From Phoenix Capital Research

Why Europe Matters… And How Spain Could Wipe Out Your 401(k)

August 6, 2012 By gpc1981

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?

Wrong. This is Europe’s problem as European banks across the board are sitting on Spanish debt: Spain’s sovereign bond market is €2.1 trillion in size.

So if Spain defaults, then a heck of a lot of EU banks (and some US banks for that matter) will see some of their “Senior Assets” go up in smoke, rendering them insolvent. This in turn could spread like wildfire throughout Europe’s banking system.

This is why the Spanish bank bailout was so rapid (it took only one weekend). EU officials know that if Spain’s banking system goes down, most of Europe will as well. This is also why EU officials continue to give money to Greece despite the clear fact that Greece is completely and totally bankrupt and has failed to meet fiscal demands placed on it throughout the EU Crisis.

Indeed, I wager most people at some point have asked themselves, “what’s the big deal about Greece? It represents only 2% of the EU economy. How is it that a country this small is still an issue after TWO YEARS!?!”

Now you know. By some estimates, Greece’s true debt exposure is north of $1 trillion. Lehman brothers had $649 billion in assets when it collapsed. Can you imagine the impact that a $1 trillion vacuum would have on the EU’s banking system (a banking system which backstops well over €200 trillion in derivative trades by the way).

How would the debt implosion of Spain’s $2.2 trillion in sovereign bonds affect the financial system? What about the effect of Europe’s $46 TRILLION banking system collapsing?

It would be Lehman by a factor of ten, easily.

So what does this have to do with the US?

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