In 2008 excessive risk-taking, massive leverage, and Fed-induced liquidity pushed the global banking system to the brink.
Like an Oldsmobile with a hole in the oil pan, interbank lending seized solid. Pistons wielded shut, crankshafts bent, and the whole overweight mess stopped dead in the road.
Banks no longer trusted one another's balance sheets.
According to friends of mine in the business, during one three-week period interbank lending stopped completely...
Folks sat at their terminals and did nothing. The phone didn't ring; emails went unanswered. Libor spiked.
Banks hoarded what money they had. They simply didn't know if their overnight loans would be paid back.
They didn't know who the next Lehman Brothers would be — they just hoped it wasn't them.
The government stepped in promised some $21 trillion in backstops, debt soared, and the long recession began...
The Banker Cartel
In the aftermath of this fiscal debacle, an international cartel of bankers met in the little town of Basel, Switzerland, to make certain nothing like this would ever happened again.
This group would raise the leverage requirements, institute rules, and ensure banks could trust other banks with higher capital requirements.
These sets of rules became known as Basel III.
When implemented, they will raise capital requirements and reduce the probability of bank failures as well as lower risk to taxpayers.
These rules aim to do away with the current system of privatized reward and socialized risk.
According to Stefan Ingves at the Wall Street Journal:
A fundamental feature of the new framework is the significant increase in required minimum capital levels.
All banks must hold common-equity capital of at least 7% of their risk-based assets, compared with only 2% previously. In the event of a credit boom, banks under Basel III would potentially need to hold a further 2.5% in common equity, bringing the total to 9.5%.
Finally, the most systemically important banks must hold up to 2.5% in additional common equity. That is a total of 12%, a sixfold increase from pre-crisis levels for these institutions.
And it's already starting. According to Fitch:
During the third quarter, Bank of America (BAC) led the way among U.S. G-SIFIs in delivering stronger Tier 1 common capital ratios calculated under Basel III rules.
BAC's estimated capital ratio improved by 102 bps sequentially to 8.97% as of Sept. 30. The ratio improvement at BAC provides some insight into the approaches being employed to meet Basel III capital standards.
State Street Corp. (STT) reported a 30-bp increase in its pro forma Basel III capital ratio to 11.30% from 11.0% the previous quarter. Bank of New York Mellon (BNY) reported an increase in the ratio to 9.3% from 8.7% at June 30.
Ok, fine. Banks must hold more capital or assets than they had in the past. So all the large banks are getting ahead of the curve and raising their assets now.
This begs the question: What is an asset?
In the past, Tier 1 assets were cash, government bonds, and mortgage-backed securities.
We now live in an era in which most government are running their printing presses overtime to debase their currencies through quantitative easing, bailouts, and stimulus.
This is a de facto race to devalue their currencies that puts into question the value of both cash and government bonds.
Mortgage-backed securities were at the heart of the 2008 crisis. High default levels and falling real estate prices have left these pieces of paper worth some 30% below face value.
Gold as Tier 1
This is why the crafters of Basel III added a paragraph or two reranking gold as a Tier 1 asset.
In the past, the yellow metal was ranked as a Tier 3 asset.
When Basel III is implemented, gold will go from being counted as being worth 50% of a Tier 1 asset to being worth 100%.
In other words, if a bank wanted to hold its required 7% of capital as gold, it could. (In the past, it would have had to hold twice as much.)
This means that after Basel III gets accepted sometime after January 1, 2013, gold will become more valuable to banks...
And as gold increases in price while cash, T-bills, and mortgages are falling or stagnant, the desirability to own gold by major institutions will soar.
This is the most significant thing to happen to gold since Nixon took the United States off the gold standard 40 years ago.
Perhaps because it has to do with the complex world of banking, very few people are talking about it...
But know this: Gold will become a lot dearer over the next year.
All the best,
Since 1995, Christian DeHaemer has specialized in frontier market opportunities. He has traveled extensively and invested in places as varied as Cuba, Mongolia, and Kenya. Chris believes the best way to make money is to get there first with the most. Christian is the founder of Crisis & Opportunity and Managing Director of Wealth Daily. He is also a contributor for Energy & Capital. For more on Christian, see his editor's page.