Banking and Debt (guest post)

Guest post by Rikardos:

Banking and Debt:

1) Forget about Greece for now. There is another far greater worry. I’ve previously mentioned Japan as having debt of over 200% of GDP. It is projected to hit 239% of GDP this financial year.

They also have an enormous job of rebuilding after the tsunami.

Their credit rating has just been cut meaning it will cost more for them to borrow on international markets. Fortunately for them they don’t get all their debt from this source, but internally.

The question becomes: how will Japan afford to service and, hopefully, eventually, repay part of the huge debt. Quantitatively and qualitatively it is a far different quantum to Greece. Imagine if global interest rates rise and the yield on those bonds rise to over 5%. Japan would have to pay 10%+ of GDP just on interest costs. If interest rates got to 10% (has happened in the past although I’m not sure of the Japanese non war experience) then they would pay 20%+ of GDP in servicing costs.

The tax base is going and the number of taxpayers per retiree is falling. There are fewer taxpayers to repay the same amount of debt. If that keeps going there could be serious problems.

2) Refinancing

How long ago was it that a Trillion was a notional sum, or an amount only reached during the hyperinflation of the Weimar Republic? And now there is $US46 Trillion to be renewed / refinanced / rolled over.

3) Hypothecation

Take a look also at re-hypothecation.

It is where banks use collateral a borrower has given them to raise money themselves (hypothecation – where a borrowed pledges collateral to a bank / financier). There are some incredible estimates of how much collateral has been re-hypothecated (when the bank then uses the collateral to borrow funds themselves).

It has been proposed that the next major meltdown will come when the value of what has been re-hypothecated is realised to be considerably less (possibly even falsely inflated) and that banks, primarily in America and Europe / Great Britain, have even less capital than thought and may even have negative equity.

Under the U.S. Federal Reserve Board’s Regulation T and SEC Rule 15c3-3, a prime broker may re-hypothecate assets to the value of 140% of the client’s liability to the prime broker. For example, assume a customer has deposited $500 in securities and has a debt deficit of $200, resulting in net equity of $300. The broker-dealer can re-hypothecate up to $280 (140 per cent. x $200) of these assets.

But in the UK, there is absolutely no statutory limit on the amount that can be re-hypothecated. In fact, brokers are free to re-hypothecate all and even more than the assets deposited by clients.

Hang on, under the UK rules there is NO LIMIT? That means I can allow my share broker to take a lien over my shares, then the broker borrows money from the bank against that lien, the bank then raises money on international markets using the security of my shares, then the lien is traded on international markets, without my knowledge and approval.

Amazing how something most people haven’t heard of can pose a risk to the financial system.


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