Friday, June 17, 2011

Why the Greek Debt Crisis Matters

The Greek debt problem may seem like a distant concern, but it could swiftly become an American problem. That's because American banks hold plenty of Greek debt.

U.S. banks had a total exposure of $41 billion to Greece by the end of 2010, according to the latest figures from the Bank for International Settlements.

If Greece defaults on its payments, U.S. banks risk losing tens of billions of dollars.

That risk is growing. On Monday, S&P said there is “a significantly higher likelihood of one or more defaults.”

Much of Greece’s precarious debt is held on the books of large European banks, which obviously puts them at risk. French banks, in particular, hold lots of that debt — to the tune of nearly $57 billion.

However, those French banks raise substantial amounts of money by selling debt to the ten largest U.S. money market funds, which has spread the risk across the Atlantic.

The problem with global markets being so interconnected is that financial risk follows the flow of capital. Consequently, U.S. banks are highly exposed to the stresses on European governments and banks.

A default by Greece could spark a chain reaction. The U.S. financial crisis in 2008 was ignited by a relatively small pool of subprime mortgages. A Greek default could cause wider defaults by subprime government borrowers like Portugal, Spain and Ireland.

Aside from the risk to French banks, a Greek default could also severely impair British and German banks, which hold copious amounts of Greek debt. The German banks alone have about $34 billion in exposure.

However, European banks are not the only ones at risk.

If American banks have to cover the bad bets of investors who insured themselves with credit default swaps — which are supposed to pay off if Greece defaults on its bonds — those Americans banks would also be in big trouble.

Such an outcome could overwhelm the U.S. financial system.

Yet, Greece is not the only concern for the U.S.

According to a recent report by the Bank for International Settlements, U.S. financial institutions have nearly $200 billion in direct and indirect exposure to the debt of Greece, Ireland, and Portugal.

The structural weaknesses in the U.S. financial system were never addressed after the 2008 crisis; they were just papered over. The banks are still too leveraged and hold too little capital in case of another emergency. In fact, there's a big fight going on over this very issue right now in Washington.

Since Wall Street and its allies spend $1.4 million a day and have about 3,000 lobbyists working for them, they will get what they want — as always.

The major concern is that the "too big to fail" banks have become even bigger since 2008. Bank of America bought Merrill Lynch and Countrywide; JP Morgan Chase bought Washington Mutual; and Wells Fargo bought Wachovia. You could now call them "too bigger to fail."

Most astonishingly, six megabanks collectively control assets amounting to more than 60 percent of the country's gross domestic product. These banks operate under the implicit, if not explicit, guarantee that the taxpayers will once again bail them out in the next crisis.

So, if you weren't sure how or why the European debt crisis affects the U.S. — and maybe even your bank — perhaps you're now seeing the big picture. And if you weren't paying attention before, perhaps you will be now.

It may not be long before we witness Financial Crisis 2.0.

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