The 'L' word is back

Fear gripped European banks last night, of a kind we have not seen since the collapse of Lehman in 2008 which brought on the global financial crisis. As I explain below, Australia will not be immune.

But when Lehman collapsed it was fear of the unknown. This time markets are scared of what they actually know – that if major European banks wrote down their Greek, Spanish, Italian and other European sovereign debt holdings to the current market, their equity capital would be wiped out.

That fear makes banks nervous about lending to each other and pushes up the cost of the wholesale money that Australian banks need. Australia's banks are among the world's largest wholesale borrowers, but fortunately most of our banks have borrowed their immediate requirements.

The flight out of the euro pushed up the US dollar and will depress our currency, particularly as commodity prices are falling. In turn our sharemarket is also likely to be affected.

Deutsche Bank took some of the heaviest punishment because its chief Josef Ackermann actually mentioned the 'L' word, saying the situation resembled that of the panic that followed the collapse of US investment bank Lehman Brothers in 2008 (European shares hit 2-week low, September 5; Europe's bank fears blow out, September 6).

But Deutsche is one of the banks in the front line in this crisis because it was a heavy investor on the damaged sovereign debt bonds.

You will remember in the global road map at the Hayman Leadership Retreat, the global traders said Europe would be forced to abandon the ineffective schemes to paper over the problem. As Karen Maley explained yesterday, already Greece is turning its back on its austerity obligations (Greece hits an austerity wall, September 5).

The traders are demanding that Europe adopt a solution of substance. There are only two – either Germany or a few others leave the euro which then slumps, bankrupting a series of German and French banks led by Deutsche. Not surprisingly, Deutsche shares fell 9 per cent last night. The second solution is for all European states to joint and severally guarantee all European bonds. That will maintain the banks but will crush the German economy. Again, not surprisingly, the German share index, the DAX, is leading Europe down.

Neither are pleasant solutions.