By: George M. Papasimakis
Is Dodd-Frank destined to fail in preventing the next financial crisis? Is the Street headed for another financial meltdown?
A quick look at the European debt crisis unfortunately answers the question, and investors are already reacting. Just last week in the U.S., stocks declined, the Dow Jones Industrial Average tumbled 134.86 points, or 1.1%, to 11770.73, down 2.7% in two days and three of the last four sessions. Stocks and bonds of U.S. banks were pounded, in particular Jefferies Group Inc. and Morgan Stanley. Gold tumbled 3% and silver dropped 6.9%, a sign that investors may be loading up on cash. “The memory of Lehman is still very fresh, so banks are probably hoarding dollars,” said Charles St. Arnaud at Nomura Securities.
But why are investors reacting this way? What do we have to do with the European crisis? It seems they’ve “followed the money.” If Greece, Spain, Italy or Portugal go down it’s going to severely damage the French and German banks that have lent them a great deal of money in the form of bailouts and “haircuts” of debt through the French and German governments. If one of these banks collapses or show signs of major strain, Wall Street will be in big trouble. Like most developed countries, the big euro-zone economies depend on lenders to refinance their large budget deficits and much of that money comes from foreign investors. Big Wall Street banks have lent German and French banks a great deal.
These concerns over the E.U. debt crisis and its effect on the U.S. banks have prompted some U.S. banks to release more information about their exposure. J.P. Morgan Chase & Co. and Goldman Sachs Group Inc., in filings this month, published for the first time their exposures to Portugal, Ireland, Italy, Greece and Spain but only Morgan Stanley included France in their filing. As I stated above, it seems like it would probably be more important to know what their exposure is in France and Germany. Fitch Ratings reported that the six biggest U.S. banks had $50 billion in risk tied to the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) on Sept. 30, and cross-border outstandings to France for all except Wells Fargo were $188 billion, including $114 billion to French banks. As if the reports weren’t vague enough, these banks published their net exposure or the gross exposure offset by hedges such as credit-default swaps (CDS), bilateral agreements that are supposed to insulate against losses from debt defaults. Questions have been raised as to the capability of that popular insurance-like hedging vehicle, covering billions of dollars in some larger institutions, and the fact that these disclosures have not put fears to rest suggests that the disclosure of U.S. banks low net exposure to the E.U. is not enough; Dodd-Frank didn’t go far enough to quell fears.
No one knows Morgan’s or any other bank’s real exposure to European banks. Investors are also not comfortable with the insurance offered by CDS’s and who can blame them. It seems investors have not yet forgotten AIG, the insurance firm that collapsed when Wall Street hit turbulent times in 2008. Wall Street thought it had protected its bets with AIG just as these banks think they’ve properly insured theirs.
If badly indebted European countries cannot pay back their loans from French and German banks, the banks may go down, are they just might take the Street down with them. If this happens, should the U.S. banks be “too big to fail”, again? Does Dodd-Frank even allow for another bailout?