Will the eurozone break up?

by Paul Mason

BBC News
September 15, 2011

"The short-term banking crisis is the biggest concern Europe is facing," said the International Monetary Fund's (IMF) Deputy Managing Director, Min Zhu, yesterday.

"There is no room for politicians to muddle through. They have to take decisive action today."

Well, did they? They had a teleconference at which they assured Greece it would stay in the euro, and urged Greece to meet the conditions of the 21 July 2011 re-bailout agreement.

Min was only repeating what his boss, Christine Lagarde has been saying for some time, that there is an urgent need to recapitalise Europe's banks - and the only shouting is about by how much.

One trillion dollars said Goldman's oft quoted but not yet leaked investor note. Five hundred million dollars said Lagarde at Jackson Hole, revising it down to 200m euros lately.

Let me just pause for an explainer on how the euro crisis and the banking crisis are linked.

• Ireland needed a sovereign debt bailout because its banks were bust;
• Greece needed a sovereign bailout because it had an uncontrollable deficit, but if it defaults, then 50% of its debt is held by Greek banks and pension funds which will go bust. But they cannot be bailed out by Greece because it has no money;
• Two French banks (SocGen and Credit Agricole) and one German bank (Commerzbank) have big direct exposure to a Greek default. Also Dexia of Belgium;
• Because many other bank prop trading desks and hedge funds have taken bets on Greek debt, a default would shoot through - a mini Lehman - into the global finance system.

This is the souce of the IMF's worry and it is reflected in the stock markets. As banks shares have been dumped by scared investors, six major EU banks are valued at below half their tangible book value.

That is, below half what shareholders would get if the bank went bust tomorrow and sold all its assets at their notional value. Even the perennially solid and diversified banks - HSBC, Santander, Nordea - are trading at just above book value. Analysts believe investors are pricing in the exit of all five PIIGS countries from the eurozone.

So what does this mean? As I have been banging on about for several weeks - institutional investors are starting to plan for the breakup of the eurozone. If you believe the eurozone will break up, leaving Portugal, Italy, Ireland, Greece and Spain outside it, then you start to look at major bank exposure - not just to the sovereign debt of this sector but to the whole economy.

If you think the peripheral Europe will drop out of the euro, you must expect a devaluation of assets in those countries or imminent defaults on loans you have made there. That will bust certain banks.

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