David Zeiler: The bankruptcy of MF Global Holdings (NYSE:MF) was a distressing signal to investors that it is possible for U.S. financial institutions to fall victim to the Eurozone debt crisis.
MF Global filed for Chapter 11 bankruptcy Monday after credit downgrades led to margin calls on some of the $6.3 billion in Eurozone sovereign debt the bank held. The position was five-times MF Global’s equity.
Although the major U.S. banks have less exposure relative to available capital, their many tendrils in Europe – particularly to European banks – will inevitably drag them into any financial meltdown in the Eurozone.
Even the U.S. banks’ estimated direct exposure to the troubled European nations of Portugal, Ireland, Italy, Greece and Spain (PIIGS) is disturbingly high – equal to nearly 5% of total U.S. banking assets, according to the Congressional Research Service (CRS).
And according to the Bank for International Settlements (BIS), U.S. banks actually increased their exposure to PIIGS debt by 20% over the first six months of 2011.
But the greatest risk is the multiple links most large U.S. banks have to their European counterparts – many of which hold a great deal of PIIGS debt.
“Given that U.S. banks have an estimated loan exposure to German and Frenchbanks in excess of $1.2 trillion and direct exposure to the PIIGS valued at $641billion, a collapse of a major European bank could produce similar problems inU.S. institutions,” a CRS research report said earlier this month.
Of course, the major banks say their exposure to the Eurozone debt crisis is much lower because they’ve bought credit-default swaps (CDS) to hedge their positions. Credit-default swaps are essentially insurance policies that pay off in the event of a default.
Unfortunately, this same strategy was one of the root causes of the 2008 financial crisis involving American International Group (NYSE: AIG) and Lehman Bros.
“Risk isn’t going to evaporate through these trades,” Frederick Cannon, director of research at investment bank Keefe, Bruyette & Woods Inc., told Bloomberg News. “The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who’s ultimately going to pay for the losses?”
Although the next MF Global will be tough to spot – most small brokerages that clear futures trades are private – the major U.S. banks all have enough exposure to put them at risk.
U.S. banks have made about $181 billion in direct loans to PIIGS nations, according to BIS.
One bank, JPMorgan Chase & Co. (NYSE: JP) already has been stung by the Eurozone debt crisis via the MF Global bankruptcy; it was the fallen firm’s largest creditor with $1.2 billion in exposure.
According to JPMorgan’s own disclosures, it has $14 billion in direct exposure to the PIIGS nations, with 26% of that tied to sovereign debt.
Bank of America Corp. (NYSE: BAC) reported $16.7 billion in exposure, while Morgan Stanley (NYSE: MS), Wells Fargo & Co. (NYSE: WFC) and Goldman Sachs Group Inc. (NYSE: GS) reported exposures between $3 billion and $5 billion.
Citigroup Inc. (NYSE: C) reported exposure in August to the PIIGS of $31.7 billion – more than double the $13.5 billion it reported in July.
The French (and German) Connection
Those figures don’t include the indirect exposure via their connections to the European banks most at risk if any of the PIIGS default. Morgan Stanley, for example, reported exposure to European banks in excess of $60 billion – three times the company’s market cap.
While U.S. banks have loaned just $60.5 billion to banks in the PIIGS nations, they’ve lent $275.8 billion to French and German banks, according to BIS.
“Although American banks have limited their exposure to Greece, they have loaned hundreds of billions of dollars to European banks and European governments that may not be capable of paying them back,” said Money Morning Chief Investment Strategist Keith Fitz-Gerald.
With U.S. banks so deeply connected to those in Europe, particularly through the $600 trillion global credit-default swap market, Fitz-Gerald said a meltdown over there would trigger a meltdown here in the United States.
“Imagine the fallout from a $600 trillion explosion if several banks went down at once,” Fitz-Gerald said. “It would eclipse the collapse of Lehman Brothersin no uncertain terms.”
Essentially, the major U.S. banks have made a collective bet that the Eurozone governments will bail out any European banks that get into trouble – a faith-based bet that could backfire if the governments fail to act accordingly, either because of political resistance or because they won’t be able to raise the money.
“We could have an AIG moment inEurope,” Peter Tchir, founder of TF Market Advisors, told Bloomberg News. “Let’s sayGreece defaults, causing runs on other periphery debt that would trigger collateral requirements from the sellers of CDS, and one or more cannot meet the margin calls. There might be AIGs hiding out there.”
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