by Shah Gilani, Money Morning
Money Morning Article of the Week
There is a “Lehman” moment out there somewhere – just as sure as there are black swans in the world.
Brexit was scary for markets around the world… but it was not a Lehman moment.
It was, as I’ve said, a “Bear Stearns” moment, a terrible harbinger of impending financial disaster.
Once again, it’s about the banks…
Except this time, it’s not the big American banks – we’re not talking about the likes of JPMorgan Chase & Co. (NYSE:JPM), Bank of America Corp. (NYSE:BAC), or Citigroup Inc. (NYSE:C), though they won’t be immune from contagion effects.
On Wednesday, I told you that the next Lehman moment could be brought about by the irreparable insolvency of one or two big Italian banks, or even a few of the big British banks. Both the European Central Bank and the Bank of England have been scrambling to obfuscate just how dire things are in Western Europe. Of course, a look at their balance sheet tells a different story – the numbers just don’t add up.
But the more likely – and far more frightening scenario – is that the entire global financial system will be brought to its knees by a single bank.
Here’s what’s really going on, what to watch for, and what to do if world’s most dangerous bank continues to falter.
European Banks Were in Trouble Before Brexit
The shares of European banks were getting pounded before the Brexit vote. Across the board their share prices were down about 20% from the start of 2016 to June 23, the voting date.
They’re down another 20% now.
The old story is that European banks didn’t repair their busted balance sheets after the 2008 financial crisis and the subsequent Great Recession. They kept a lot of bad loans on their books and managed to meet increasingly stringent capital requirements and regulatory pressures by juggling how they accounted for the risks on their books and how they measured their capital.
In short, European banks, because they are all tied together in ways that will shock you, and coddled and protected by the European Central Bank, believed economic growth would eventually generate revenues and profits enough to offset write-downs of their hefty non-performing loans.
The continent never got the growth it needed and after the ECB fired every round in its bazooka, nothing changed for the better for any of the banks.
Things got a whole lot worse with Brexit.
The British are going their own way, which means exiting the ECB. That takes Europe’s second-largest economic power off the roster of central bank backers. Now the weight of the ECB’s grossly inflated balance sheet – heading towards $5 trillion or more before this pending crisis is over – will be spread among fewer and weaker countries.
Italian banks look like they are on the front line. And they are. They have almost $396 billion of non-performing loans on their books, forget the technical measures of NPL or whatever terms bankers prefer, the truth is they are not going to get paid back.
If the ECB doesn’t rescue teetering Italian banks, if the European Union doesn’t come to their aide, if Italy isn’t allowed to throw an immediate $40 billion at them, in fact, if all of the above doesn’t happen, Italian banks are going down, which will be a Lehman moment.
But it’s worse that you think. In fact it’s about 100 times worse, according to Italian Prime Minister Matteo Renzi.
When he said that, though, he was not talking about Italian banks – he was talking about one bank, Germany’s biggest bank…
He was talking about Deutsche Bank AG (NYSE:DB), the most dangerous bank in the world.
Financial Weapons of Mass Destruction
You see, Germany’s been telling Italy to rein in their bad banks because the Germans don’t want the European Central Bank (and, really, German citizens) bailing out Italian banks.
Prime Minister Renzi’s simply pointed out the fact that Deutsche Bank is technically insolvent, so how dare the Germans lecture him?
Deutsche Bank is for all intents and purposes probably technically insolvent. But of course it is “too big to fail,” so every lie out of every banker’s playbook has been trotted out to prove otherwise.
Forget about losses at Deutsche, forget about its faked-up capital, forget about its book of bad loans, forget about all that. It’s child’s play.
Deutsche is sitting on about $49 trillion worth of derivatives trades. That’s 49 trillion dollars, not billions.
If Deutsche Bank isn’t propped up, and it has to unwind its derivatives trades, all its counter-parties to all those derivatives trades, all of them are going to crack one way or another.
And that would make the 2008 financial crisis look like a day at the beach.
What we have to watch is the European Union’s stance on Italian banks. If there isn’t going to be unanimous consent on bailing them out, and soon, the ECB may not have the political power to act to save the banks.
It’s all about politics now.
That’s the danger of Brexit. It’s disrupted and divided the continent and put the EU’s future in jeopardy.
Germany is Europe’s largest economy, and Deutsche Bank lends to every giant German company. The bank’s representatives amount to about 30% of board members of Germany’s biggest companies. They are all married, come hell or high water.
Deutsche Bank’s derivatives book is almost 15 times Germany’s GDP. It’s almost four times as big as the entire Eurozone’s output. It’s a frighteningly large cache of financial weapons of mass destruction.
If Deutsche Bank falters, it will be Lehman times 10.
Watch what’s happening with Deutsche Bank.
If the Lehman alarms start ringing we won’t have much time to react to the devastation.
At the first sign of panic, here’s a quick checklist of things you can do to protect your money:
Short European banks
Short the euro against the U.S. dollar
Short European equities
Short Japanese stocks (Japan will be next up to walk the plank)
Buy U.S. Treasuries
Why U.S. treasuries? Well, sure, there will be a typical “flight to quality” when panic sets in.
But the real reason you’ll want to buy U.S. bonds – and a lot of them – is because the Fed will flood U.S. banks with liquidity and embark on an instant negative interest rate policy, which will mean bond prices will SOAR.
That’s why you’ll want to own them – not for their negative yields.
If this all passes, we’ll have dodged a nuke.
But it’s not over till it’s over.
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