Another Global Banking Crisis Is Just Around the Corner
The big banks, that is the giant octopus-like banking oligopoly of G20 systemic banks, are fueling another banking crisis. Many of these are ready to take on bigger risks again. These could provoke a literal “risk superstorm” with chain repercussions leading to a general financial crisis.
Globalization, the kind that President Trump purports to be challenging, has been good to banks. In the “deregulation 1990’s” under President Clinton, money and financial markets took on a global scale. The “banking crisis 2017” will result in an implosion of the system. That’s why it will be a global banking crisis.
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These banks include eight American, 16 European (including four British, four French, two Swiss, and one German) and four Asian banks. They are sometimes known as the systemically important banks. Naturally JPMorgan Chase & Co. (NYSE:JPM) and Goldman Sachs Group Inc (NYSE:GS) are among them. (Source: “2015 update of list of global systemically important banks (G-SIBs)” Financial Stability Board, November 3, 2015.)
Their balance sheets rival global public debt; because they are overleveraged through financial derivatives. Not only do these banks occupy a dominant position in the world’s money and financial markets, but over the past ten years, they have abused both. It’s a wonder that a major banking crisis has not happened yet.
An adage suggests the more things change, the more they stay the same. The regulations implemented after the financial crisis of 2007/2008 that the systemic banks provoked have in no way impaired the power of their oligopoly. Nor have they fundamentally changed the banks’ financial logic and behavior.
Meanwhile, because of a credit crisis, many western economies have not recovered. The big financial institutions have merely delayed the banking crisis. Between 2008 and today, they merely shifted a good chunk of their toxic private debt into public debt. The banks have made the public pay for the excessive risks they took. The reckoning is coming.
The banking oligopoly has either rejected or failed to learn from its mistakes. Then again why should it? Governments and taxpayers have been more than happy to bail it out. It has been feeding on lax monetary policies of central banks. The result is another debt bubble.
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Another Financial Crisis Has Become Probable, Let Alone Possible
It could be triggered by the bursting of the bond bubble. All that needs to happen for that thrilling prospect to materialize is for a state to default. At the time of writing the spread between the Italy-Germany ten-year bond spread (the Bund) has hit its highest point in three years.
The France-Germany Bund spread has hit an 18-month peak. A political crisis in France—and another in Italy—could pull the plug on the eurozone. Indeed, the Bund spread has become a barometer for the health of many eurozone economies. (Source: “French political turmoil hits bond spreads,” The Financial Times, February 6, 2017.)
A high spread indicates low investor confidence. Speculators tend to buy debt (in this case French or Italian) when the Bund spread is high. Skipping the technical-financial details, a runaway Bund spread is a sign of potential default. The EU has already bitten that bullet with Greece. The Hellenic state defaulted on a €2.0-billion International Monetary Fund (IMF) loan in 2015.
This was the first time that a developed country defaulted on the IMF. But others came close. Italy—the world’s fifth-largest economy no less—was experiencing a spike in the Bund spread in 2011, but did not default because it did not take the humiliating German offer of borrowing from the IMF.
Italy’s government fell in the fall of 2011 under that pressure. Italian bank stocks hit rock bottom. The bank and debt problems were simply shoved under the carpet for a few years. But the janitors have arrived and they are about to uncover more financial dust.
As the world has looked the other way, busy dealing with other problems, Greece has reached the brink once again. Its debt repayment situation remains as difficult as ever. By next summer, Greece could see a repeat of the 2015 crisis. International creditors will renew demands for the return of €6.0 billion in loans.
However, Greece’s public debt is a staggering 180% of Gross Domestic Product (GDP). In practical terms, it means Greece has a debt worth almost twice as much as the total value of its economy. The Greek government—under Prime Minister Tsipras—has continued to ask for a debt cut, but with little success.
The most Tsipras can do is focus on sustainability commitments. The International Monetary Fund has proposed a moratorium on Greek debt repayments until 2040. But, European creditors—largely German banks—insisted at their last meeting on January 29 that Greece is “capable” of paying its debts. (Source: “Greece has three weeks to deal with ‘potentially disastrous’ debt,” The Guardian, January 29, 2017.)
The disagreement between the two parties is of great importance for both the IMF and the European Union. The IMF believes that for Greece to be able to repay the debt, it would have to achieve a 3.5% surplus (the difference between government revenue and expenditure) this year. This is pure fantasy now; even the major industrial powers in the EU struggle to get those numbers.
The Risk of an EU Member Defaulting on Debt Has Grown
Europe also faces a reluctant public opinion in addressing the Greek demands. But here’s one of the likely ways this Greek tragedy might play out. In 2015, the Greek government increased taxes and reached a 0.7% surplus. But actual economic growth has been lacking. Athens is not in a position to impose additional tax increases on a population already on its last legs. Greeks have already lost their purchasing power.
To attain the demanded 3.5% surplus, Greece would have to go on a layoff spree. The resulting rise in unemployment that would follow would only accentuate those problems, GDP would drop further still, amid a credit crunch—if not outright credit crisis.
But, time is crunching. Because, other than a debt and banking crisis, there is a political avalanche that’s about to hit the EU. The election campaigns in Holland, France, Germany, and possibly Italy have already begun. If the Greek debt problem does not get resolved promptly—before March—Greece, the euro, the credit crisis, the debt crisis and the banking crisis will be the hottest debate topics.
Holland goes to the polls in March, France goes in April, and Germany in September. The inevitable banking crisis shadow will destabilize Greece. Its government will not withstand a second default humiliation. Tightening the economy as some EU banks have described would increase the already deep popular discontent.
Greece would enter a political crisis. Tsipras would have to resign and call an election, whose main theme would be the end of austerity. The campaign would take on a decidedly anti-euro tone. If Greece were to abandon Europe under the weight of such a scenario, the banks would be left with nothing.
Other high public debt countries as Italy and Spain would suffer a major hike in the Bund spread. They would be forced out of the single currency. France, where an anti-EU party is expected to win, would follow.
The End of the Euro Would Not Be Painless. A Global Banking Crisis Is the Minimum
It all sounds innocent from the lofty heights of a wide perspective, but euro exits will not be painless. Rather, it won’t be like a quick removal of a “Band-Aid.” Imagine, you held a mortgage in these conditions in Greece—or in Italy, Spain, Germany, Portugal etc. How would you pay back your euro mortgage in currencies that could be on average some 30%-50% less valuable?
Under the same logic, how would the various euro-exiting governments pay back foreign debt? The prospect of a default becomes inevitable. The resulting banking crisis would have massive repercussions and hit Wall Street as well as Milan, Frankfurt, and London.
Simply put, more than one systemic bank risks bankruptcy, given their hazardous speculation in derivatives markets. Deutsche Bank AG (NYSE:DB) comes to mind, but so does JPMorgan or Bank of America Corp (NYSE:BAC). But, the next banking crisis could have even more serious consequences than the previous one, given the paralysis of over-indebted states still struggling under the weight of the previous crisis.
Fiscal austerity at the Fed or the European Central Bank (ECB) has helped eased the current pain. It has managed the illness, but hasn’t cured it.
If there is a cure after the financial earthquake that will shake Wall Street, it’s that banks’ deposit and investment functions should be separated. That’s the very least to reduce the risks we have seen exacerbate over the past decade. The solution even has a name: The Glass-Steagall Act. It would end the tendency to build up the monstrous speculative debt that causes a banking crisis.
Meanwhile, even if Wall Street saves itself, the risk of a European banking crisis remains. The derivatives exposure of major European banks, has not disappeared. The ECB has extended their life support by extending quantitative easing (QE) until the end of 2017. But, such a situation is not sustainable.
At least it’s not sustainable without at least adopting some form of the Glass-Steagall Act, before it happens uncontrollable explosion. Meanwhile, in Washington, the opposite is happening. President Trump has repealed the Dodd-Frank act. Banks like Goldman Sachs are happy.
They say the repeal will save them billions in additional costs related to regulatory measures. (Source: “Dodd-Frank law’s legacy: safer banks, banker headaches,” CBS, February 6, 2017.) Dodd-Frank was one of the measures President Obama used to curb another global banking crisis. Its purpose is to discourage the kind of excessive risk that caused the financial crisis of 2008. Now, we’re back into the financial Far West.
