U.S. Banks Aren’t Nearly Ready for Coming European Crisis
By Simon Johnson
Jun 24, 2012
The euro area faces a major economic crisis, most likely a series of rolling, country-specific problems involving some combination of failing banks and sovereigns that can’t pay their debts in full.
This will culminate in systemwide stress, emergency liquidity loans from the European Central Bank and politicians from all the countries involved increasingly at one another’s throats.
Even the optimists now say openly that Europe will only solve its problems when the alternatives look sufficiently bleak and time has run out. Less optimistic people increasingly think that the euro area will break up because all the proposed solutions are pie-in-the-sky. If the latter view is right — or even if concern about dissolution grows in coming months — markets, investors, regulators and governments need to worry not just about interest-rate risk and credit risk, but also dissolution risk.
What’s more, they also need to worry a great deal about what the repricing of risk will do to the world’s thinly capitalized and highly leveraged megabanks. Officials, unfortunately, appear not to have thought about this at all; the Group of 20 meeting and communique last week exuded complacency and neglect.
Very few people seem to have gotten their heads around dissolution risk. Here’s what it means: If you have a contract that requires you to be paid in euros and the euro no longer exists, what you will receive is unclear.