John Mauldin monitors the markets. He is the author of Endgame. He also used to be my business manager. He is less apocalyptic than I am, but is is scary enough. Here is his latest assessment:
I am constantly asked what my biggest worry is. What is the largest monster I think I hear in my closet of nightmares? And the answer has been the same for a long time: it is European banks.
Those who think this is all a non-event note (correctly) that US net exposure to European banks is not all that large, and that while it may not be a non-event, it’s not system-threatening. The problem is that little three-letter word net.
Gross exposure is huge, and we are starting to read that regulators and other authorities are becoming concerned. As well they should. The problem is that as a bank sells risk insurance, it can buy protection from another bank in Europe to hedge it. But who is the counterparty? How solvent are they? It was only a month before Dexia collapsed that authorities and markets assured us that the bank was fine, and then bang! it was nationalized.
That is the part we do not know enough about. If European banks are as bad as they appear to be, then that counterparty risk is large. Will sovereign nations step up and bail out US banks on the credit default swaps their banks sold? Care to wager your national economy on that concept selling in today’s political climate?
Contagion is the #1 risk on the minds of European leaders and regulatory authorities, and it should be in the US, too. This points to a massive failure in Dodd-Frank to regulate credit default swaps and put them on an exchange. This is the single largest error in the last few decades, as it was so predictable. At least with the repeal of Glass-Steagall it was the unintended consequences that got us. Dodd-Frank almost guarantees another credit and banking crisis. Don’t get me started. . . .
As I have been writing, there is no credible source other than the ECB for the amount of funds needed. Maybe something can be cobbled together under the pressure of a crisis, but for now there is no realistic option. Europe is at the end of the road unless Germany “blinks.” The only thing we can do now is to see how it works out.
If the ECB can’t print, then the rules have to be changed, if the eurozone is to survive. And while a recession is underway. . . .
Time is not on the Europeans’ side. Let’s hope they can figure it out, but prepare for what might happen if they don’t.
