Why Sovereign Defaults Matter… And Why Spain is a BIG Deal !
- Practically, all major western banks are bankrupt! They hold a large amount of sovereign debts which is rated at ‘AAA’ and the belief is that sovereigns will not default! When Eurozone countries (PIIGS) start to default, it will bring down the entire banking system. The reason why these banks are still standing is because they are allowed to mark to fantasy all these worthless sovereign debts instead of using a mark to market model. The FedRes and ECB are infusing massive amount of liquidity into these banks to prop them up. But you cannot solve a solvency issue with injections of liquidity created out of thin air. It is like giving a heart which has stopped beating a blood transfusion!
Why Sovereign Defaults Matter… and Why Spain is a BIG Deal !
by Phoenix Capital Research,
The following is an excerpt from my latest client letter explaining why Spain is such a big deal and why when it defaults it’s game over for the EU.
I’ve received a number of emails asking me why Spain is such a big deal for the global banking system. To fully understand the implications of Spain, you first need to understand how the global financial system works “behind the scenes.”
We’ll start first with the US financial system, particularly the Primary Dealers which are the real controllers of the monetary supply (via lending). If you’re unfamiliar with the Primary Dealers, these are the 18 banks at the top of the US private banking system. They’re in charge of handling US Treasury Debt auctions and as such they have unprecedented access to US debt both in terms of pricing and monetary control.
The Primary Dealers are:
1. Bank of America
?????2. Barclays Capital Inc.
3. BNP Paribas Securities Corp.
4. Cantor Fitzgerald & Co.
5. Citigroup Global Markets Inc.
6. Credit Suisse Securities (USA) LLC
7. Daiwa Securities America Inc.
8. Deutsche Bank Securities Inc.
9. Goldman, Sachs & Co.
10. HSBC Securities (USA) Inc.
11. J. P. Morgan Securities Inc.
12. Jefferies & Company Inc.
13. Mizuho Securities USA Inc.
14. Morgan Stanley & Co. Incorporated
15. Nomura Securities International Inc.
16. RBC Capital Markets
17. RBS Securities Inc.
18. UBS Securities LLC.
These are the firms that buy US Treasuries during debt auctions. Once the Treasury debt is acquired by the Primary Dealer, it’s parked on their balance sheet as an asset. The Primary Dealer can then leverage up that asset and also fractionally lend on it, i.e. create more debt and issue more loans, mortgages, corporate bonds, or what have you.
Put another way, Treasuries, or US sovereign bonds, are not only the primary asset on the large banks’ balance sheets, they are in fact the asset against which these banks lend/ extend additional debt into the monetary system.
A similar banking system exists in Europe though in that case there are no single unified EU bonds/ Primary Dealers. Instead we have 17 countries all of which issue sovereign bonds that their largest banks purchase and park on their balance sheets as assets against which they lend.
According to data collected from the Bank for International Settlements, IMF, World Bank, UN Population Division, UK banks are sitting on €74 billion worth of Spanish sovereign debt while French banks and German banks are sitting on €112 billion €131 billion, respectively.
So, as a ballpark estimate, roughly €317 billion worth of Spanish sovereign debt is sitting on banks’ balance sheets in these three countries. This debt is then recorded as an asset against which these banks have leant out money to corporations, property developers, etc. at a ratio of more than 10 to 1.
What I’m trying to say here is that the entire EU banking system is based on capital requirements that are an absolute joke. The banks not the regulators determine how risky their assets are and leverage their balance sheets to the maximum levels possible based on their in-house assessments.
So… when Spain defaults (and it will) you will very likely find the entire Spanish banking system collapse. This in turn will bring the entire EU banking system to its knees as collateral calls and margin calls are made across the board when EU banks’ portfolios take a “haircut” on their senior most assets.
With that in mind, the clock is ticking on Europe. On that note, I fully believe the EU in its current form is in its final chapters. Whether it’s through Spain imploding or Germany ultimately pulling out of the Euro, we’ve now reached the point of no return: the problems facing the EU (Spain and Italy) are too large to be bailed out. There simply aren’t any funds or entities large enough to handle these issues.
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