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News In Brief

Why we care about Eurozone debt.

Paddy Hirsch Aug 18, 2011

Europe’s problems are tanking bank stocks, as investors worry about a repeat of the 2008 financial crisis. Last time it was toxic mortgages that nearly sank the banks: this time it’s European sovereign debt. A study by the Federal Financial Institutions Examination Council revealed US banks aren’t holding much Eurozone debt. But what about the US branches of European banks?

The Bank for International Settlements, which tracks bank holdings, says French and German banks are carrying about $27 billion in Greek bonds. That’s got regulators here thinking about how exposed the US divisions of Deutsche Bank, Societe Generale and others might be.

Daniel Martin of the Economist Intelligence Unit told Marketplace’s Bob Moon why the New York Fed is concerned enough to launch an investigation.

When banks become uncertain about other banks, in terms of what kind of things they’re holding, they become reluctant to lend them money. Do you really want to lend a bank money when they’ve got things like that on their books?

Martin is talking about the “overnight market,” where banks lend money to each other. This happens all the time in our financial system. Because they don’t hold much money in their coffers, and because they’ve invested the rest, banks are often short on cash. They need quick money to do things like make payroll or interest payments. So they go to the overnight market, where they borrow money for a very short period of time, at very low interest rates.

Billions of dollars stream through the overnight market every day: if you think of the financial system as a body, the money in the overnight market is like the blood that pumps through its veins and nourishes all its parts.

Just as a body depends on a strong heart. so the overnight market depends on trust. One bank will only lend another bank money overnight if it believes it will get the money back the next day. In 2008, banks had no idea who was holding toxic mortgage debt, or how much. So they couldn’t be sure they would get their money back if they lent it out. So they stopped lending to each other. Remember Lehman Brothers? It had a lot of valuable investments, but it also had a lot of bills to pay. And when the other banks refused to lend it any money, it collapsed.

Today banks are looking at Deutsche Bank and SocGen and wondering the same things: How much Greek or Italian debt are they holding? Are they going to be able to pay the money back if I lend to them? They’re a bit like expeditioneers walking across an icecap. They’re all tied together, so it just takes one of them to fall into a crevasse to drag everyone else down. As soon as one bank looks shaky, the rest of them start to worry about themselves, and that’s what people on Wall Street and in Washington are worried about now – that the banks will freeze in thier tracks. And if the banks freeze up, the economy will freeze up right along with it.

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