Kevin Drum posts a nice summary of the concerns about European Pull back in the shadow banking system.

Translated, this means that as sovereign debt woes get worse, bank woes get worse too. And as bank woes get worse, sovereign debt woes get worse. The result is a vicious circle that produces a big credit contraction, and since European banks have become so important as funding sources to the U.S., it means a big credit contraction in the U.S as well.

Its still not clear to me that this poses a major threat to the United States. At least, through this channel. This is especially true because, unless I am mistaken here, the way European banks are providing additional credit is by raising funds in the money markets and then purchasing Asset Back Securities.

However, these are not markets in which European banks have unique advantages. As they retreat American banks can step in to provide liquidity. Further American banks currently have about $1.6 Trillion in excess reserves, so that shouldn’t be an issue, so liquidity strains shouldn’t be an issue.

In short, I see no particular reason why this action short spark some sort of generalized run in the shadow banking system. The US banks can pick up the slack and have more than enough reserves to quell fears of illiquidity.

The issue, I see, comes from losses that might occur from exposure to Europe.

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