Update: This post was published on Sept. 14. On Sept. 15, the European Central Bank, along with other central banks from around the world, announced a new lending program to fight the slow-motion run on Europe's banks. Here's more on that program.
Fear can wreck a banking system and cause havoc in an economy. That's why the recent worries about big French banks are so important, and so scary: Even without a Greek default, Europe could slide into a financial crisis.
For the past few months, what The Economist called a slow-motion run has been underway for big French banks. It looks different than the classic bank run, where ordinary people lose confidence in a bank and rush to pull their money out. That's because big European banks are different from traditional, Main Street banks.
At a Main Street bank, regular people put money in savings and checking accounts. This is, in effect, a short-term loan to the bank. The bank then takes that money and makes long-term loans to other regular people in the form of mortgages, small-business loans, and the like.
Big European banks work sort like that — but on a much, much bigger scale.
Big institutions like money-market funds lend billions of dollars to big European banks. These are short-term loans of a month or so.
The European banks take that money and make huge, long-term loans to big companies national governments. That includes loans to Greece (in the form of Greek bonds) and other countries with financial troubles.
Recently, many of the big institutions that lend money to French banks have grown worried about the banks' loans to Greece and other countries. So they've started pulling their money out of the banks.
For example, U.S. money market funds reduced their deposits in French banks by about a third between May and August of this year, according to one recent analyst report — that's tens of billions of dollars they've pulled out of French banks.
So far, French banks have been managing. They've been paying higher interest in order to borrow from other sources. In a pinch, they can also borrow from European Central Bank. This may allow them to muddle through, particularly if European leaders come up with a bigger, bolder bailout plan for Greece that eases investors' worries.
But if the slow-motion bank run continues, the banks may ultimately be forced to sell off bonds and other assets they hold. If several banks are forced to sell assets at the same time, the price of those assets will fall. It's simple supply and demand.
As Gary Jenkins of Evolution Securities put it when I talked to him this morning: "If all the banks go, who is buying?"
In the language of finance, this can push a bank from liquidity to insolvency.
At the beginning, the bank is fundamentally sound, but can't come up with enough money to meet its short-term needs. It has liquidity problems.
So it's forced into a fire sale of its assets. This drives down the assets' value. The fall in value means that the bank is no longer fundamentally sound — it's insolvent. In plain terms, the bank is bust.
The big French banks are too big to fail. So instead of going bust, they would get a bailout from the French government.
But this would likely be an ugly, scary process. It would cause more fear, and more problems, in financial markets throughout Europe and beyond. It could, in short, be another financial crisis.
STEVE INSKEEP, Host:
The movie "It's a Wonderful Life" includes the following scene: Jimmy Stewart, playing the manager of a savings and loan, is trying to get out of town for his honeymoon when he sees people racing down the street.
(SOUNDBITE OF MOVIE, "IT'S A WONDERFUL LIFE")
UNIDENTIFIED MAN: (as character) Don't look now, but there's something funny going on over there at the bank.
MAN: (as character) You got any money in the bank, you'd better hurry.
INSKEEP: It's a run on the bank, people scrambling to withdraw money. A panic is not always that dramatic. And, in fact, in recent months, a slow-motion invisible bank run has been underway at big European banks. Here's Jacob Goldstein from our Planet Money team.
JACOB GOLDSTEIN: Who's causing this slow-motion bank run? In a way, it's us. In your retirement account, you probably have some money in stocks, some in bonds and some in cash. That money in cash, it's not actually a bunch of bills sitting in a vault somewhere. It's probably invested in what's called a money market fund. This is where the invisible run is happening. David Glocke is a money market manager at Vanguard, where he manages $130 billion.
DAVID GLOCKE: You know, money market managers, we kind of have a bunker mentality. You know, we're not looking to take risk. We're trying to hide from it.
GOLDSTEIN: For a long time, part of the way Glocke hid from risk was by making loans to big, safe European banks. But these days, the banks don't seem as safe as they used to. Those big European banks, and especially big French banks, have loaned lots of money to Greece and to other troubled European countries. This makes people like David Glocke nervous. If Greece doesn't repay the French banks, the French banks may not be able to repay David Glocke. How much do you have invested in French banks right now?
GOLDSTEIN: The French banks say people like David Glocke have nothing to worry about, but in the past few months, lots of other U.S. money market funds and other big institutional lenders have yanked hundreds of billions of dollars out of European banks. This slow-motion invisible bank run has not yet turned into a full-blown panic, but it is worrying enough that just yesterday, the European Central Bank and other central banks from around the world stepped in. They told the European banks if the David Glockes of the world won't lend you the money, we will. This program is scheduled to run for about six months, so it should buy some time for European banks. That could be enough, but only if Europe puts together a plan to bail out Greece and the other troubled European countries, and only if investors like David Glocke at Vanguard actually think the plan will work.
GLOCKE: I expect at some point when conditions have improved in Europe, that we'll begin to invest in those banks again.
GOLDSTEIN: Do you think six months is enough time? Do you think they'll have their act together in six months?
GLOCKE: I certainly hope so.
GOLDSTEIN: But if Europe doesn't resolve the debt crisis, this slow-motion bank run is likely to continue. And one key thing about bank runs: They tend to feed on themselves. So, what starts out in slow-motion can turn into a full-speed crisis. For NPR News, I'm Jacob Goldstein. Transcript provided by NPR, Copyright NPR.