Learn About Money

Why Banks Are in Trouble

The media reports that all mortgage defaults in the U.S. amount to approximately 1.5 or 2% of all outstanding mortgages. That doesn’t sound like much, so why is it a problem?

Banks’ leverage is 30 times – meaning that for every dollar they have, they can loan out $30. Therefore, if a bank uses its full capacity to give out loans, and then just 4% of all oustanding loans default, the bank will be wiped out. (If you have no cash on hand, how can you loan out anything?) The more loans/mortgages are in default, the less the bank can loan out, because it now has less money to leverage against.

And then it goes like this: less cash on hand -> less able to loan out -> less able to make money on the loan interest.

This is a simple explanation for the people like me, with only basic understanding of banks and credit. If I made a mistake here, please correct.