More Equity Please

Bill Bonner over at the Daily Reckoning had this to say recently:

Bankers are just lemmings disguised as human beings; everybody knows
that. Austrian bankers search out the high cliffs. The collapse of
CreditAnstalt in May of 1931 took the banking sector over the edge,
leading to the Great Depression. This time, Austrian banks have lent
the equivalent of 70% of their nation's GDP to Eastern Europe. If as
little as 10% of it goes bad, the whole Austrian financial system will
be broke...and could bring down all of Europe with it. In the '31, the
economies of France, Britain and the US were contracting at the rate of
about 6% per year. In the last quarter of '08, the US economy shrank at
nearly 7% - and CreditAnstalt hasn't even happened yet.

My Commentary: Well let's consider the Tangible Common Equity levels of banks.

Canadian banks recently reported 6.4 to 7.8% levels.
American banks - lower
European banks - lower yet.

So, if we see asset prices drop 8% or so, all the tangible net worth of the banks is wiped out!!

Even with the Canada's "strong" banks, it does not take much of a hit to equity to knock them out cold.

As someone with years of lending experience, I have to wonder, how we could think these outrageously low equity levels are normal?

A firm that has a leverage level of 5 to 1 is usually considered too weak to be credit worthy. Yet, we have built a credit system with 10 to 1, 20 to 1 and even 50 to 1 leverage ratios.

Are we crazy?

The sword of leverage has two sharp edges. We have swung it and it is threatening to swing back with vengeance.