US building firewall to protect against European debt contagion
How big a problem is it? Oh, not too bad - just $4 trillion worth of exposure to euro debt, credit default swaps (you remember those, don't you?), and indirect exposure through european big banks. And there are individual banks worse off than others.
Officials were stung by the implosion of Wall Street firm MF Global, which gambled and lost on European debt, and they are working on contingency plans for a worst-case scenario should another financial firm crumble.
A senior U.S. Treasury official said regulators are contacting big U.S. financial institutions to make sure they are scaling back exposure to Europe and are ready for a potential worsening of the crisis.
The Financial Stability Oversight Council, an inter-agency group set up after the 2007-2009 financial crisis, was trying to identify specific firms that could be hit by financial turbulence and then sort out ways that each one can fortify its balance sheet, the Treasury official said.
While the Treasury has been at pains to say that direct U.S. bank exposure to European countries now receiving bailout aid -- Greece, Ireland and Portugal -- is moderate, once the debt of Italy and Spain, plus credit default swaps, and U.S. bank indirect exposure through European banks are added, the potential sum could exceed $4 trillion.
"As such, the potential for contagion to the U.S. financial system is not small," the Institute of International Finance, the lobby group for major international banks, said last week.
Hedging and netting would limit the true size of any losses, so the $4 trillion figure would be the outer edge of U.S. total exposure.
U.S. banks had about $180.9 billion of debt from Greece, Ireland, Italy, Portugal and Spain on their books at the end of June, based on Bank for International Settlements data. Italy accounted for the largest chunk, more than $250 billion. Guarantees and credit derivatives added another $586.6 billion, bringing the total to $767.5 billion, the IIF said.
"Hedging and netting" are euphemisms for strengthening reserves and dumping risky paper. The financial overhaul following the meltdown requires bank to carry more cash reserves in relation to debt, but the credit default swap market - still unregulated and non transparent - may hide even bigger problems.
Evidently, the big banks didn't learn their lesson the last time. Let's hope they don't have to get schooled again.