The Next Major Banking and Credit Crisis is Almost Here

The next major banking and credit crisis is right around the corner, and it will dwarf the U.S. subprime crisis. The brewing crisis is affecting European banks, which made home loans to home buyers in Eastern Europe. These loans were typically denominated in a stable currency (usually the Swiss franc), although the home buyers worked in their home countries earning wages in the home currency. As the home currency weakens against the Swiss franc, the home buyers – the borrowers – have to pay more of their home currency wages to the European bank to make the loan payments.

For example, a Polish home buyer borrows two hundred thousand Swiss francs to buy a home in Poland. That Polish home buyer works in Poland earning zlotys (the Polish currency). If the zloty weakens against the Swiss franc say by 50%, then that home buyer’s payments in Swiss francs will double. If the zloty strengthens against the Swiss franc, then the home owner’s payments will shrink. Currently, Eastern Europe is facing its worst economic collapse since the 1930’s, and Eastern Europe was already running a current account deficit before the economic crisis took hold. Thus, the currencies of Eastern Europe are likely to continue to decline against the Swiss franc making payments to the banks from Eastern Europe increasingly speculative.

Some estimates of total home loans to Eastern Europe are 14 trillions dollars, compared to the U.S. subprime lending of merely two trillion dollars. The U.S. Federal Reserve was able to bailout banks dealing with two trillion of bad debt, but no central bank or consortium of central banks is likely to be able to take on a 14 trillion dollar problem. This multi-trillion dollar looming problem could result in nationalization of many large European banks creating a crisis of confidence of historic proportions in Europe. Unfortunately, that could sink Europe’s economy and weaken her currencies across the board, which would have severe consequences for the U.S. and Asia who depend on Europe as a trading partner. It is difficult to imagine European demand for goods shrinking say 20% in one year because of a massive uncontrolled devaluation of the Euro. Such a devaluation would put enormous pressure on U.S. and Asian manufacturing companies, and the calls for protectionism would be heard in Washington and Beijing.

If this catastrophic bank crisis scenario comes to pass, one can only hope that the governments do not resort to tariffs and protectionism. A restriction on global trade would severely curtail opportunities for economic growth in a time when economic growth of all sizes and shapes is sorely needed.