Europe risks Lehman Brothers moment while Chinese shares plunge

Desmond Lachman asks whether Greece will trigger a Lehman Brothers moment for Europe.

In September 2008, United States policymakers made the costliest of policy miscalculations by allowing the Lehman investment bank to go bankrupt. That mistake triggered the worst global economic recession in the post-war period.

Judging by recent statements by German and French political leaders, it appears that it is now the European policymakers’ turn to make a major economic policy blunder. Since, ahead of the January 25 Greek parliamentary elections, those leaders are clearly signaling that they stand ready to cut Greece loose from the Euro should Greece choose not to comply with its European commitments...

Sadly, it is all too likely that, as was the case when U.S. policymakers allowed Lehman to go bankrupt, European policymakers are now underestimating the all too real risks of a Greek exit.

The reality, though, is that markets and financial institutions have become highly leveraged and a Lehman Brothers moment can potentially be triggered by a number of events. For example, even the decision by the Swiss central bank last week to abandon its cap of the Swiss franc against the euro is causing significant losses among financial institutions. From Bloomberg:

The $400 million of cumulative losses that Citigroup Inc., Deutsche Bank AG and Barclays Plc are said to have suffered from the Swiss central bank’s decision to end the cap on the franc may be followed by others in coming days.

“The losses will be in the billions -- they are still being tallied,” said Mark T. Williams, an executive-in-residence at Boston University specializing in risk management. “They will range from large banks, brokers, hedge funds, mutual funds to currency speculators. There will be ripple effects throughout the financial system.”

And it is not just Europe. The 16th Geneva Report on the World Economy in September last year identified the debt trajectories of emerging economies, especially China, as a source of concern and “which could host the next leg of the global leverage crisis”.

Indeed, after a strong rally that some say has been fuelled by margin financing, Chinese shares plunged on Monday, with the Shanghai Composite Index falling 7.7 percent, the biggest fall in more than six years, after the China Securities Regulatory Commission said on Friday that it had suspended three brokerages from opening new margin trading customer accounts for three months after an inspection found rule violations.