U.S. Banks Can't Hide From Europe's Debt Crisis

Oct 12, 2011

For months now, Europe's debt crisis has hung ominously over the U.S. markets and economy. But even as U.S. banks begin lessening their investments in Europe, it remains difficult to quantify the threat they face.

Among other crises, earlier this week, Franco-Belgian bank Dexia agreed to a rescue plan and political wrangling continued over how to handle another round of funding for Greece. European Bank President Jean-Claude Trichet warned that the high interconnectedness of the European financial system has lead to a rising risk of contagion.

"This threatens financial stability in the EU as a whole and adversely impacts the real economy in Europe and beyond," Trichet said this week.

It would be nice to put a number on the amount of money the U.S. has at stake in European financial institutions. But because money moves so quickly through so many different channels, and because banks don't have to report where their money is at all times, it's not something for which there's an easy answer.

That's not to say there aren't estimates: The Congressional Research Service last month put the direct U.S. banking exposure in Greece, Portugal, Ireland, Italy and Spain at a whopping $641 billion.

Major U.S. banks say it's much lower. Citigroup, Bank of America and JP Morgan have the largest stakes. Combined, those firms say they have about $50 billion in private and public investments in the five troubled countries. Of that, a small fraction is in problem loans to those governments.

Pulling Out Of European Investments

Whatever the exact number, Treasury Secretary Timothy Geithner assured the Senate Banking Committee last week that the banks have enough capital to withstand the stress coming out of Europe.

"U.S. financial institutions, including our major banks and the money markets as a group, have substantially reduced their exposure to the economies of Europe that have been under the most pressure," Geithner said.

Jacob Kirkegaard, a fellow at the Peterson Institute for International Economics, notes that Geithner does have a stake in the matter.

"Secretary Geithner has confidence in the U.S. banks because he's the U.S. treasury secretary, and therefore he has to have confidence in them," he says.

But Kirkegaard also says Geithner has a point: U.S. banks are cautious about lending to European banks. And money market funds — those short-term, low-risk investments — are also cutting back. U.S. money markets used to lend about half a trillion dollars to European banks; they've cut that back by almost two-thirds.

But there are other, indirect ways Europe's problems bounce back on the U.S. financial system. Kirkegaard identifies the issue of investment and trade, for one.

"When the banks are not lending to each other, they're also not lending to many other private businesses," he says.

That means slower growth for Europe, which is the United States' largest trading partner as a region. Combined with the U.S., Europe accounts for 40 percent of the world's gross domestic product.

'No Bank Can Be An Island'

Finally, there is another issue, also hard to quantify, that is both psychic and financial: economic sentiment.

"That's virulent, you know. Poor sentiment in Europe will affect sentiment in the U.S.," says Jan Randolph, director of the Sovereign Risk Group for IHS Global Insight in London. Randolph says the notion that we can limit exposure is itself limited.

"Whether American banks like it or not, or whether Americans living in Nevada or Colorado like it or not, we do live in globalized markets, and that's particularly true when it comes to financial markets," Randolph says. "And there's no way out of that. No bank can be an island in this world anymore."

Anyway, Randolph says, it goes both ways; just think back a few years ago, when Europe found itself ailing from problems that began across the pond.

"We were affected by [the] U.S. subprime [crisis], you are now affected by peripheral eurozone government debt," he says.

In other words, what goes around, comes around.

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