Watch the European Banks

In the States, the news revolves around the Impeachment of Trump and the trade war. That is the financial media spreading noise. All of this is a side show.

The real deal is in the RePo market which froze up a few weeks ago. Since that time, the United States Federal Reserve has pumped tens of billions into it to allow overnight lending to take place. Before the year it out, there will be about $500B put in by the Fed.

This all has to do with the European banking system. During the last financial crisis, the United States took it on the lip and bailed the banks out. In return for this, the standards were raised, most notably the amount of cash reserves they had to hold. The bankers fought, screamed, and cried about it but to no avail. Thus, the American banking system was shored up.

Europe is a totally different matter. It did not allow for the writing off of the debt. Instead of bailouts, the view was that a turnaround in the economy would allow for profits to tolerate the losses. This did not happen since the recovery in the EU has lagged elsewhere.

This weekend, we saw Italy step up and help the Volksbank Popolare di Bari. It issued an emergency ordinance of more than 900 million Euros. The plan for the ECB to keep lowering rates in hopes of stimulating a recovery did not happen. The bank now has losses of over 1 billion Euros.

We see this same story across the continent. Remaining in Italy, the government had to also bail out the Monte dei Paschi di Siena (MPS) which is the oldest bank in that country. The situation with Deutsche Bank in Germany is well known. Other German banks are considered to be equally as precarious.

In other words, watch Europe and its banking system because there is a chance it might fall off a cliff.

Which brings us back to the repo market. Why did it freeze up? In simple terms, banks are unwilling to lend to each other, even on a short term basis. The reason for this is because nobody is sure who has exposure to the European banks. Thus, they do not trust each other.

Which brings up the larger question: who does have exposure? If we cannot figure out what the U.S. banks are holding, how are we to know where the rest of the danger lies? What is Japan's exposure? China? Pension funds?

This could quickly become a mounting crisis. Unfortunately, by the time people are alerted, it could be too late.

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