More Concern The Global Banks Could But Hurt By EU Finances

There has been speculation that banks outside Europe could be badly damaged by the default of debt by several EU sovereign nations or the collapse of banks within their boarders. US and UK banks clearly hold paper in both the troubled countries and many of the financial firms. This may also be the case for banks in China and Japan. Some estimates of the amount of Greece, Spain, and Portugal debt held by Western firms range as high as $2.6 trillion.

Greece represents immediate financial risks for many banks, but serial failure of debt obligations across weak European nations could be catastrophic to the worldwide financial system. The Times of London reports that the FSA “is stress-testing Britain’s biggest banks over fears they could be hit by the growing financial problems of the eurozone.” The war games are based on looking at each European nation individually and then several in groups.

The program is not unlike plans put forward by Congress for banks to create “living wills” in case they falter. These plans allow the financial firms to close themselves with as little risk as possible to the government or taxpayers. The philosophy behind them is that there is a way to keep a colossal bank collapse separated from the balance of the credit system. There is no proof that a firewall could be built against such a large blaze.

The US conducted stress tests on banks last year, but that clearly did not take into account dangers from European sovereign or bank debt. Those early tests were based on further damage in the housing market and drops in GDP. The Treasury and Fed have almost certainly begun an informal process of going through those exercises again.

Most bank executives, the IMF, and The World Bank have affirmed that the worst of the global bank crisis is over. That may prove to be one of the worst predictions since the credit crisis began two years ago.

Douglas A. McIntyre