Thursday 29 December 2011

A web of debt

Europe's Besieged Banks Have Trillions In Claims Against US Banks
By Robert Lenzner

29 December, 2011

A chance meeting with famed  economist Kenneth Rogoff at the Harvard Club today wised me up about  potential damage to the American banking system from the $10 trillion in potential claims by European banks against their American counterparties.

Rogoff  suggested I  read Princeton economist Hyun Song Shin’s lecture on the Global Banking Glut that was given in early November. Shin’s conclusion  shook me up a bit; “cross-border banking and fluctuating leverage of the global banks are the channels through which permissive financial conditions are transmitted globally,” Shin wrote. And shocked me by claiming that “US dollar denominated accounts of banks outside the US are comparable to assets” held by banks in the US.

This is all to say that “permissive financial conditions” are easily transported from continent to continent when trouble arises as they do today, with vastly under-capitalized European banks owing American banks trillions– at the very moment they need an injection of trillions in Europe so as not to cause a run to default by sovereign nations or the giant banks themselves.

In other words, we are bloody well in this together; our crummy banks holding tons of lousy mortgage loans– and Europe’s banks holding tons of lousy  loans to Italy, Greece, Portugal, France and Ireland. Hands across the sea! Trillions of dollars across the sea!. Massive obstacles to the smooth running of global financial markets across the sea.

Princeton’s Shin concludes that  “the European crisis of 2011 and the associated deleveraging of the European global banks will have far reaching implications not only for the eurozone, but also for credit supply conditions in the United States an d capital flows to the emerging economies.”

Quantifying this overhang is hard to do– but it turns out that Rogoff told the Washington Post a few days ago that Shin’s paper “has orders of  magnitude that I didn’t know… If we saw a meltdown, it’s hard to be too hyperbolic about how grave the effects would be,” Rogoff told the Post.

Rogoff”s best guess; The European Central Bank would keep lending more cheap short-term money to Europe’s banks to keep them operating.

My best guess; We have vastly reduced our vulnerability to the European banks by liquidating those banks borrowings from us.  Just in time  reduction in these risky liabilities.

We know that the major liability of the US financial system to Europe’s banks was from short term loans from  the huge money market mutual funds like Fidelity, Putnam and T. Rowe Price.  It’s very beneficial for US financial markets that  this trillion dollars or so has been recovered by the money market funds ensuring that this strategic part of the US shadow banking system would avoid crisis from Europe. Conversely, the withdrawal of that funding source in US dollars is a negative for the Euro accounts of the European banks.

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