We Are All Europeans Now
12:00 AM, Oct 1, 2011 • By IRWIN M. STELZER
We are all Europeans now. Doubt that—and just try to get news about the American economy on the financial news networks on any morning. No luck. Lots of talk about German chancellor Angela Merkel’s balancing act—trying to keep from being turfed out of office, while still sending Germans’ hard-earned money south to rescue Greece. More talk about the perilous condition of the European financial system, with under capitalized banks struggling to survive as the value of the sovereign debt on their balance sheets heads south. CNBC reporters bundled onto planes for quick overnight trips to Athens to interview everyone from politicians providing assurances that Greece, with its debt-to-GDP ratio a staggering 165 percent, really means it this time when it promises to lay off public sector workers and collect taxes, and the man on the street who vows to shut the country down if there are layoffs, and not to pay any taxes, much less the draconian new levies on property. If there is time to spare, they take a quick hop to Madrid to hear why it is not feasible for the government to privatize the lottery system, as it had promised to do. And with luck, some partying in Rome with Silvio Berlusconi—not really, but I am sure financial reporters would find that a relief from the mostly dull people they interview as a regular matter.
All of this has consequences here in America. In part because news watchers tend to give great weight to bits that confirm their already held views, and bad news is absorbed almost immediately. Most Americans already think we are on the wrong track, as they witness the spectacle of a president who has decided to campaign rather than govern for the next 14 months, and a leading Republican candidate calling Federal Reserve Board chairman Ben Bernanke “almost treasonous.”
No surprise that when Europe’s politicians can’t agree to head off what looks like another Lehman Brothers moment, already nervous Americans start dumping shares and fleeing to U.S. treasuries that yield negative inflation-adjusted interest rates. Then, reports that the Bundestag has backed Merkel’s bailout plans, and U.S. markets jump a few hundred points, with banks leading the way. Never mind that the exposure of U.S. banks to their European counterparts is limited more or less to the large, core country banks, rather than to banks in Greece and the periphery countries. Dino Kos, a former executive at the Federal Reserve Bank of New York and now managing director of Hamiltonian Associates Ltd., says the risk of transatlantic contagion is low, since governments in France, Germany, and other core countries will in the end support their banks. Besides, U.S. financial institutions have had ample time to reduce their exposure to Europe: money market funds reduced their short-term lending to European banks to $214 billion from $391 billion between the start of the year and the end of August, according to JP Morgan Chase.
But attempts to immunize the American financial system from European contagion can only be partially successful. European banks depend on the Fed to provide dollars to make up for the retreat of money market funds from the lending market. That has U.S. politicians on edge. Many have been looking for a stick with which to beat Bernanke, with Republicans who have recently sent him a letter urging him not to launch QE3 leading the charge. “Increasing [the Fed’s] exposure and that of the U.S. government to foreign banks is a moral-hazard problem,” says Edward Royce, the California Republican who sits on the House Financial Services Committee. The Fed “does need to be concerned about how a liquidity run on the European banks will impact us—our financial markets, our financial institutions, the economy as a whole,” says Texas Republican representative Kevin Brady, vice chairman of the congressional Joint Economic Committee, reports Bloomberg News. And William Dudley, president of the Federal Reserve Bank of New York, adds that regulators lack enough data on foreign institutions operating in America to “make informed judgments about the adequacy of such firms’ capital and liquidity buffers”. And since experience suggests that we do not fully understand the extent of the inter-relatedness of the world’s financial institutions, Americans have good reason to watch developments in Europe.