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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.
Bottom line,
the problem is that for those who are invested in European banks as stock
holders and depositors, if you wait too long, you're not going to get your
money back. Why not? Because unless the governments step in and
begin to step up the tax revenue they collect from their citizen taxpayers, they're
never going to have the money
with which to pay the banks who bought their bonds, and therefore the banks are not going to have the money
with which to pay their investors and
depositors.
This problem
is compounded by the fact that if you count the value of the bonds they've
purchased from these governments, then financially speaking, many of these banks are several times the
size of the economies of some of the governments whose bonds they've purchased. Therefore, the likelihood that all the
customers of these banks (i.e. their depositors and investors) are going to get
their money back is quite small. Hence the
coming run on European (and America's biggest) banks, and the coming crash of
the European economy (and possibly the US economy as well).
The potential negative consequences for America's biggest banks and the US
stock market
Bank of
America's beleaguered bank's shares crashed through the psychologically
important $5 mark yesterday, the lowest they've traded since March 2009. Other bank stocks including Morgan Stanley
fell even harder as investors fretted on renewed concerns about bank capital
cushions and "a darkening economic
outlook in Europe."
Back in
December of 2009, Bank of America was trading near $15 a share, a far cry from
the $5 at which it closed yesterday. The loss of two-thirds of its value far
exceeds the drop in other battered financial institutions like Citigroup,
JPMorgan Chase and Wells Fargo over the same period.
"This is
like a fire in a 10-story building," said a former Federal Reserve bank
examiner who now teaches courses on banking at Boston University. "It's
burning through each floor as investors dump their shares."
Financial
stocks fell by more than 2% Monday in the United States, leading the entire
stock market down. During the day, "the focus shifted to European sovereign debt
troubles, as the European Central Bank warned of a perilous year ahead. The sovereign debt crisis is colliding with
slower economic growth and a dearth of market financing for banks." Citigroup fell 4.7% and Morgan Stanley
5.5%. For Bank of America, which tumbled
4.1%, trading below $5 represents one more cause for concern this year.
Even the $5
billion investment in BofA by Warren Buffett this summer has failed to mollify
sellers -- Buffet has lost roughly $1.5
billion on the deal. Not surprisingly, "institutional money managers are quietly
dumping their losers before 2012 arrives."
Some observers had speculated that having its stock's value go below $5
would force some institutional investors to unload Bank of America stock and
they were right.
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