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A Lehman-like Situation in Europe?

With the prospect of a European bank failure all too real, it’s important to know what separates a catastrophic Lehman Brothers-like collapse from a “freakout but workable” non-Lehman collapse, Cramer said Tuesday.

And it comes down to one thing: the brokerage business, he said.

Many European banks bought sovereign debt from EU members and are levered against it. If that debt falls like the subprime debt did, it is dangerous to lever against. Since Europe’s regulations are not as tough as those in the U.S, Cramer presumes that the banks are valuing subprime sovereign debt at its face value amount, which is no where near its real worth.

Left to their own devices, many of these banks will have to be merged, bought cheaply or partially nationalized, he said. And that’s workable.

A Lehman-like situation is “a brokerage house with many derivative positions sold to hedge funds that are now worried about getting their money back from these positions because of a bankruptcy. A bankruptcy the authorities either let happen or fail to anticipate,” he said.

And right now, traders think Societe General looks the most like Lehman. Cramer called it “the principal maker of the derivative book in the world.”

He said hedge funds know if SocGen gets “Lehmaned,” those contracts will be caught up in bankruptcy and it could be years before they get their money back. They could be getting nervous and may be looking to unwind their positions before things go bad.

If that happens, SocGen will have to take the other side of the trade because it either laid off the risk to an account in a long-term contract that can’t be undone, or they actually own the other side.

It’s also possible, Cramer said, that eventually no other banks will want to lend money to Societe General. Ultimately, there will be an insurmountable need for capital and, at best an AIG-like bailout will occur, he said.

While Cramer doesn’t know if all of this is happening right now, he’s urging caution, especially since the market doesn’t seem to be appeased by any of the denials from Societe General that anything is wrong.

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