your gut. All of the accounting gimmicks and bailout ideas will never work for the simple fact that the system in Europe is totally broke. The US’s financial system, while problematic (that’s putting it lightly) is nothing compared to how bad Europe is.
In simple terms, this time around, when Europe goes down (and it will) it’s going to be bigger than anything we’ve seen in our lifetimes. And this time around, the world Central Banks are already leveraged to the hilt having spent virtually all of their dry powder propping up the markets for the last four years.
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