There is a “shadow banking” system that has massively and often unknowingly leveraged client assets into possibly the largest credit bubble the world has ever seen. Because of more favorable rules, much of the leverage has occured in the Euro, meaning a collapse of the Euro will be much more catastrophic than the public is aware.
One of the shadow banking systems favorite tools is re-hypothocation. This means institutions can use client funds as collateral for the institutions own investments. The institutions take $1 of client collateral and use it to purchase $1.40 to $2.00 of investments for the institution. So for $1 of client money, the client may be trading at leverage, and the institution is trading at leverage.
A much more thorough explantion is provided by Reuters, who concludes
The volume and level of re-hypothecation suggests a frightening alternative hypothesis for the current liquidity crisis being experienced by banks and for why regulators around the world decided to step in to prop up the markets recently. To date, reports have been focused on how Eurozone default concerns were provoking fear in the markets and causing liquidity to dry up.
Most have been focused on how a Eurozone default would result in huge losses in Eurozone bonds being felt across the world’s banks. However, re-hypothecation suggests an even greater fear. Considering that re-hypothecation may have increased the financial footprint of Eurozone bonds by at least four fold then a Eurozone sovereign default could be apocalyptic.
For further reading we suggest this dire post from zerohedge.com, who sees truly frightening possiblities
It turns out the next AIG was among us all along, only because it was hidden
deep in the bowels of the unmentionable shadow banking system, out of sight (by
definition) meant out of mind. Only it was not: and at last check there
was $15 trillion in the shadow banking system in the US alone, where the
daisy chaining of counteparty risk meant that any liquidity risk flare up would
mean the AIG bankruptcy was not even a dress rehearsal for the grand finale.
The real threat is not the collapse of financial institutions, but the threat of governments stepping in to resuce so called “to big to fail” insitutions. Governments don’t have the money, so they will print it up via the central banks. This will certainly lead to inflation, and perhaps hyper-inflation.
A more hopeful opinion on the odds of hyper-inflation is provided by dailycapitalist.com
I respect many of the writers who believe that we will experience hyperinflation. A number of them are, like me, students of Austrian theory economics. I think most of them are jumping the gun. At this point none of the economic or political factors required to set off hyperinflation are present. A careful analysis of theory, fact, and history leads me to conclude that inflation/stagflation is our future. It is quite a leap of fancy to say we are certain to have hyperinflation.