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NEW YORK ( RealMoney) -- What makes a Lehman? What makes it so it's not Citigroup (C - Get Report), which could be saved by capital infusion, or Wachovia, which could be saved by merger, or Washington Mutual, where some securities are saved and others aren't?
The answer? The brokerage business. The way a brokerage business works.
Which brings me to SocGen. We have heard endless denials that anything is wrong with SocGen. Yet it keeps going down.What does that mean? I think it means something is wrong. I do not think it means something is right and people don't want it to be right. I do not think it means that the shorts are just spoiling for a fight to take it down. I think there are fundamental problems having to do with SocGen that are sui generis -- meaning the other guys don't have them, as it is isolated to SocGen. And, like Lehman, I am not sure that the people running SocGen really get the gravity of the situation. Let me explain. Most banks here borrow money from depositors or borrow money in the markets and from each other and lever it. Many banks in Europe do the same, but they also buy sovereign debt and lever that. If you are buying U.S. debt and borrowing against that, then you don't have too much to worry about. Maybe some interest rate risk. Not default risk. Many banks in Europe bought sovereign debt from EU members. They levered against that. Now, just substitute "subprime debt" for "sovereign debt" and you can see the problem with levering against it. As long as the stuff's at par, you have no problem with capital. When the stuff falls like subprime, then it is dangerous to lever against. Europe's very loose with the rules about how much you can lever up on sovereign debt. Our rules are tougher; our regulators are tougher. We have to presume that many banks there, particularly French banks, are valuing subprime sovereign debt as par so they are vastly overlevered. Left to their own devices, these banks are all Citigroup, meaning that they need to have capital injected and equity watered down. If it is really bad, then you have an RBS situation on your hands, a real dilution that makes it basically a government-owned bank.