In this very short video
clip, Carl Denninger quickly explains this problem on RT TV and RealEcon TV.
In laymen's
terms, here's a fleshed-out explanation of what Carl is saying:
European
banks (and to some extent US banks) have a huge amount of assets, but those
assets are mostly state debt (i.e. bonds purchased by the banks from European
governments -- in other words loans they have made to those governments.)
However, the
banks have no collateral for these
loans they've made. (Example: when you take out a mortgage on the house you
are buying, the bank has your house
as collateral; when you buy a new car, the bank has the
legal right to seize "your' car if you should stop making payments on the
car. Its collateral is "your' house and/or
"your' car.)
In other
words, if something goes wrong and these governments become unable to buy back
the bonds (plus interest) that they sold to these big banks, then the customers
of the banks are in trouble. Why? Because the bank loaned out 40 or 50 dollars
to these governments for every dollar of depositor money it had in its
possession. That's called "leverage':
if you're a bank you can, by law, create some specified amount of money,
say $50, out of thin air, with which to buy bonds (or whatever), for every
dollar your customers have deposited on your bank. But if the government whose bonds you have
purchased cannot redeem those bonds (i.e. pay back the loan), then (at least in
Europe) your depositors and stockholders are screwed.
Another way
to think of "leverage' is that when a bank has an asset, such as customer deposits,
it then loans those assets out more than once, perhaps many times more than
once. Historically, leverage of more
than five- or six-times deposits were considered dangerous. In the late '90s JP Morgan was leveraged
10-12 times its deposits. Nowadays,
leverages of 40-50 times deposits are tolerated by our regulatory agencies.
American depositors
are protected, up to $250,000 per account, by the FDIC. If Spain defaults and BofA goes belly-up, the
bank's shareholders get screwed, but the bank's customers' deposits are still
safe -- as long as the FDIC is solvent!
BofA's remaining assets, including the deposits and loan money owed to
it, will get divvied up among its creditors, and life goes on. (But if the FDIC isn't able to cover
the deposits, we've got much, much bigger problems than a failed bank.)
Of
particular concern is that a lot of these big banks are invested in each
other. This means that the actual value
of CitiCorp stock could take a dive if BofA's stock dives. Depending on how much flexibility there is within
the system, the shock of a couple of mega-banks failing could conceivably be
distributed throughout the rest of the financial system. Otherwise, the entire system could fall apart. Problem is, no one knows for sure how much
flexibility there really is within America's overall financial system.
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