John Mauldin, editor of Thoughts from the Frontline, says Europe’s banks are in worse shape than their US counterparts—and there’s no Fed or Treasury to bail them out.

Europe's banking system is in far worse shape than the US. The losses may be bigger, and their capital to meet those losses is certainly less. Europe's banks have been much more aggressive in funding emerging-market expansion than US or Japanese banks. Western European banks have lent $4.5 trillion to various emerging-market countries, businesses, and consumers.

In the first few years of the Bush administration, the banking authorities decided it would be OK to allow five banks to increase their leverage from 12:1 up to 30:1.

Which five banks, you ask? Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley (NYSE: MS), and Goldman Sachs Group (NYSE: GS).

Thirty times leverage means that if you lose 3.3%, you wipe out all your capital. And we watched as banks too big to fail were bailed out with taxpayer dollars. The point is that here there was a central bank and a government that not only could step in but was willing to.

Regulators in the UK allowed 20:1 leverage on a regular basis. It is now almost 40:1. Assets of UK banks are about five times as large as UK GDP. By comparison, for the US the ratio is barely 2:1.

Think about that for a second. The UK has banking assets which are five times as large as the annual domestic output of the country. They also had a housing bubble. They have their own bailouts to deal with, which are massive and will potentially get much larger. But at least they have a central bank and government that can try to fix the problems.

But [in] the Eurozone, leverage is now 35:1. Given the massive credit problems that Eurozone banks have with emerging markets (plus Spain's housing bubble, which is every bit as bad as that of the US), will this not end up in wailing and weeping?

And here's the real issue: They have no Paulson and Bernanke. The European Central Bank cannot step in and start saving individual banks. How do you save a Spanish bank and not an Austrian bank? Austria's banks have made large loans to Eastern Europe, in euros and Swiss francs, and are going to have large losses, far more than 3%, which would wipe out their capital.

We think of Switzerland as a stodgy, by-the-numbers, clockwork type of banking country. But somewhere, somehow, UBS (NYSE: UBS) and Credit Suisse Group (NYSE: CS) ran up a little leverage. Before the crisis, they were over 40:1. And now they're nearly at a nosebleed-high 70!

Eurozone banks are already reeling from losses from US subprime-related problems. They are now getting ready to deal with even deeper losses from their own lending portfolios. If the losses were just 5% of the portfolio (an optimistic assumption), it would be 20% of Eurozone GDP. But each country is responsible for its own banks. Where does Europe find a few trillion dollars?

Subscribe to Thoughts from the Frontline here…