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Wall Street Goes to Davos: What It Wants

As airplanes full of Wall Street’s elite land in snowy Switzerland for the World Economic Forum’s annual confab, the stakes couldn’t be higher. Europe’s banking system is on the brink — and Wall Street is its bedfellow. The agenda? Skiing, distressed debt deals, and above all: solvency.

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“We’re fighting the last war. The sovereign debt crisis is undermining the global banking system. We need to take the dire scenario off the table and get a credible path to a resolution,” says Tobias Levkovich, Citigroup’s chief US equity strategist.

On paper, the stakes for Davos’ Wall Street guests look very different. For example, Société Générale has $7.7 billion in European sovereign debt exposure, according to the European Banking Association. In contrast, Bank of America has only $398 million, according to its 2011 third quarter financial statement.

In practice, however, the ‘dire scenario’ acts like a house of cards — falling on both US and European banks. “No bank wants to see European banks fail,” says Dean Ungar, financials analyst for UBS. “It’s not just sovereign debt: European and US banks hold each other’s debt too,” Ungar explained.

European banks depend on each other for short-term financing. If one bank fails, European lending freezes, and the ice is already forming. This January, emergency overnight borrowing fell to its lowest levels since November of last year. US banks are also increasingly reticent to lend to European counterparts, which has IMF leader Christine Lagarde warning of the threat of contagion.

“The main objective at Davos is to persuade European leaders to solve the liquidity crisis. Rescue funds like the EFSF , and IMF funds are not adequate. Everyone has a stake. It’s a big problem,” says James Nixon, chief economist for Société Générale.

That said, participants don't expect Davos discussions to produce a grand deal. For years, critics of the event have said it’s all talk and no action.

The deals that may actually manifest, each source agrees, will involve US banks who have the opportunity to mine the spoils of Europe’s banks.

Getting in on the Distressed Debt Sale

“European banks are having to significantly deleverage their assets (cut down on lending), which is great for US banks who can step in and buy the loans,” says Ungar.

But US banks have competition for Europe’s market share. International banks, and private equity firms can also buy these assets.

“International banks are picking up Europe’s choice assets. Sumitomo bough RBS’s [Royal Bank of Scotland’s] airplane leasing business for between 4 and 5 billion just last week,” says Nixon.

Private financial services firm Perella Weinberg did not comment on European bank debt, but it is sending partner Daniel Arbess to Davos to check on his distressed credit investments.

“I will have the chance to visit with a number of CEOs in whose companies we have invested. And it can’t hurt to learn about how economic policy makers are viewing the issues. We’ll see if it helps,” he said.

It bears repeating that the success of these activities require to Europe remain financially afloat, which is why some think loosening banking regulations is a necessary next step.

Negotiating Basel III

“There’s still a tremendous amount of lobbying to be done on Basel III regulations. The need for liquidity means the global regulatory environment is still up for grabs,” says Nixon.

New international banking rules under Basel III set higher minimum capital requirements, and banks must comply by 2013. The rules affect US banks equally, having been implemented this year by the Federal Reserve .

Banks contend that the new requirements, meant to ensure liquidity, will do exactly the opposite. Here’s why: the European Central Bank is getting European banks to buy sovereign debt, in order to stabilize the entire euro zone economy. The problem is sovereign bonds are falling in price — making it very difficult for Europe's banks to keep up with Basel III's 'good' capital standards.

Basel III effectively places ceilings on how much banks can buy. Its an obvious area for policy loosening” adds Nixon.

It’s clear that the last thing European banks can afford now is more risk.

“There’s a critical difference here. The capital ratios in Europe are much worse than the ones in the US. Even before Basel III, there was already a concern that they didn’t have enough capital, before they took any of these hits,” said Levkovich.

Loosening Basel III is much more of a concern for European banks than it is for US banks, who can comfortably meet the Basell III's capital standards, and so some US participants may have other goals in mind.

“Part of the allure of Davos is just to be there. If you are, you are a mover and shaker, or at least you are perceived that way,” said Levkovich.

Still, an unresolved European debt crisis threatens both sides of the pond. So whatever is done or not done at Davos, Wall street’s reasons to parlay status for results are stronger than ever.

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