Brexit Banking Crisis Unfolding

[cieldumort]

The Bank Index in Europe Just Had it's Largest Daily Drop Ever

"They're going lower ... avoid these ... don't pick bargains.. there's going to be some European bank stocks that lose all their equity value in 2016 ... like Bear Stearns style... it's a very grim picture.. it's a mess..."

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[peristaltor]

From a book I read:

If you were a European bank back in the late 1990s seeing sovereign bond yields falling, it might have bothered you since a source of risky profits was disappearing. On the other hand, if this new ECB gizmo really did get rid of exchange-rate risk for the sovereigns issuing the debt and take inflation off the table by housing in Frankfurt the only money press in Europe, then it really was a banker's dream-a free option-safe assets with a positive upside, just like those CDOs we saw in the United States. So you would be a fool not to load up on them, and European banks did exactly that. But as yields converged, you would have to buy more and more bonds to make any money. There was, however, a small but significant difference in yield between the bonds of Northern European sovereigns and those of the periphery after the yields converged. So, if you swapped out your low-yield German and Dutch debt and replaced it with as much PIIGS debt as you could find, and then turbocharged that by running operating leverage ratios as high as 40 to 1-higher than your US counterparts-you would have one heck of an institutionally guaranteed money machine. What makes this a moral hazard trade?

Imagine that you knew Greece was still Greece and Italy was still Italy and that the prices quoted in the markets represented the bond-buying activities of banks pushing down yields rather than an estimate of the risk of the bond itself. Why would you buy such securities if the yield did not reflect the risk? You might realize that if you bought enough of them-if you became really big-and those assets lost value, you would become a danger to your national banking system and would have to be bailed out by your sovereign. If you were not bailed out, given your exposures, cross-border linkages to other banks, and high leverage, you would pose a systemic risk to the whole European financial sector. As such, the more risk that you took onto your books, especially in the form of periphery sovereign debt, the more likely it was that your risk would be covered by the ECB, your national government, or both. This would be a moral hazard trade on a continental scale. The euro may have been a political project that provided the economic incentive for this kind of trade to take place. But it was private-sector actors who quite deliberately and voluntarily jumped at the opportunity.

(Mark Blyth, Austerity: The History of a Dangerous Idea, Oxford University Press, 2013, pp. 81-82.)