Afraid of Another Financial Crisis? Watch the Banks

Financial crises like we had in 2008 before the Great Recession, and earlier in the 1930's before the Great Depression, are the triggers for big, long lasting economic downturns that require painfully long times from which to recover.  They differ from ordinary economic recessions (i.e., two quarters of negative economic growth), which generally don't last more than a couple of years and are usually followed by good levels of growth.  Financial crises are caused by liquidity shortages in the financial system.  When major banks and other financial institutions cannot obtain ready access to loans, especially short term loans, the financial system can teeter, and in worst case scenarios, collapse. 

Recent news articles report that European banks are under stress because of the decline in oil prices (http://www.cnbc.com/2016/02/08/european-banks-face-major-cash-crunch.html), and because of low interest rates and legal costs, as well as oil prices (http://money.cnn.com/2016/02/05/investing/bank-stocks-worse-than-oil/index.html?iid=EL).  Things got so shaky today that Deutsche Bank, Germany's largest, felt compelled to put out a statement reassuring shareholders about its financial condition.  http://www.reuters.com/article/us-deutsche-bank-stocks-idUSKCN0VI1WI.  If Europe's major banks begin to encounter liquidity shortfalls, we could have a problem.  If not addressed properly, it could be a big problem.

Europe's big banks are in general not as well capitalized as America's big banks, so it's not surprising that the Europeans might encounter turbulence sooner.  But if Europe's big banks teeter, America's big banks will, because of the interconnections between all major banks worldwide, at least feel pretty nauseated.  Of course, in such a scenario, the European Central Bank and U.S. Federal Reserve will mount up and ride to the rescue.  But not even the Brobdingnagian bailouts of 2008 prevented the Great Recession.

If the financial system stays sound, the slowdown in China and the other BRICS may cause a recession, but probably not a catastrophe.  But if the financial system dives into the septic tank, as it did in 2008, then we can expect a stinky mess.  So watch the banks.