Delevering in Europe Remains a Threat to World Economy

Among the several ways that recession in Europe could hurt the global economy is via the specter of bank deleveraging. As you may recall, one of the proximate causes of the Great Panic of 2008 was the fact that American banks had run up huge amounts of leverage, something that makes the banking system extremely vulnerable to sudden shocks — like, say, a housing bubble bursting.

Well, European banks were even more leveraged than American banks. The top chart on the right, courtesy of a new IMF report, shows that American bank leverage peaked in 2008 at a ratio of about 25:1, and since then has dropped to a much more sustainable 15:1. European banks, even after four years of deleveraging, are still at 25:1. This means they remain vulnerable to sudden shocks — like, say, Spain going bust — so they’ll need to continue deleveraging for several more years.

There are basically two ways they can do this. First, they can raise money by selling off assets. This is OK unless it turns into a fire sale, which is always a possibility. Second, they can reduce the amount of credit they make available. The bottom chart on the right shows the IMF’s estimate of credit contraction over the next couple of years.

The good news for Americans is that this probably won’t affect us directly very much: Most of the credit contraction will happen in Europe, and American corporations have deep access to capital markets to replace whatever they lose from European banks. There is, however, a potential indirect effect via derivative exposure, and also some more general exposure at a macro level if bank deleveraging keeps Europe’s economy in a rut.

Still, the IMF doesn’t think the credit contraction in Europe is likely to be all that severe: “The implied decline in the credit-to-GDP ratio [] sits between the relatively moderate experience in Japan in the 1990s and the more pronounced credit contraction in the United States in the earlier part of the financial crisis.” As long as European banks avoid a “synchronised and large-scale deleveraging” — i.e., a fire sale of assets — things will likely stay under control.

In other words, the big danger remains not sluggish growth in Europe, which everyone has already priced in, but the possibility of panic. And with sovereign debt still extremely wobbly in the south, monetary policy still too tight, austerity still the order of the day, and bank leverage still high — with all that still in front of us, panic remains a distinct option. A eurozone crackup is still a real possibility.

DOES IT FEEL LIKE POLITICS IS AT A BREAKING POINT?

Headshot of Editor in Chief of Mother Jones, Clara Jeffery

It sure feels that way to me, and here at Mother Jones, we’ve been thinking a lot about what journalism needs to do differently, and how we can have the biggest impact.

We kept coming back to one word: corruption. Democracy and the rule of law being undermined by those with wealth and power for their own gain. So we're launching an ambitious Mother Jones Corruption Project to do deep, time-intensive reporting on systemic corruption, and asking the MoJo community to help crowdfund it.

We aim to hire, build a team, and give them the time and space needed to understand how we got here and how we might get out. We want to dig into the forces and decisions that have allowed massive conflicts of interest, influence peddling, and win-at-all-costs politics to flourish.

It's unlike anything we've done, and we have seed funding to get started, but we're looking to raise $500,000 from readers by July when we'll be making key budgeting decisions—and the more resources we have by then, the deeper we can dig. If our plan sounds good to you, please help kickstart it with a tax-deductible donation today.

Thanks for reading—whether or not you can pitch in today, or ever, I'm glad you're with us.

Signed by Clara Jeffery

Clara Jeffery, Editor-in-Chief

We Recommend

Latest

Sign up for our newsletters

Subscribe and we'll send Mother Jones straight to your inbox.

Get our award-winning magazine

Save big on a full year of investigations, ideas, and insights.

Subscribe

Support our journalism

Help Mother Jones' reporters dig deep with a tax-deductible donation.

Donate

Share your feedback: We’re planning to launch a new version of the comments section. Help us test it.