Int'l Mega Banks Still Ticking Time Bombs

by Steve Rumsey of Optimus Advisory Group, 3/25/14

Five years and counting

During the past five years, following the worst financial crisis since The Great Depression, the financial media has been talking about the deleveraging process happening worldwide. We've all heard the stories of how banks to consumers to corporations have deleveraged and continue to do so. It's as if all the global financial bailouts were all orchestrated just to buy us enough time so that we could get our financial houses in order. Then, miraculously, after someone blows the "all clear" alarm we can all go back to living our normal lives once again.

Back in 2009, I remember watching an Australian television interview with Paul Keating, the former Prime Minister and Treasurer of Australia. When asked if he thought this was a three-year crisis, a five-year crisis or something worse, he chose the latter. Mr. Keating went on to explain that our massive global debt had been accumulating for several decades now and that it would take many, many years to undue the damage.

How right he was! After five years supplying bridge loans to the global financial system, central banks worldwide have been playing a game of chicken. Can they actually print enough money to carry us over the abyss to the promised land? Or, will time become our bitter enemy?

As seen in the chart below, some progress has been made. The developed world's mega banks have reduced leverage throughout the system. If only we had a limitless amount of time available to continue on this road, all things would just work themselves out eventually. Or so it seems.

(Source: Morningstar - Quarterly Financial Leverage - Optimus Leveraged Global Mega Bank Watchlist)

Fortunately, for those of us in the U.S., things look better on a relative scale. While our own mega banks were highly leveraged (24:1) pre-crisis, we've made great strides (thank you taxpayers!) in dropping that level back down to earth.

There is a different story, however, on the other side of the world. European mega banks' financial leverage peaked at 42:1, while Japanese banks peaked at 48:1. They weren't using punch bowls back then; they were filling up the swimming pools! Shockingly, five years removed, European banks are just now hitting U.S. peak leverage levels, while Japanese banks still have a little ways to go. To put it another way, Europe has just now reached our dangerously high levels of leverage from 2007 and Japan is still in the "extremely dangerous" level we never actually reached.

International Mega Bank Hit Parade

Examples of the "swimming pool" sized punch bowls overseas are not hard to come by. In 2008, Deutsche Bank AG in Germany had leverage of 72:1! Five years later, they have brought it down to only 32:1.

European Bank Credit Agricole's current financial leverage is 24:1 and they are rated "F" by Morningstar for financial health, which is a rarity. Current financial leverage is 24:1.

Japan's Mizuho Financial's leverage hit 66:1 in 2008-2009 and is now only 32:1.

Along with Japan's Mizuho Financial, Europe's Barclays Bank is the only other bank on our Global Mega Banks Watchlist that has the dubious distinction of running greater than 50:1 financial leverage four years in a row! No wonder they backed out of any Lehman deal in 2008.

There Will Be A Test

Our fragile financial system may be going through another real-life stress test soon. Who can say what the so-called "trigger" will be: China credit crisis/hard landing/property market collapse? Emerging markets currency crisis? The Russian/Ukraine crisis?

At this juncture, allocating assets toward tactical equity & bond strategies that can move to safety makes sense, especially since we are so long overdue for a double-digit correction in the equity markets.

Disclosures

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