????The European economic contagion that began 18 months ago as a sovereign debt crisis is dangerously mutating into a full-blown banking crisis. With Greece in de-facto market default, weak banks within the eurozone have started to fall ill as their investors, trading partners and clients pull short-term funding. The move by central banks on Thursday to provide extended U.S. dollar loans to European banks is only a stopgap measure. A Lehman Brothers-like collapse or a Northern Rock-like bank run still cannot be ruled out at this point for several of the eurozone's largest financial institutions.
????The market has hammered French banks into the ground first, but banks in Italy, Spain, Germany and the United Kingdom face serious funding issues as well. Swift action is needed on the part of eurozone members to shore up confidence in its crippled banking sector. The expansion of the European Financial Stability Facility (EFSF) is a good start, but more money will be needed to ensure investors that it's all clear to park their cash with European banks again.
????The alarm bells were sounded on trading floors in Paris and New York this week. Société Générale, Credit Agricole and BNP Paribas – the three major French banking institutions - have seen their share prices move violently in recent days, ostensibly because of their exposure to toxic Greek sovereign debt. On Wednesday Moody's downgraded the credit rating of Société Générale and Credit Agricole one notch and kept BNP Paribas on review for a downgrade.
????But the violent drops in their share prices seem to go beyond the banks' exposure to Greece and the credit downgrade. Take Société Générale for example. The bank's total exposure to Greek sovereign debt, including the amount held by its Greek subsidiary, is around 5 billion euros. That's equivalent to around 1% of the bank's balance sheet and around the same amount of money the bank lost at the hands of rogue trader Jér?me Kerviel in 2009.
????As punishment for its Greek sovereign investments, the market wiped out 56% off Société Générale's market value in the last three months up to Thursday. That's around 3.5 times the value of its exposure to Greek sovereign debt, which is clearly overkill. Some of the extra losses baked in to the market value haircut derive from the bank's exposure to the private Greek credit market through the bank's local subsidiary. But the market seems to be sending a signal that it is worried about much more than the bank's measly Greek exposure. The big fear is that Société Générale, along with its French banking brethren, is extremely undercapitalized and could therefore collapse at any moment.
Echoes of Lehman
