Tags: Problems | Italy | US | Banks

Why Problems in Italy Scare US Banks

Thursday, 11 Aug 2011 12:47 PM

By Michelle Smith

“How would United States banks hold up through the European debt crisis?”

CNBC reports that this question prompted the Federal Reserve to conduct stress tests last year. The outcome didn't seem so bad back then, but it's quite a different ballgame now.

“At the time, the results made us a bit relieved; our focus was on Ireland and Greece,” a Fed insider told CNBC.

Spain and Portugal were also starting to show signs of trouble, but this wasn't too concerning either because U.S. banks didn't appear to have too much exposure to those countries.

But the sentiment was “if Italy goes, God help us all,” the Fed insider said.

Now, the question is no longer a hypothetical thinking exercise at the Fed nor is the problem contained to Ireland, Greece, Portugal, and Spain. Economic concerns have reached a point where the European Central Bank has found it necessary to step in and buy Italian and Spanish bonds.

The New York Times says the plunge in American bank stocks are evidence of growing concern about the effects European debt could have on U.S. banks, The New York Times reports.

“Bank of America dropped almost 11 percent. Citigroup sank 10.5 percent. Goldman Sachs fell 10 percent, while Morgan Stanley was down 9.7 percent,” the paper reported.

Investors could possibly be consoled if they were told that the problems in Europe may be spreading across that continent but are not so contagious as to travel across the Atlantic. However, that type of assurance is currently unavailable, even from the Fed.

According to CNBC, there are at least two obstacles preventing a determination of the effects on U.S. banks. The first, and probably easiest to overcome, is that the Fed and SEC haven’t required banks to make detailed disclosures about their exposure to European debt.

The second, and far more complex, obstacle is the lack of reliability on the results even if that information was available.

“Prior to the financial crisis of 2008, the Fed couldn't really do this type of analysis,” CNBC reports.

Now that they have the tools, “the biggest problem is whether the data truly reflects all the risks. That continues to be a matter of intense debate within the central bank. Given the complexity of the trading arrangements within the global financial system, it’s far from clear that the banks have a handle on their own exposures.”

“The European situation is back and isn’t going away,” Alex Roever, the head of short-term fixed income at JPMorgan Chase told the New York Times.

“If the European debt crisis spread to Italy, it could cause another global financial catastrophe,” says CNBC. “Only this time, global regulators might have fewer weapons to combat it.”

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