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As the sovereign debt crisis remains unresolved the potential for a full-blown credit crisis increases substantially.  European leaders don’t seem to understand that the banking crisis is a direct result of the sovereign credit crisis and that the risks here can be substantially reduced by creating a sovereign monetary union.  But political bickering and a lack of agreements has led to no real resolution in Europe.  So, recession is turning to depression in some parts of the region and the risks throughout the EMU are rising quickly.  The longer this goes on the greater the risk of contagion.

In a recent note, GMO highlighted enormous capital needs for European banks:

Recapitalization efforts by European banks are starting to gear up. Within the last few weeks, the Italian bank Unicredit has scheduled a new capital raising of 7.5 billion euros; Commerzbank of Germany has replaced preferred bonds with equity; Spain’s BBVA has sold a mandatory convertible bond worth 3.5 billion euros to retail customers; and Spain’s Santander has sold a stake in its Chilean subsidiary, scheduled a group placement of holdings in the Brazilian subsidiary, and announced a deal to sell 95% of its unlisted Colombian subsidiary. The family jewels are being sold.

I believe those deals are merely the beginning. The capital needs of European banks are large – in some scenarios dwarfing the 100 billion euros identified by the Europeans earlier this year even without incorporating the needs that might arise from a European or global recession. Spanish and Italian banks face the greatest needs, but there are plausible scenarios that would also generate large capital calls from French and German banks.

In any case, you can bank on it: European banks need tons of money.

Shades of 2008. Because politicians don’t understand the root cause of the crisis they remain unable to identify the cure. And without a cure, the disease spreads and infects many more than necessary….

Source: GMO

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