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Big Banks, Big Problem

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A recent report by ("Bank failure tally passes 100 for the year") revealed that the number of banks shuttered by the FDIC has now passed 100 for the year. Community Security Bank in Minnesota was the 101st bank closed in 2010. According to the report, the number of banks that must be closed will probably exceed 2009's number of 140 closed banks. Yet despite this, writes that the economy is getting better: "Meanwhile, there is evidence to suggest that the banking industry has recovered from the worst of the financial crisis."

What they really mean is that the big banks are recovering from the financial crisis. In the US, it's the little community banks that are suffering the most. As mentions, "Analysts expect small banks to remain the most likely to fail. Regional lenders continue to suffer from mounting loan losses, particularly in areas like commercial real estate. Big financial firms, on the other hand, have largely returned to profitability."

This is because, as I wrote in Conspiracy of the Rich: The 8 New Rules of Money, bailouts are only for big banks, banks that are deemed "too big to fail." Bailouts require friends at high levels and huge political influence. Small, regional banks don't have the clout necessary to get bailed out by the government. So they fail. That big banks are doing better is not a sign of a better economy. It's a sign that the government has bailed them out. In the process our leaders have increased our national debt, which will increase our cost of living through taxes and inflation—the two wealth-stealing forces used to pay the interest on our government debt.

The Big Test

Meanwhile, across the pond in Europe, despite a massive injection of EU money, even the big banks aren't doing so well. Coming off a fresh round of regulator tests, the media is talking up the hope of confidence being restored in European banks. Turns out only 7 banks out of 91 failed the tests. But to people on the inside, the smart investors, this may not be enough to restore confidence in the European banking sector.

An even greater challenge than the regulators' tests is coming. According to The Wall Street Journal ("European Banking's Next Focus is Funding"), over the next three years European banks will need to refinance hundreds of billions of dollars in bond debt as it matures. As the article reports, "The Bank of England warned last month in its semiannual Financial Stability Report that banks world-wide—but especially in Europe—face a 'substantial challenge' of renewing funding that is set to come due. The bank estimated that lenders world-wide have about $5 trillion of funding due to mature in the next three years." The article continues, "The problems are particularly acute in France, Germany and Italy, where banks will need to refinance more debt than they traditionally issue in a given year, according to the Bank of England" (emphasis mine).

It's a problem when banks need to borrow more money than they're lending.

Falling Dominos

In Europe, the problem of banks finding funding is especially troublesome because more than 70 percent of business debt comes from bank financing. In other words, the money that European businesses depend on to operate comes primarily from European banks—which have no money. If the European banks aren't able to raise more funding, which they primarily do through bank bonds, bonds that investors are shying away from, they won't be able to refinance their own debt let alone provide adequate funding for European banks.

When I was a kid, I enjoyed playing with dominos. I'd set them up in long lines and then knock over the first domino and watch the others fall. In Europe, an even bigger game of dominos is being played—and the potential for a catastrophic fall looms. If the European banks can't refinance their debt, confidence will fall. As confidence falls, investments in bank bonds will dry up. If bank bonds dry up, European banks won't be able to keep European businesses liquid. And if European businesses lose their liquidity, they'll have to fire many people—or close entirely. That would lead to a huge economic crisis even bigger than we currently have—possibly even a global depression.

One thing I discovered when I played dominos was that you could remove one domino and the chain would come to a halt. As I write, you can be sure that European leaders are scrambling to figure out how to remove a single domino from the potentially disastrous chain—of which the banks are at the forefront. It remains to be seen if they'll succeed—and at what cost.

It will be interesting to keep an eye on the European economy and banks over the next year. Most likely any solution will require a huge output of government power and money, which will continue to drive up taxes and inflation. Both the dollar and the euro are in trouble.

As I've said before, in today's economy, if you're a saver, you're a loser. The rules of money have changed. Stay vigilant, continue your financial education, and always remember knowledge is the new money.

Original publish date: July 27, 2010

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