A few months after October 2008, following Lehman Brothers’ unthinkable and calamitous bankruptcy, there were a number of explanations, both from academia and political circles, suggesting that free trade, combined with the free-flow of capital in deregulated global financial markets, would be most helpful in coping with the severity of this crisis.
Not only was that naïve, but it overlooked the fact that globalization had clearly changed the rules of the game and sacrificed predictability along the way. With persistently large trade imbalances combined with salient differences in financial regulations or banking laws and business practices across the globe, suggesting that we now had an increased capacity to manage worldwide instability was plain wishful thinking.
For starters, banks that have been operating globally with vast cross-border operations were primarily European in origin. What set these banks apart relative to their American counterparts was their outsized assets compared to the economic output of the nations that harbored them. As the Swiss and the Dutch quickly discovered, having large universal banks with massive and disproportional global operations posed bigger national risks than originally understood. Yes, Citibank had to drastically curtail its global presence and reach after the crisis, but in a less dramatic way than the government-mandated retrenchments or reorganizations imposed on companies like UBS, ING and a few other European banks.
Euro Zone Financials: Still Too Risky
Seven years later, European banks still remain among the less well capitalized of the world with higher leverage ratios. According to the Bank for International Settlements’ latest report of January 2015, the majority of the 14 participating banks -- out of 31 worldwide – which reported that they will still be unable to fully comply with the risk management principles of the Basel Committee by the 2016 deadline were from the Eurozone.
Rephrased differently for simplicity,, should another banking crisis develop unexpectedly, some European megabanks are still inhabiting the riskier “too big to bail” universe.
What makes their job a lot harder is that deleveraging at the national level has not even started yet. After all these years, the combined private and public debt as a % of GDP has gone up, not down like in the US, for the entire Euro Zone, the U.K. and Japan.
COMPARING DEBT BURDENS: 5 years after the Crisis
Combined Private and Public Debts as a % of GDP
The significance here is that, as recently demonstrated once more by Greece, Euro Zone banks are still saddled with oversized sovereign credit risks which are still present in their balance sheets.
The untold lesson in this is that, unfettered global finance is a lot more unrealistic than previously believed. When the largest global banks faced insolvency in 2009, only one factor mattered in their rescue: their nationality. It was the Dutch, Swiss or British governments that saved their banks from possible extinction, and not the still non-existent global resolution authority for banking insolvency. So, lawmakers beware: behind the allure of profitable global banking operations lie the untold domestic taxpayer liabilities.
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