SGM Metals: Why Sovereign Defaults Matter as All Banks are Connected Through Debt

May 29, 2012 - PRLog -- zerohedge.com reports: [ 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.

So, let us consider Spain. 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.

Let me explain this last point. Basel III requirements which have yet to be implemented will require banks to have equity and Tier 1 capital equal to roughly 10% of risk weighted assets. Before this, Basel II only required equity and Tier 1 capital equal to 6% of risk weighted assets thereby permitting leverage of 16 to 1.

However, these ratios are only for risk-­?weighted assets. Let me explain this term: a bank’s risk weighted assets are determined on its in-­?house models based on how likely it is that a given asset (loan) will enter default. In other words, the banks get to determine themselves how risky their loan portfolio is and then leverage their balance sheets accordingly. This is like asking an alcoholic to assess how much alcohol he should have.

Oh, and bank executives are highly incentivized to downplay the risks as their pay is often based on returns on equity (which in turn is based on leverage). So it shouldn’t be a surprise that EU banks are downplaying the risk to their portfolios.

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.]

This is what the banks have hidden from the public, but is known by the regulators as well as the politicians who have agreed to bow down to the banks and give them endless bailouts to cover this ugly truth up. Why else would the governments of the western world agree to take the toxic investment portfolios off the banks hands and put them burden to eat the losses and cover the debts on the taxpayers of their nations? Because the other option is one of complete implosion and the complete destruction of the entire wealth of the western world. The United States and its western banking influenced European counter parts have seen inconceivable legislation passed to permit this fiat empire to be created, watched not a single banker get indicted for this global disaster, create bottomless bailouts to keep the house of cards upright and been told they have to permit the banks to continue for the benefit if the system. And yet nobody is alarmed?

The normalcy trait will in the end be the undoing of the western world as we are unwilling to consider that this may end in a true disaster that can and will change the living standards of the western world for ever more. We have lost 2/3 of our manufacturing capacity in America and have no real jobs to send citizens back to work in order to stabilize the economy. Over 1/2 of Americans in one way or another are getting some handout from the government and have become dependent. The middle class is being taxed out of existence in a vain attempt to service the collectors of the government handouts. And all the while it seems the federal debt is actually 4 times what we were told by the politicos, but there is nothing to be worried about, right? On top of that, we are now hearing that the social security debt isn’t that bad for the government because they can simply change the terms of what they owe you or raise taxes on everyone to keep their promise to pay. . . .  yeah.

When is enough enough? At what point will you finally feel that things are far greater of a threat than you are being told? At what point will you over ride the ‘normalcy trait’ that keeps you from seeing the ugly nature of our ‘recession’ and allow yourself to begin to consider the what ifs? Establish your “Plan B” in physical gold & silver bullion now and begin to participate in the sound money debate that is spreading globally as we speak. There is a reason why central banks of the world are buying gold bullion by the hundreds of metric tons. There are reasons why pensions and retirement funds are buying gold & silver bullion to replace the paper derivatives they used to hold like stocks and bonds. There is a reason that gold & silver have been real, sound money for over 6,000. And if you aren’t sure why that is, I can assure you that you will find out soon enough. The question is do you want to learn the hard way or do you want to learn the fun way by profiting as gold & silver rise in demand to offset the collapsing fiat money system when China drops a bomb on the world as it introduces a gold back currency again. Everything goes in cycles. Will you embrace this ahead of time and benefit from it? Tick, tock.