“Which means any other bank holding similar assets can no longer hide them away and value them to whatever model they chose. The true value, or lack thereof, of those ‘assets’ is revealed.”

Interesting. Why does that ‘follow’ for ‘any’ other bank? Walk us through that?

Okay, I is confuzzled.

Sadly, the truth of it is that an undeclared ‘bad debt’ is actually held on the bank’s books as an asset.

What else would it be?

So not only are the banks not telling us how many bad debts they really have, they are actually counting those bad debts as assets.

Eh?

It’s our old friend Leverage. Say a Spanish bank has 6 billion in undeclared bad debts. The bank is leveraged. Which means that the six billion in assets, which were actually bad loans pretending to be assets, were underpinning 10 times that value of other loans.

So the problem for our Caja is not just 6 billion in new losses, nor having a new 6 billion Euro hole in its assets, it is also that the 6 billion assets that disappeared were holding up 60 billion in other liabilities.

I like to think I’m reasonably good at this sort of stuff: numerate, econ post grad, blah, blah, blah. But I’m afraid that I couldn’t parse this at all. The 6 billion assets were doing what now?

By leverage, I suspect you mean total assets relative to stockholder equity. Total assets minus total liabilities equals equity.

Say you have 60 billion in assets and 6 billion in equity, writing down ten percent of your assets would wipe out your equity. This is generally regarded as bad.

So your point re other Euro banks is (I’m guessing) what’s their exposure relative to their equity. The Guardian Data Blog had some figures via some iBank analysts recently suggesting that this was not too severe, IIRC, but who frickin’ knows, at this point.

What else would it be?

Written down?

But I’m afraid that I couldn’t parse this at all. The 6 billion assets were doing what now?

His point is that since the banks are leveraged and those 6 billion in ‘assets’ are then lent out (since banks only need to hold fractional reserves) – if those assets were written down, what would happen to the money lent out on the back of those assets?

” Thus at the moment Greece defaulted the French and German Banks it would not just be a question of absorbing a blow and staggering on, the French and German banks would need to raise 84 billion euros or face a run on their own solvency. ”

No they wouldn’t. You are assuming that they already have absolutely no loss bearing capacity. It depends how highly each institution is capitalised.

” The bad new is this – when The Greek banks default, as they will whether it is put off for a few more months or not, when they do default, all the assets they were holding suddenly get valued and marked to market. ”

Only assets available-for-sale (AFS) would be marked-to-market. Most of the bonds would be classified as held-to-maturity (HTM), which are not marked-to-market. Over 80% of eurozone peripheral debt was classified as HTM on European bank books at the last European stress test. The HTM impairment charge would be arrived at by comparing the current book value of the bond with the present value of estimated future cash flows, which are likely to be impaired. They would estimate the future cash flows from the bond under the terms of the restructuring, and then discount them at the yield that prevailed on the bond when it was first issued and that then gives them the impairment charge. If coupon payments were maintained and the maturity extended, there might be no or little impairments on bank bonds. Stopping it spreading is more of a problem than impairments from Greek assets.

The Greek pension funds and the mug European taxpayers are going to be the ones eating a sovereign default as so much of the exposure has been transferred to the ECB.

Written down?

A written down asset is still an asset. Banks lend money, that’s what they do! It should be no surprise that the lender books a loan as an asset, and the borrower as a liability.

His point is that since the banks are leveraged and those 6 billion in ‘assets’ are then lent out (since banks only need to hold fractional reserves) – if those assets were written down, what would happen to the money lent out on the back of those assets?

Assets are money that is owed to the bank. Liabilities are money that the bank owes. An easy way to think about banking is in a simple model where the bank borrows from households and lends to firms. If the loans turn out to be “bad” (i.e., what the OP describes as “bad debt”), for example, if the firms go bust, then the bank will not be able to repay its creditors in the household sector.

Unlike the US, the UK doesn’t actually have reserve requirements. Reserves are liquid liabilities that banks hold to meet their obligations to their depositors, etc. The BoE supplies whatever level of liabilities the aggregate banking sector needs. I suggest that we ignore them, because the conversation will become unnecessarily complex.

The issue in the OP, as far as I can see, is assets relative to equity. Say that you are a bank. You have 60 billion in assets, and funded this portfolio by selling shares equal to 6 billion and borrowing the rest (from depositors or whatever). So you are highly levered–for every dollar of your own money, or “equity”, you have 9 dollars of borrowed money–and a fall in the value of your assets > 10% will wipe you out, i.e. you’ll be insolvent, because in that situation your liabilities will be greater than your assets.

Fractional reserves and capital adequacy are different things.

Writing down a loss reduces a bank’s equity. It also reduces the balance sheet by the same amount. But the balance sheet is a multiple of equity so the ratio of equity to the total balance sheet is reduced. And it is this equity ratio that represents the problem. There are strong regulatory and market pressures to maintain an adequate equity ratio.

So when a thinly capitalized bank realises a loss, it has to reduce it’s balance sheet proportionally. That means selling assets and clearing debts – deleveraging. So to maintain an equity ratio of 10% (for example) the bank has to deleverage by 10 times the loss it realises. This is where the multiplier comes from.

This is not the same concept as a fractional reserve.

“The BoE supplies whatever level of liabilities the aggregate banking sector needs.”

Sorry, I’m adding to the confusion there. That should read,

“The BoE supplies whatever level of reserves the aggregate banking sector needs.”

Try this grim assessment by Martin Feldstein who sees a default by Greece sooner or later as inevitable:
http://blogs.ft.com/the-a-list/2011/06/22/postponing-greeces-inevitable-default/?

Btw has the Coalition government here worked out the spin yet on how to blame all this on Gordon Brown and Ed Balls?

“Our leaders have no answer to this question beyond the ideologically driven claim that it is all the fault of too much public spending.”

Ignoring the UK for a moment, Greece does seem to have reached its current position by spending far more than they were taking in tax, (and were able to do so to the extent they did by joining the Euro and also through fraud). So wouldn’t this “ideologically driven claim” be fairly accurate in this context?

So, in non-economic language, A lends big wedge to B, who then lends some to C, but if C defaults on the loan from B,…….A gets stung for the loss? WTFing hell kind of system is that? “Lend us twenty quid mate, so I can lend my mate a tenner, no you do’nt know him, but it’s OK, he’ll pay me back, honest.” Sounds like a VERY big risk based on a hell of a lot of trust.

“So, in non-economic language, A lends big wedge to B, who then lends some to C, but if C defaults on the loan from B,…….A gets stung for the loss?”

No. A only gets stung for the loss if B doesn’t have enough to cover the loss himself. This is what is called capital adequacy and we lend to the banks on the understanding that they have enough of it. Unfortunately, they sometimes don’t.

The alternative is finding someone who wants to borrow the money and lend it to them directly – obviously after reaching a considered judgment about how much of a credit risk they represent. Of course, if we need to get our money back early then we have to find someone else to buy the loan off us at a fair price. Most people are more than happy to let the banks manage these credit and liquidity risks for them.

@9: “So wouldn’t this “ideologically driven claim” be fairly accurate in this context?”

Judging by this from OECD National Accounts At A Glance, up to the financial crisis General Government Expenditure in Greece as a percentage of national GDP was lower than for Denmark, France, Finland, Sweden and Belgium:
http://www.etui.org/en/content/download/14316/76037/version/1/file/OECD+-+Brussels+2011.pdf

By this source in The Economist, Greece’s budget deficit as a percentage of national GDP is currently 8.4% – less than for the US and Britain:
http://www.economist.com/node/18836676?story_id=18836676&CFID=166259430&CFTOKEN=57326426

“A MESSY end to Greece’s debt crisis seems ever more plausible. Standard & Poor’s this week slashed the country’s credit rating to the lowest notch above an actual default.”
http://www.economist.com/node/18836390

We’re still having problems because too many parties are in hock to the unions and so the necessary reform is impossible – see Greece.

If we’d told the banks “fail and you’re on your own” would it have made any difference?

http://outspokenrabbit.blogspot.com/

By the way the author needs to improve his accountancy knowledge or at least terminology. He seems completely confused about assets and liabilities and he should be aware that there is no such thing as a debt column – I presume he meant debit column, but if so he’s using the wrong term to describe how you would account for a provision made against an outstanding loan. As others have implied, banks with Greek assets have undoubtedly made some level of provision against these assets already (I don’t know on what basis he supposes that these are all held at nominal value in other institution’s books) but even if the Greek crisis escalates the debt isn’t bad until it is wholly written off – it probably just becomes more doubtful.

His implication that banks will be able to lend less due to their own or their regulator’s capital adequacy rules, but you can’t simultanaeously rail against banks lending too much/recklessly etc etc and moan about banks reducing their lending to ensure they remain solvent/liquid.

You know how the saying goes:
“If you owe the bank $100 boy are you in trouble. If you owe the bank a million dollars , boy are they in trouble.”

Maybe we should add for the zeitgeist “If you owe the bank a billion dollars – don’t worry about it the grandchildren will pay”

Remember how Blair and Mandelson and Patricia Hewitt and Heseltine and Kenneth Clarke etc wanted Britain to join the Eurozone?

Sigh. That isn’t what leverage means Sunny. I have explained this to you before, I genuinely cannot understand why you are impervious to this information, I would have thought it would be in your interest not to make school boy errors in public.

The author of the OP is similarly confused, but that didn’t stop him writing a book about it.

loans are assets for banks. If those loans turn out to be worth less than thought, say there is default, the value of the banks assets may fall beneath that of its non- equity liabilities in which case it is insolvent.

If a French bank has 53bn of Greek debt, let’s say for simplicity it is completely worthless, knowing that bank is leveraged 10 to 1 does not tell us whether it is involvent. It could have 100bn of equity and 1000bn of assets, in which case a 53bn reduction in its assets is no problem, or it could have 10bn equity and 100bn assets in which case 53bn loss is game over. Saying “they would be looking at 530 billion in loans and liabilities without adequate foundation” is utter garbage. It’s pathetic.

Anybody with even the most modest pretentious to writing about finance should know this, it is absolutely the key to financial reform.

But I tell you what is not going to happen now: David and Sunny are not going to pay attention to these simple facts, and acknowledge that they don’t know what the hell they are talking about and try to correct their errors henceforth. Instead they will continue writing articles about finance, quite confident of their own competence.

The monetary system built on big government, central banks printing money and private banks operating fractional reserve banking is coming to a messy end.

The financial system is imploding, and the oligarchs who have brought us to this point are posing as the saviours.

Brothers and sisters, we’re in a lot of trouble.

I don’t think the inevitable Greek default will be so catastrophic. Some loans will be written off or written down. Some banks may have to be nationalised and recapitalised (by printing money) but this is potentially a great opportunity to form new mutualised national investment banks for the support of real investment in real enterprises, rather than the inflation of asset price bubbles – which is what private banks tend to do.

What’s really important here is how the costs are apportioned. Bailouts favour the rich who live off unearned income from interest: they allow the bond holders a free breakfast, lunch and dinner at zero risk. Yes, Greece may have been living beyond its means (thanks to the insane single currency experiment), but banks were also lending beyond theirs, and they should bear the greater part of the responsibility for adjustment now. Why? Because it makes more sense to make imaginary money disappear again than it does to make real jobs and real enterprises (whether private or public) go to the slaughter, just so that the wealthy can continue to have their pound of flesh and bankers continue to pocket their bonuses.

More here: http://sodiumchorus.blogspot.com/2011/06/my-big-fat-greek-default.html

“It’s our old friend Leverage. Say a Spanish bank has 6 billion in undeclared bad debts. The bank is leveraged. Which means that the six billion in assets, which were actually bad loans pretending to be assets, were underpinning 10 times that value of other loans.”

This is nonsense as Luis E points out.

It is *capital* that is leveraged, not assets. This is as stupid as that comment that Polly made about Lehmans lending out 30 times its assets.

So, to explain. I have $100 in capital as a bank. I have to have 10% capital/equity for each loan I make.

OK, so now I can lend out $1,000. No, I don’t just create the $900, I’ve got to go and borrow that from somewhere (yes, banks do balance their books. And even if you want to go down the line of banks simply create credit, that’s banks, the banking system as a whole, not a bank).

So, now my balance sheet looks like this. I’ve $100 in equity/capital. I’ve $900 in liabilities (that money I owe to depositors etc) and $1,000 in assets (money owed to me).

I do not get to include my assets as part of my capital/equity. They are not part of the multiplier.

So, OK, I’ve got a bad loan of $50. As I’ve never counted the $50 as part of my capital, I’ve not been multiplying the amount I can lend by that $50. So having a bad loan of $50 does not mean that I’ve got to reduce my lending by $500.

What it does mean is that when I acknowledge the bad loan, I’ve got to write down my capital by the loss I’m going to take on that bad loan. Which, unless soemthing is really terrible, isn’t going to be $50. I’m always going to get something back. If it’s a mortgage in negative equity, I might get 70%, 80% back. So I write down my capital by the loss on the loan, not the amount of the bad loan. Say it’s an 80% recovery: I’ve lost $10 of capital from that $50 bad loan.

At which point I should reduce my lending by $100, not $500, for I’ve now only got $90 in capital to support my lending.

Greek bond losses? I think we’re talking about 40-50% write offs, maybe. So my $50 loan gone bad would lose me perhaps $25 of capital, not $50.

And note that this is all static, it’s not looking at the dynamic situation. Which is that banks have lowered the amount they pay to depositors and increased the amount they charge to borrowers. Why? So that they can make larger profits, which allow them to add to their capital bases and thus potentially cover these losses without reducing their total capital and thus without having to reduce their loan books.

And yes, this is what everyone has been pushing banks into doing for the past 3 years. Rebuild their capital bases.

And finally, it’s the ECB and other public institutions which own the majority of the Greek debt. So even if it does all go kablooie, there’s a complete and total loss on all Greek debt, it’s the EU taxpayer picking up the bill, not the private banks which then have to collapse their lending books.

I’ve no problem with people having different ideas from mine about what would be a desirable world. But it would help if those advocating a different world were actually sufficiently knowledgeable about this one to critique it effectively.

Isn’t it amazing (and perhaps rather telling) that David Malone, author of the Debt Generation, cannot properly distinguish between a bank’s capital and its assets?

Is all left-wing commentary based upon similar levels of ignorance? That would explain a lot……

@22 Flowerpower

I will freely admit that much of the above discussion on the dismal science is outside of my envelope, however if you think you can draw generalised conclusions about the basis of all left-wing commentary from this example, you obviously don’t pay much attention to the quality of much of the discourse in right-wing commentary.

The only consistantly accurate prediction made by an economist is that in the long run we are all dead. You could have 10 of the best economic brains in the world analysing the Greek problem and get 11 different answers.

Even assuming the correct course was chosen to “solve” the Greek crisis, or avoid the worst of it, it doesn’t take a nobel prize in economics to work out that those claiming it was the only true path may be being economical with the truth.

@23:

As with politicians, some economists predicted the Eurozone would run into serious problems and fragment while others – like Lord Layard, the Labour peer, and Christopher Huhne, the LibDem minister – were saying it was essential for Britain to join.

Currency unions involving separate countries, each with an autonomous national government, have bad historic records for surviving. Sooner or later, the unions come apart.

Countries in such unions need to be sufficiently alike to be able to maintain internal economic stability (lowish unemployment and tolerable inflation rates) after their central banks lose the option to set interest rates to suit national conditions. With currency unions, the central bank for the union sets base interest rates to achieve some adopted target relating to average conditions across the whole union – the European Central Bank aims to target the average inflation rate across the Eurozone.

For some countries, this doesn’t work – the interest rate set by the central bank of the union proves to be too low to hold back their internal inflation rates to tolerably near the average. The result is that the goods and services produced by such countries become increasingly uncompetitive as compared with other union members leading to mounting difficulties with balance of payments deficits with rising unemployment. In those circumstances, the normal appropriate remedial policy is currency depreciation but that policy option is blocked because they no longer have a national currency.

The EU Maastrict Treaty of 1992 set out eligibility criteria for joining the Euro. Only Luxembourg met all the criteria at the time the Euro was launched at the end of 1999. Britain would have been eligible except that the Pound had not been part of the Euroepan Exchange Rate Mechanism for the two years leading up to the launch of the Europe.

With hindsight, it is now transparently clear that countries such as Greece, Spain and Ireland should not have been in the Eurozone.

Christopher Huhne was part author of book with James Forder: Both Sides of the Coin (Profile Books, 2001), which set out the arguments for and against Britain joining the Euro:
http://www.amazon.co.uk/Both-Sides-Coin-Arguments-European/dp/1861973217/ref=sr_1_1?s=books&ie=UTF8&qid=1308825623&sr=1-1

Btw economists are no more prone to disagree than, say, medics, lawyers or politicians. So what? There was an extensive technical literature on the issues following Mundell: A Theory of Optimal Currency Areas:
http://www.columbia.edu/~ram15/ie/ie-12.html

@12 Bob B

The 8% of GDP deficit figure differs from these given by Wiki which points out that the Greek Government has regulalry revised its debt and deficit figures upwards as previous figures were deliberatly misreported.

http://en.wikipedia.org/wiki/European_sovereign_debt_crisis

There is a reason why the markets consider a Greek default a certainty.

@24 Bob B

“Btw economists are no more prone to disagree than, say, medics, lawyers or politicians. So what?”

I didn’t say they were more prone, altho’ arguably disagreements amongst acolytes of the dismal science take on a more…. how shall we say…. manichaean tone than lawyers or doctors. WRT politicians you may have more of a point.

Arguably again however, the results of acting on the wrong advice given by economists are likely to be more serious to the body politic as a whole than acting on that of lawyers or medics. Nobody expects much better of politicians..so maybe we can give them a free pass.

@25: “There is a reason why the markets consider a Greek default a certainty.”

Market reports are saying that Greek sovereign debt is now priced on that basis.

Probably the most topical subject now is to focus on the implications for Britain’s financial institutions holding Greek debt and on how the Eurozone will be affected as that will affect the market for Britain’s net exports – which we are looking to so as to make up for the cuts in public spending here.

@Tim W / 21:

I actually agree for the most part with what Tim says about the effect of bad loans on bank balance sheets. I think that’s the 2nd time in a year that I’ve agreed with him; these are strange times indeed!

But he’s being very economical with the truth when it comes to who owns the Greek debts. Sadly, there has already been a huge transfer of the original debt from private to public sector, because of last year’s bailout. The new bailout will transfer even more, as the private bond holders cut and run, leaving European taxpayers high and dry. But as we speak, here’s who currently owns Greek debt:

http://www.leimonis.com/2011/05/mainholdersofgreekdebt/

So even now, private institutions hold the majority of Greek debt (54%). Before last year’s bailout, the private banks and investors were exposed to 70%. So you see how bailouts favour the rich and screw everybody else.

But we can still fight back. How? Governments can print money and spend it in the public sector: more money for education, the NHS, housing, transport etc. This will make Tim absolutely apoplectic with rage as he screams about ‘crowding out’ and maybe ‘inflation’.

Sure enough, there WILL be crowding out – let’s see that as payback for the outrageous bailouts. But there won’t be much (extra) inflation, because there is so much slack in the economy (look at unemployment), which the private sector is totally paralysed to take up due to continued toxic debt fears. (So ‘crowding out’ is not really a problem anyway).

There is maybe one sense in which Greek default could be truly catastrophic: it could destroy the shadow banking system (and much of the private banking system too). Nobody really knows how the derivatives are going to unravel, and whether Ireland might also default as a result. I will grab some popcorn and watch the ensuing pyrotechnics with great amusement and wonderment, but as long as we insulate real people and real businesses from all that casino nonsense, we needn’t worry about it.

It’s the end of the world as we know it, and I feel fine.

So even now, private institutions hold the majority of Greek debt (54%).

Newer information.

http://www.economist.com/blogs/freeexchange/2011/06/greek-debt

Public majority.

“Before last year’s bailout, the private banks and investors were exposed to 70%. So you see how bailouts favour the rich and screw everybody else.”

This has been the very purpose of these bailouts. And why I’ve opposde them right from the start. To get the risk off the banks books and onto the public books so it has to be the taxpayer that picks them up. Why have they done this? Because there’s a large pro EU interest that thinks that preserving the EU and the eurozone is worth any pain to hte taxpayers. It ain’t the banks or the financiers screwing the taxpayers: it’s the EU.

“Governments can print money and spend it in the public sector: ”

That’s the thing about the eurozone. They can’t. Because they don’t have their own central banks (actrually printing money is such a small part of money supply that it doesn’t make any difference). It’s the ECB which issues money now. I agree, one way out for Greece is just to print money and give it to the bondholders. But they can’t….they’re in hte euro, see?

We can, they can’t. But we’re not in a bad enough state yet that such printing and the inflation (wouldn’t be inflation now, I agree, but it would come in hte future, and with a rush) is worth the risk. Might come to hte point when it is, but it ain’t yet.

“he screams about ‘crowding out”

No, it’s excessive borrowing that does that, crowds out private borrowing. Printing money doesn’t. Or, at least, if you’re printing enough moeny that you’re hiring labour or cement or whatever that teh private sector wants, then you are crowding out, but through inflation. Which is the thing that you don’t think that printing money would cause yet,.

“Nobody really knows how the derivatives are going to unravel,”

Oh, I do. Derivatives (ie, CDS) on Greek debt is about $30 billion gross. A pittance nett. And everyone, but everyone, has been putting up daily cash margin as prices have changed. There will be no AIG here. The point being that AIG had an AAA rating and didn’t have to post daily margin calls. So the day it lost it s AAA rating it had to post $100 billion in such calls…….and there ain’t anyone with an AAA rating anywmore, everyone must post daily margin calls.

@26: “Arguably again however, the results of acting on the wrong advice given by economists are likely to be more serious to the body politic as a whole than acting on that of lawyers or medics. Nobody expects much better of politicians..so maybe we can give them a free pass.”

I much agree with that take. There are many examples of bad economic advice prevailing – notoriously, returning the Pound to the Gold Standard in 1925 at the pre-WW1 parity or entering the Pound into the European Exchange Rate Mechanism (ERM) in October 1990. In both cases, particular economists advised against – respectively Keynes and Alan Walters – but they were pushed aside and ignored.

The only possible safeguard is to encouraged open public debate and – especially – to probe the analytical reasons why economists are reaching different conclusions.

Part of the trouble is that there are folk in prominent political positions who believe they know all the economics they need to know and brush aside any advice which conflicts with their views. Nigel Lawson is a good example of just that.

Try this forthcoming analysis of the likely Greek default in the next issue of The Economist:
http://www.economist.com/node/18866979?fsrc=nwl|wwp|06-23-11|politics_this_week

Hello all,

I would like to appologise to you all and most of all to Sunny, I did make mistakes in the article as many of you pointed out. Various people on my own blog also pointed them out and I was able to correct them. None of them, I don’t think obscured the main thrust of the article but they are errors nevertheless.

It is one of the problems of having article re-printed in other places that I cannot then correect mistakes. That said I am very grateful to Sunny for occasionally choosing to reproduce something I have written on my own blog on this one.

I think perhaps the problem is that on my own blog I make it very clear that I am not an expert but merely a very abgry citizen who is trying to sort out in his own head a truer and less biased story of this crisis that the one being fed to me by the army of financial experts in the media. I remind people I am merely someone who reads widely and tries then to think clearly about what he has read.

My blog is clearly marked as a place where I and others think aloud and educate ourselves free from the ideological capture that rules the mainstream.

I don’t think I have made many mistakes in the 3 years I have been writing and there are none in my book. I am self taught and I still have a great deal to learn. I learn every day. But while I have been learning I have noticed that my few errors, mistakes and miscomprehensions are dwarfed into nothingness compared to the utter, self serving bollocks, and mind numbingly stupid things uttered by the army of financial experts who have been destroying my country and the rule of law and democracy within it.

So while I apologize unreservedly for my mistakes, I do feel that on balance I have made far fewer mistakes than most of the ‘experts’ I hear and read.

@Luis enrique,

on the subject of leverage, I have asked many professinal bankers to define leverage for me and have received back a whole range of different definitions. Mine may not suit you but many bankers find it just fine.

As for the notion that the banks would have 530 billion in assets without foundation – of course teh banks will have other assets or capital. But surely the point is that when some of what the bank counts as it’s asset base is revealed as being worth far less than the bank was claiming, then a highly leveraged bank is in trouble because it will need to raise capital.

@ Tim Worstall

You insist that capital and assets are quite different. It seems to ignore the fact taht what banks count as capital in Tier one or Tier two is all sorts of different kinds of assets which are judeged to be more or less akin to liquid capital.

Simialrly when you say its not the one bank which created money out of nothing, but the whole system – this seems to be somewhat jesuitical in its careful obfuscation.

I am grateful to you for taking to reply as you did.

As I say I am sorry for my mistakes. I don’t think I make many. Many financial professionals read my blog and are quick to tell me if I have misundertood something. It is thankfully rare. I am sorry one of those time happend here.

David,

that’s a very laudable response and I owe you an apology – the predication I made at the end of comment 18 was wrong and evidently made without basis. Sorry.

fwiw, there may be some debate on the definition of leverage, but there’s no debate about muddling up leverage with fractional reserve banking, nor on the difference between an asset and a liability. You are certainly correct that losses on assets are more dangerous the more leveraged you are – as explained @18, it can mean you are insolvent if the losses exceed the quantity of loss-absorbing equity you have, and more leverage means less equity relative to assets. And even if you aren’t insolvent – as you wouldn’t be in the 100bn equity 1000bn asset example – you’d then be even more leveraged, even more vulnerable, and in need of raising new capital to recover.

On the 53bn loss and then “530bn assets without foundation” thing (although the OP originally said liabilities – big difference!) – even when you are leveraged, assets don’t in any sense back or support other assets – if 10 to 1 leverage meant every £1 of assets somehow supported another £10, then those £10 would support £100 and on to infinity. Likewise, 10 to 1 leverage does mean £1 of assets supports £10 of liabilities – assets and liabilities are equal always equal, unless you are insolvent. Liabilities come (crudely) in two forms – shareholders equity and creditors – leverage is the ratio of equity to total assets. The ratio governs the percentage decline in assets you can suffer, before you go bankrupt. So you can’t use absolute numbers – if 50bn of assets become worthless, you need to know what proportion of your assets that represents. Equity is not like cash in a vault or anything tangible – it is the “value” of your business – if you have £10m equity, that’s like saying your business is worth £10m. It’s regarded as a liability from the point of view of the accounts because that value is, in a sense, “owed” to the shareholders, like you owe money to a creditor.

there is an important “not” missing after “Likewise, 10 to 1 leverage does ….”

@ Tim W / 29:

Hi Tim. I can’t believe I’m agreeing with you again, about the euro. The euro is one of the main sources of Greece’s difficulty, and they need to leave it so that they can begin to sort their problems out. Portugal, Ireland, Spain, Italy and (probably) France also need to leave it and none of them should have gone into it in the first place. I’m not saying monetary unions can’t work, but they can only work when there is

a) democratic political union, or

b) near-total economic convergence before union

The merger of East and West Germany is an example of condition a) and we saw how hard that was to achieve. Condition b) was satisfied for the Schengen Group countries, but neither condition was ever satisfied for the peripheral countries.

The euro is massively overvalued for the periphery countries and also allows too much cheap credit to flow into those economies, due to interest rates that are designed to suit Germany. The result is an insatiable demand for German imports in the peripheral zone, which is great for German manufacturing, but completely unsustainable in the long run.

There are just a few other points to tidy up:

1) Greek debt is now mostly in the public sector. OK, thanks for the info Tim. This is, of course, what the bailouts are meant to achieve, and it should be a total scandal: theft on a massive scale. Every banker and politician has known for some time that Greece is going to default, so what’s the point of throwing all that public money down a black hole? Go figure …

2) ‘Crowding out’ is generally what happens when the state appropriates resources that the private sector would also like to have. It can lead to inflation or higher interest rates depending on how exactly those resources are claimed (just as Tim says).

My point is simply that the private sector is in no fit state to claim any resources at all right now: it’s got a massive hangover from its last binge. Only the state sector can get the economies of Europe and the US moving again, but our governments are cutting spending, in some kind of insane hara-kiri ritual. It’s really pathetic to watch. The alternative is for the private sector to go for ‘hair of the dog’, but we all know where that leads.

3) The derivatives. I really don’t know what’s going to happen with these, but I’m not convinced that Tim does either. It’s not just the CDS contracts on Greek debt that are in the firing line here: it depends on how many other defaults are triggered by Greece falling over. What if Portugal and Ireland follow, as I believe they will? The analogy here is with a nuclear reaction – a debt bomb in fact. It could get pretty tasty.