The European Debt Crisis in Lehman Terms

No, that's not a typo. The United States of Europe's balance sheet is Lehman Brothers bad and don't feel out of the loop if you haven't kept up, the average American doesn't know how to even begin to understand it, because truth be told, it's complicated stuff. In this week's column, I'll explain the Euro crises and what it means in terms of our fragile economy. As usual, there's little good news.

The experiment known as the EU, once so promising, is beginning to look like a house of cards and not one built on those good, casino-grade type, but rather the cheap plastic sort that come two in a pack at Dollar Tree. But don't start looking down your nose at our friends across the pond, their troubles are remarkably similar to ours and casts a rather large shadow over our ever-so tenuous ”recovery.“

The problems:

To start with, the European banks are leveraged to the hilt. At about 25-1, that's twice that of U.S. banks and close to the 30-1 that Lehman Brothers was sporting when they imploded – and that's based on the supposed values of some pretty hard to price toxic debt instruments, so it could be much worse – and probably is.

EU banks, even the strongest ones, need to roll over an incredible amount of debt in the next year just to service maturing loans. When you start looking at the numbers, you see that the ”massive bailouts“ being proposed are more of a band-aid than a cutting out of the cancer. The number that keeps getting promised is $3 trillion because that is what the markets seem to need to hear in order to maintain ”confidence,“ and while the recent solution claims to promise that amount, how they arrive at that number looks like voodoo math because it includes too many guarantees from countries who couldn't get a payday loan at Amscot.

Greece, Ireland and Portugal (who have over 61 billion Euros in combined EFSF guarantees) are ”stepping-out guarantors“, which means that their guarantees cannot be called, as long as they remain Troika Programme countries, receiving funding from the EFSF. Right behind them, Spain and Italy (whose guarantees are much higher at over 240 billion Euros), are also less than credible as guarantors.

As you go down the list, you see that this really becomes about Germany, who if you've been following even a little, has been presented as the one strong economy in the union, as well as the only one with a solid system of banks. But the idea that Germany can fund a $3 trillion Euro bailout is a non-starter. Their entire GDP is slightly less than that, and they are also leveraged at a level close to that of the U.S., even before such write-downs. To give you an idea of scale, the entire 27-country EU combined is only slightly larger than the U.S. economy, which despite having the unique role as printer of the world's reserve currency, was not able to pull off a $3 trillion bailout when economists deemed it necessary to fill the hole in the economy caused by the 2008 collapse here.

Will any "bailout" work?

Can the EU stave off a run on the banks? Probably, if only because too many people will be willing to ignore the long-term reality. But for how long? Where will the fix ultimately come from? There are simply too many debt instruments attached to too few real assets. In Lehman terms, there's too much debt and no good reason to be a fair creditor to someone that might be breathing, but is eating up costly life support while doing so. But the solutions being offered all sound like they are actually adding more debt, you say. Well you're right, and if you can sense that it seems absurd that they're going to cure the patient with more of what's killing him, you're definitely on to something.

At the core of the problem is the fact that the entire developed world is drowning in debt, and those getting by are merely rolling over enough of it to keep a half step ahead of the juice man. There is no "paying it off" in any true sense. Any solution to deflate the debt is going to include a massive write down of assets (called a universal haircut), or a massive inflation of the currencies. Guarantees by nations are, after all, on behalf of their taxpayers and in the form of debt which they must be taxed to service. Much of the debt, in fact nearly all of the debt, has been issued to ratchet up consumption yesterday to be paid for tomorrow. Guess what, it's tomorrow and even if you find a way to pay the bills, you're not going to find a way to return to anything approaching the levels of inflated, credit-driven consumption that kept things rosy in the past, without instantly finding yourself right back in the same situation. That ultimately means demand is further reduced, which only compounds the problem.

Is the EU doomed?

So, what's the endgame? I'd bet that the Euro goes away at some point, probably by way of Germany ultimately deciding not to backstop any more debt for hopeless member states and returning to their Deutschmark, maybe with a two-tiered Euro (one for better states, one for worse) as the transition piece, something that was discussed last summer. The European Union, too eager to take on more developing nations fueled by cheap credit and cheaper labor – and without a real central bank to impose fiscal policy, will be a failed experiment, after which, the countries of Europe might look a lot more like they did in 1945 than 1995.

The U.S., whose banks have an unknowable amount of toxic crap tied up in the whole EU mess (best estimated at over a hundred trillion with a T) mostly via opaque derivatives that make it hard for investors to tell good banks from bad and apt to pull money from all of them as soon as one falters as a result, will probably force taxpayers to fund another backstopping of bad debt, while Goldman Sachs finds a way to make money on the way down, and more people take to the streets to occupy something. Our ”leaders“ will have wished they would have enacted meaningful financial reform when they had the chance, and our citizens will have wish they demanded it.

Banks like JP Morgan Chase and Bank of America are currently (and seemingly illegally) transferring derivative exposure from this mess from their investment subsidiaries to FDIC insured bank holding companies, putting normal deposits at risk, and setting up taxpayers to once again foot the bill when the enormously profitable, though highly-risky, insurance policies they've been racing to sell Eurozone players eventually aren't worth the paper they're written on. Whistle-blowers at the FDIC are shouting from the mountaintops, but the Fed (and whoever gives Bernanke his marching orders) are giving this move their blessing. Lawmakers are just starting to ask questions and the manner in which this blatant upward redistribution of wealth scheme of reverse capitalism, in which private banks enjoy free-market success and socialized failure, is handled will tell us a lot about who really runs this country.

Remember, the Great Depression was preceded by massive international trade reductions that resulted from monetary and trade policies following the debt run up during WWI. The EU does a little more than the U.S. in terms of trade with China and the two combined account for more than half a trillion dollars in Chinese trade, which means the ripple effect in the Far East for any major plunge will be considerable. Simply put, the 2008 banking crisis may have only been the first sneeze in a serious illness yet to come. The European debt crisis may well be the fever, with the vomiting and cold chills soon to follow.

Dennis Maley is a featured columnist and editor for The Bradenton Times. An archive of his columns is available here. He can be reached at dennis.maley@thebradentontimes.com.