Many people have been writing in to ask me, “why are you focusing on Europe so much? Who cares about Spain?”
The short answer is that everyone should care about Spain. Spain could potentially take down the banking system in Europe, which would mean the US facing a Financial Crisis at least on par with 2008.
How would this unfold?
To understand this, you need to understand how the European banking system works. By now everyone knows that many European countries have massive debt problems: Portugal, Italy, Ireland, Greece, and Spain, the infamous PIIGS.
Well, when these countries issue debt, it is mainly the European banks that buy it. So let’s say Spain issues €5 billion in new debt. Most of that will be snatched up by Spanish banks or some other European financial entity.
This bank will then park this debt on its balance sheet as a “senior asset” or an asset that has the least amount of risk (I realize this sounds insane given how bad Spain’s finances are, but this is how the banking system’s “risk models” work).
The bank will then use this Spanish bond to backstop loans to Spanish businesses, developers (not so much any more) even student loans: pretty much every other type of loan the bank might make.
On top of this, the bank will also use this Spanish bond to backstop hundreds of billions of Euros worth of trades.
Do you see the problem with this? If Spain defaults, one of the most important “assets” used to backstop its loan and trade portfolio goes up in smoke. At that point the bank is essentially insolvent and would have to liquidate its loan portfolio while trying to stave off a bank run (as you’ve likely noticed, Spain is facing bank runs galore).
So what? Who cares? This is Spain’s problem right?