Subscribe to Money Morning get daily headlines subscribe now! Money Morning Private Briefing today's private briefing Access Your Profit Alerts

The European Banking System is Finally on the Verge of Collapse

I hate to sound alarmist, but it looks as though the European banking system – and consequently the global banking system – is edging its way towards another epic collapse.

That means in just a few short months, stocks could be back at their 2009 lows while gold prices travel north of $2,500 an ounce.

This is the worst-case scenario that's been bandied about ever since Europe's debt problems first came to light.

How do we know that this is what's happening?

Because somebody is having trouble obtaining the money they need — and they just borrowed it from the lender of last resort.

The European Central Bank (ECB) last week lent $500 million dollars to an undisclosed Eurozone bank through a credit mechanism that had been dormant for the past 12 months, with the exception of one $70 million draw in February.

This comes as no surprise – the warning signs have always been there.

In fact, I warned Money Morning readers just a few weeks ago that the Eurozone could have its own American International Group Inc. (NYSE: AIG) – or worse, its own Lehman Bros. Holdings Inc. (PINK: LEHMQ) – lurking somewhere in the shadows.

Still, while this may not surprise you, it certainly surprised the heck out of the rose-colored glasses crowd that can't seem to understand the European sovereign debt crisis is finally about to wash up on our shores.

That's why stocks in the United States and around the world have taken such a brutal beating recently. Officially the story is about the renewed worries over Europe's debt crisis and U.S. data that suggests we're once again sliding into a recession.

But what's really happening is that global traders are moving quickly to liquidate holdings and raise cash while they can.

That's why so-called risk assets like stocks, corporate bonds, industrial metals, oil and higher-yielding junk instruments are tanking, as gold, the dollar and the yen are bucking up.

The U.S. Federal Reserve already is engaging in damage control. President of the Federal Reserve Bank of New York William Dudley has said the risks of a double-dip recession are "quite low," despite anemic growth. And it's been rumored that U.S. Federal Reserve Chairman Ben S. Bernanke will telegraph new monetary stimulus measures Friday during his speech in Jackson Hole, WY.

But really, who are they kidding?

This crisis has nothing to do with liquidity (which is how the central bankers are trying to fight it) and everything to do with solvency (which is how they should be fighting it).

Not only are the risks of a global recession mounting by the minute, but I believe the concentration of risks is approaching critical mass.

A Return to 2008

First take a look at the Euribor-OIS swap (the spread between the Euro Interbank Offered Rate and the Overnight Indexed Swap). This swap, widely regarded as a gauge of fear in the European banking system, is at levels we haven't seen since April 2009, and is climbing rapidly towards levels we experienced during 2008 at the height of the financial crisis.

These rates, along with the London Interbank Offered Rate (LIBOR), represent a sort of feedback mechanism similar to the body's circulatory system. If the system goes into "shock" there will be a negative, self-sustaining reaction.

At the same time, shorter-term euro basis swaps have fallen to the lowest levels we've seen since Lehman Bros. blew up.

The premium that European banks are paying to borrow in dollars through the swaps market is at its most extreme level since the credit crisis of 2008. The cost of converting euro-based payments into dollars as measured by the three-month cross-currency basis swap fell as much as 93 basis points below the Euro Interbank Offered Rate (Euribor), indicating a higher premium to buy dollars.

Historically, anything in the neighborhood of -150 basis points suggests imminent bank failure.

European banking system

Meanwhile, funds parked in the ECB's "deposit facility" are rising, which means they aren't being lent to other banks. Funds at the ECB deposit facility hit their highest level – $209.3 billion (145.2 billion euros) – earlier this month. And ECB data shows commercial banks parked $154.4 billion (107.2 billion euros) in the central bank's deposit facility last Friday, up from $130.5 billion (90.5 billion euros) on Thursday.

This suggests banks are more concerned with having liquidity available to them via "official" sources rather than the open markets.

There are two reasons they would feel that way:

  1. Because they can't get it from other sources.
  2. And because they don't trust the other banks who would otherwise serve as their counter party.

Remember, banks only make 0.75% on their deposits at the ECB, which is a smaller return than what they'd receive by lending to other banks. This suggests banks value the return of their money more than the return on their money.

This happened before, most recently in Japan in the 1990s. I remember living in Japan at that time, and things got so bad that the spreads on overnight deposits actually went negative for short periods. That is, Japanese banks actually paid the Bank of Japan (BOJ) to hold their money because they were scared to hold it themselves.

Finally, non-U.S. bank reserves on deposit at the Federal Reserve declined from $900 billion on July 13 to $758 billion as of Aug. 3. I've done some calling around and heard from two confidential sources that the level may have fallen as low as $500 billion this week, which would be a near-50% drop in only weeks.

According to the Fed, foreign banking institutions hold approximately 25% of all commercial banking assets in the United States. That makes me think EU banks are calling money home not because they want to but because they need to.

How to Prepare for Another Banking Breakdown

So now what?

Well, if the data is even halfway accurate with regard to what it suggests, then stocks will likely retest their March 2009 lows. That means the Dow Jones Industrial Average could fall to the 6,600-level, while the Standard & Poor's 500 Index drops to 683, and the Nasdaq Composite Index slinks all the way down to 1,293.

Gold likely will head in the opposite direction to $2,500 an ounce or higher and 10-year Treasury bond yields may drop as low as 1.5%.

More immediately though, I expect central bankers to attempt one more Herculean effort to "save" things. Whether that intervention will take the form of a third round of quantitative easing (QE3) or another federal "stimulus" plan is unclear.

But regardless of what happen, these are the steps you should take:

  • Sell weaker positions and transition that money into companies you really want to own -particularly if they are the "glocals" we talk about so frequently, and especially if they have high dividend yields.
  • Begin tightening up your protective stops so that you can both capture gains and protect your capital as the market rolls over.
  • Buy commodities including gold, silver, oil and pharmaceuticals.
  • Invest in the specialized reverse exchange-traded funds (ETFs).
  • And, most importantly, KEEP BUYING – but change up your tactics to include dollar cost averaging. There's no sense in making all-or-nothing decisions when that type of thinking doesn't fit market conditions.

Remember, you miss 100% of the shots you don't take, so getting to the sidelines is not a profitable plan. Staying in the game always has been, and always will be, the way to profit.

News and Related Story Links:

Join the conversation. Click here to jump to comments…

About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at

Read full bio

  1. fallingman | August 24, 2011

    Thanks for this analysis.

  2. marvin | August 24, 2011

    when the big wreck happens 4 to 8 wks – 2009 every thing got hit gold- silver 8$- want the great escape take all down -oil especially and a big spike in dollar

  3. Marc Elardo | August 24, 2011

    You are calling for a re-test of the March 2009 lows and I agree with this. But you also suggest that whenn this happens, gold will rally. Back in 2009, it tanked. Why the opposite reaction this time?

    • John Smith | August 24, 2011

      Gold tanks along with other investments as leveraged investors sell their gold to cover their losing bets. Buy gold when the carnage subsides, or dollar average down during the carnage as you don't know where it will end.

    • JORGE O O | August 24, 2011

      Good question . Why?

  4. Glenn Quader | August 24, 2011

    Finally a report with credible facts. Thank you. I totally agree.

  5. Mauro | August 24, 2011

    It seeme to me that are you giving contrasting advise. First you expect the indices to go back to the 2009 lows, then you recommend to keep buying and stay invested. Why keep flying to the site of the crash? I have been out of the market for more than 90% in my IRA since de beginning of May and so far I am a happy camper. I feel uncomfortable to get back in until the feds stop printing fake money and until the European situation is clearer. Am I really wrong since I am freshly retired?

    • Mike Walker | August 24, 2011

      Unless you want to become a daytrader in these volatile times it is prudent to step aside until the dust settles. Once it does there will be so much damage done that recovery will take much longer than it did in 2009. I believe this next crash will be far worse than the last one. In the mean time investing a portion of your money in gold and silver whenever it corrects is a good idea .

    • Jeff Pluim | August 24, 2011

      Keith is suggesting staying in the market in positions that are fairly safe for the forthcoming downturn. I agree with the inverse funds idea and the Glocal companies, but I am not sure about the gold idea. But he may be right because things are different now than in 2009 because the USA is devaluing the USD quicker than you can say "quantitative easing".

  6. Michael Foley | August 24, 2011

    I agree with Mauro. If in fact you are predicting 683 on the SP why would you buy anything but inverse ETF's? Makes no sense. It is hard to pull the trigger both ways, but if you have cash now and believe the market is going to tank then it certianly makes sense to wait on the sidelines.

  7. Michael Gushue | August 24, 2011

    As a new invester with little liquidity and a new family, how do I not take this info and run for the hills?

    • Tim Bon | August 27, 2011

      Michael, maybe in the short-term if you feel uncomfortable, go to cash for the next 30-45 days. There are really good buys out there right now, but don't jump in just because. Having cash on hand, just in case, is definately more helpful when you have a family. When you have the time to research do so and you will see what I mean. Good luck to you and your family.

    • BILLHARTMAN@ACM.ORG | September 5, 2011

      The situation he is calling for is deflationary. So cash is king. Keep your cash as cash. Wait until the crash is over, then buy gold and silver to offset the inflation that the Fed will eventually succeed at.

  8. DOMINICK BRUNONE JR | August 24, 2011

    I agree Mauro – The 2009 low, S&P 666, is more than 40% lower from here. If Keith really believes we are headed there, it is disingenuous to urge readers to keep buying.

  9. Stocksicity | August 25, 2011

    Well that's going to be bad for the economy (especially in regards to the Stock Market).

  10. Gordan Finch | August 25, 2011

    I agree on the European bank situation, this is down to Zurich Financial Services greed corruption and fraud. But gold and commodities and all non rare metals will decline. Lithium Lanthium etc are stable and will increase over a long period as will property in the longer term.

  11. Steve | August 26, 2011

    Gold will be the only safe haven to survive and will become monitised in it's own right… that's when it will be seized for revaluation to back a new reserve basket of currencies.

  12. Max | August 26, 2011

    Please sign me up for the Money Morning Newsletter

  13. Piero | August 27, 2011

    Piero from Italy…

    i agree with your analysis (even if Euribor-Swap Spread until now is below the Aprile 2009 while you are saying that it's above)..

    i agre with you about the contagious meccanism from Europe to Usa..

    but it's only a part of the true..

    the other part is the Us PRivate+Public Debt = 500% is in Bankrupt like Eu..
    and the the Us Big Multinational Bank are shooting Euro to maintain the $ like World Reseve so you don't hate to Re-Pay your Debt..

    but sorry.. this Us strategy can last only for some months.. maximun 1 year..
    and the the World Financial Market will discover the Eu is quite Dead.. and the Us is a Dead King Walking..

  14. E R Zopp | August 27, 2011

    please sign me up for the Money Morning Newsletter

  15. Tim Bon | August 27, 2011

    Great article. Going to take care of protecting what I have just in case of the next upcoming downtrend. Thanks!

  16. Mike Timmons | August 27, 2011

    I sincerely believe Mr. Fitz-Gerald is not only sincere, but sage in his recommendations. My favorite analogy for these times is that of a Titanic passenger right after striking the iceberg. I would imagine many intelligent, savvy leaders-of-men aboard that liner, once learning of the collision, felt that since the ship (metaphor for U.S.) was deemed unsinkable, there was no imminent threat and any time spent worrying was squandered. "Come on, boys, we'll be under sail momentarily. Belly up to the bar! This one's on me." For my money this is decided NOT 2008. Three years ago faith in the almighty dollar was still strong. It was THE safe haven. Does anyone else find it interesting that M3 is no longer reported? Mr. Bernanke, who, to me, is a very sincere man who was handed a potato hotter than any human could hang on to. No, fellow investors, I think Mr. B felt his only option was to inflate ourselves out of our unimaginable debt load. He's terrified of deflation. Every move he's made is to prevent the "evil D." Unfortunately, as he inflates the money supply, every dollar in existence is worth that much less. For me, it's silver, gold and mining stocks – 100%. I was shorting the Dow (DOG ETF), but I think financial market manipulation by the central and larger banks is rampant. Why bother with an ETF that will leave you sleepless when you can bank on the almost certainty of precious metals and miners? No, fellow readers, Mr. Fitz-Gerald is erring on the side of caution. Mark my words: Dow: 5000, Gold $5,000/oz; Silver $250/oz, and sooner than you think. Care to wager?

  17. H Craig Bradley | August 29, 2011


    O.K> Keith, you are calling for a severe stock market correction sometime in the near term. Others (Weiss Ratings) are claiming the arrival of Financial Armaggeddon sometime between now and 2012. Others say it must happen by 2013, or thereabouts. Seems there are a great many doomsayers these days.

    Arnold Schwarzenegger starred in a 1999 film called "End of Days". Former FED Chairman Alan Greenspan used Y2K as an excuse to lower interest rates (uncork the Champaign early). Remember the your own contrarian advise: "When everyone goes to one side of the boat, move opposite to the crowd". In the financial press, the crowd is doomsaying. Like the twist, nearly everyone is doing it.

    I have heard all this stuff before. I remember the first Bush recession in 1991. Real estate was on the ropes, at least in places like California. The economy and stock market were down. Unemployment was up. People were bummed. Just like today, there were books and books about pending financial disaster. Such tomes as "Yen" by Daniel Burstein or "The Coming Currency Collapse" by Ravi Batra. In addition, a slew of books about gold were on the bookshelf. As always in recessions , gold was also being mass marketed on television.

    Recently, Meridith Whitney said at least 100 municipalities would go bankrupt THIS year and muni's would be trashed. Bond holders would take a Greek bath. Get my point? There will always be market ups and downs, sometimes way up, sometimes way down. Volatility is here to stay some have said here. Well, I have said for some time that there is just plain more risk to just about everything in life these days. (Terrorism, natural disasters, government financial crisis, yep, you name it).

  18. H Craig Bradley | August 29, 2011


  19. zee | August 30, 2011

    Sign me up for the Money Morning Newsletter please.

  20. JohnnyJ | September 7, 2011

    Dear Timmons:

    I'll take your wager. I will bet you that gold will not reach $5,000 within the next three months. How can we make this work?

    By the way, for all gold bugs, an infinite supply of gold will be available at current prices. It is just a matter of mining firms working tailings and reopening marginal mines. Over time, gold prices will fall. Short term, though, gold may be great.

Leave a Reply

Your email address will not be published. Required fields are marked *

Some HTML is OK