What Europe Means For You and Your Savings

In order to understand why we’re at risk of the financial system collapsing, you first need to understand how the global banking system works. When you or I buy an asset (say a house, or shares in a stock, or a Treasury bond), we do so because we’re looking to increase our wealth through either capital gains or through the income that asset will pay us in exchange for us parking our capital there.

In simple terms, you’re putting/ lending your money somewhere (especially if you’re buying a bond) in the hope of increasing the value or your money.

This is not how banks work. When a bank buys something, especially a bond, it parks that bond on its balance sheet as an “asset.” It then lends money out against that asset. This in of itself is not problematic except for the fact that the financial modeling of 99% of banks base assume that sovereign bonds are “risk-free.” Put another way, these models assume that the banks will always get their money back on 100 cents on the Dollar.

Yes, you read that correctly, despite the fact that world history is replete with examples of sovereign defaults (in the last 20 years alone we’ve seen more than 15 including countries as significant as Russia, Argentina, and Brazil), most banks assume that the sovereign bonds sitting on their balance sheets are risk free.

This phenomenon occurs worldwide, but given that it will be Europe, not the US that takes the system down, I’m going to focus on European bank models/ capital ratios.

You may or may not be familiar with EU banking law. EU banks are meant to comply with Basel II which is a series of capital requirements and other specifications meant to limit systemic risk.