U.S. banking stocks suffered another pounding as Greece's high-stakes referendum gamble and futures trader MF Global Holdings Ltd.'s bankruptcy provided a 2008-style reminder that when financial crises threaten to spread their tentacles, banks are a risky place to be.
Fears of European sovereign debt defaults and their potential contagion on the U.S. financial sector surged with the news of the Greek referendum plan, which puts the European Union's Greek-debt rescue plan in the hands of angry voters, and MF Global's collapse, which was brought on by bad bets on European government bonds. Investors shed banking shares, worried that MF Global is a sign that U.S. financial firms may be a black box of unknown exposures to the European debt crisis.
The S&P 500's banking sector fell 4.4 per cent Tuesday, bringing its two-day decline to nearly 8 per cent. The S&P 500's investment-banking and brokerage group was hit even harder, losing 6.1 per cent on the day, and nearly 12 per cent over the past two days.
Among the biggest losers were trading houses, as investors worried about which firms are exposed to MF Global – and who else might have a big, undisclosed exposure to increasingly uncertain European debt. E*Trade Financial Corp. and Morgan Stanley each fell 8 per cent, while Legg Mason Inc. slumped 7 per cent and Goldman Sachs lost 5.5 per cent.
The big banks also absorbed deep losses. Citigroup Inc. fell 7.7 per cent, Bank of America Corp. lost 6.3 per cent and JPMorgan Chase & Co. was down 5.9 per cent. Standard & Poor's equity research division cut its recommendation on all three to "hold" from "buy" Tuesday, citing heightened risks over the European debt situation.
S&P banking equity analyst Erik Oja said risking risks warrant lower valuations for bank stocks – something the market knows all too well from the deep discounts in bank valuations during the 2008 financial crisis.
"A lot of smart investors realize that in times of uncertainty, the value of [bank assets]is at risk," he said. "These banks are still able to crank out the earnings. But the risk is now higher."
Experts said the exposure of U.S. banks, both to MF Global and at-risk European debt, is not onerous. However, the MF Global situation was a reminder that financial firms may have other exposures to European debt – either directly or through assets of European banks that may be in danger in the event of an outright Greek default – that investors can't see.
"The direct exposure is pretty low. It's not that important," said Pierre Lapointe, global macro strategist at Brockhouse Cooper in Montreal. "What we don't know is the indirect exposure – do they hold any paper of the European banks?"
Mr. Lapointe said total U.S. bank-sector exposure to the sovereign debt of the PIIGS is $391.6-billion – about 15 per cent of the total, and much lower than the subprime debt exposure in the 2008 financial crisis.
Similarly, Mr. Oja said the MF Global bankruptcy is minor in terms of its impact on the U.S. financial market – the assets in question are only one-fiftieth the size of a JPMorgan or Bank of America. But it's more important as a symbolic arrival of a long-feared threat to the U.S. banking sector.
"It's the first company in North America to fail because of the problems in Europe," he said.