Europe`s debt crisis

Europe`s debt crisis and the danger we can`t see :

There are plenty oI reasons to be Ireaked out by the banking and sovereign debt crisis now
reaching a crescendo in Europe. But one Iactor that's gotten little attention could turn this Very
Bad Situation into a True Calamity.
It's this: Regulators here and in Europe have no idea repeat, no idea oI the Iull extent oI the
derivatives exposure that could be triggered by an "oIIicial" Greek deIault, or by the Iailure oI a
major French bank. And iI the people in charge have no clue as to the Iallout Irom what may be
trillions oI dollars in side bets waiting to be triggered in a catastrophic cascade, they're basically
Ilying blind.
II it strikes you as insane that oIIicials don't know the exposure oI these derivatives, given the
havoc these "Iinancial weapons oI mass destruction" wreaked last time, you're thinking clearly.
The idea that we could be back on the edge oI a Lehman/AIG-style implosion, just three years
aIter the near-death experience oI 2008, deIies all presumptions about the human species'
capacity Ior learning. But then, Darwinian optimism leaves little room Ior the greed and myopia
driving the global banking lobby today or Ior the industry's destructive power to kill or deIer
common-sense reIorm.
Remember, it was always odd that problems in the relatively small market Ior subprime
mortgages could have brought the global economy low. The reason they did was because these
subprime woes were massively ampliIied by trillions in side bets placed on these mortgages via
exotic derivatives. "Naked credit deIault swaps" allowed parties with no interest in the
underlying mortgages to place huge bets on whether borrowers would or would not perIorm.
Fear oI the explosive power oI this casino and its hidden concentration in a reckless, "too-
interconnected-to-Iail" giant like AIG led U.S. oIIicials to cough up no less than $180 billion
in taxpayer money to pay oII these bets in Iull. These oIIicials, Iearing a meltdown, treated
sophisticated derivatives traders exactly as they would treat innocent consumer depositors in a
Iailing bank, as people to be protected at 100 cents on the dollar.
It was, and is, grotesque.
Today, Greece's economy is roughly the size oI the economy oI Massachusetts. The notion that
its debt problems could bring down the global Iinancial system seems absurd.
Except Ior two things. First, many European banks holding Greek debt are so thinly capitalized
(another way oI saying "so imprudently managed") that even tiny Greece's deIault could wipe
them out. Yet Europe's emerging plan to cover this capital shortIall is tragically inadequate.
As Douglas Elliott, a Iormer investment banker now at the Brookings Institution, points out, the
plan to add 100 billion euros in capital represents a 10 percent capital boost Ior the top 90 banks,
which have about a trillion euros in capital today. But since they also have around 27 trillion
euros in assets, this new capital would protect them against a Iurther decline oI less than halI a
percentage point in the value oI their assets.
In other words, this is not a serious plan.
Yet the derivatives black hole makes matters worse. Exactly how much worse? We don't know,
because the big banks dont have to disclose this information. The derivatives markets' opacity is
precisely what lets banks make a killing. II such trading becomes transparent and standardized,
bank proIits Irom derivatives will plummet. So they resist.
Even more outrageous, the chieI negotiator Ior the banks being asked to take a deeper loss on
their reckless loans to Greece uses this unknown derivatives exposure as a negotiating ploy.
"Nice little global economy you've got here," he's basically saying. "Be a shame iI something bad
were to happen to it, iI you make us say there's been a 'deIault.'"
To be sure, in the United States, once the Dodd-Frank implementing rules are written, traders
will have to disclose a good chunk oI their derivatives activity sometime in ... 2013. A bit
late Ior today's crisis, but there's always the next one.
In the meantime, U.S. oIIicials obviously talk to the banks they supervise. I'm told they have a
better sense oI U.S. banks' derivatives exposure than was the case in 2008, and that they're not
Irightened by what they see. But taking comIort here requires one to believe that banks are
telling regulators the truth today, and that they actually know their own risk positions (which
even their CEOs didn't understand in 2008).
Even then, you can take comIort only iI you think U.S. banks are the major holders oI the
relevant derivatives, when it's almost certain that European Iirms are. And analysts tell me the
Euro-banks' books are monuments oI deceit that make our own banks' Iaulty Iinancial statements
look like models oI truth in accounting.
Where does that leave us? There are more than $22 oI derivatives Ior every dollar oI goods and
services produced in the U.S. economy. Some oI these are harmless hedges; others, bombs
waiting to detonate. Nobody knows. As one hedge Iund manager told me: "All the bad lending is
like a keg oI dynamite, and all oI the derivatives are like little Iuses running Irom one house to
another to another, and in each house is another keg oI dynamite."
One thing is certain. II it all goes kaboom, the banking elites who've sniIIed dismissively at
Occupy Wall Street ain't seen nothing yet.
$&ER FIE: How Europe's
Debt risis Hits Your Wallet
Volatility may lead to portIolio rebalancing
--Sovereign-debt write-oIIs can aIIect investors worldwide
--More European problems could mean Iewer U.S. goods purchased overseas

By Jennifer Jpenshaw
A DJW JJNES CJLUMN

Everyday newspapers and news programs are headlining about the events in Greece, France,
Italy, you name it.
Debt gone bad. Two prime ministers kicked out oI oIIice. Countries coming to the rescue. It's the
European crisis soap opera that makes "All My Children" look tame by comparison.
Mom sees all the scary headlines every day, and doesn't understand what it means, nor do most
people. All she knows is that she's worried and wants her money saIe.
So what does it mean to you and me as consumers? Well, there are actually three ways the
European crisis can and will have a huge impact.
Volatility: II you've watched the news, you've seen how volatile the stock market has been since
the Greek crisis began to unIold last year, and particularly since this past August when S&P
downgraded our nation's credit rating. Up 200 points one day, down 200 the next.
This volatility is measured by the CBOE Volatility Index (VIX), a measure oI near-term
volatility conveyed by the S&P 500 stock index option prices. This index is popularly described
as the "Iear index." The higher the VIX, the more volatility, hence the greater the market's level
oI worry.
On Thursday, the VIX was trading near 36; its 52-week low was 14.27 and its 52-week high was
48. As a point oI comparison, at the height oI the credit crisis three years ago, the VIX soared to
a record 89.
OI course, a high VIX also could imply that investors expect prices to rise sharply soon. But in
general it means less certainty over where your portIolio will stand, whether it's two years or two
months Irom now.
II you've got money in a college savings plan or are nearing retirement, more-pronounced swings
in prices oI all assets means you need to think diIIerently about your portIolio. Are you too
heavily weighted toward stocks? Should you devote a greater portion to Iixed-income
alternatives? Perhaps you'd be better oII Iollowing many aIIluent Americans and staying in cash
or Treasurys.
Sovereign debt and your bank: Major U.S. banks, according to a report by the Congressional
Research Services, are exposed to some $641 billion in debt Irom Greece, Ireland, Italy and other
hard-hit European economies. Depending on the outcome oI this euro zone crisis, that debt could
be worth signiIicantly less than expected. SigniIicant write-oIIs will impact investors around the
world.
Say, Ior example, your bank held $1 billion in Greek debt. Europe's current proposal is to reduce
the burden oI debt to that nation by Iorcing a 50 "haircut" on all holders oI that debt. Your
bank would then have to write down the value oI the debt by $500 million. The eIIect oI that
write-down means the bank would have to reserve against the 50 oI value it has lost, which
would hurt the bank's Iuture earnings, and certainly negatively aIIect its stock price.
Remember what happened during our own Iinancial crisis? Banks had to write down their
holdings in billions oI dollars oI subprime home mortgages, blowing huge holes in their balance
sheets. That put a real damper on lending activity to consumers and small businesses. We could
see a repeat oI that scenario iI the European debt crisis spreads beyond Greece (Italy could be the
next casualty), Iurther impairing our recovery and hurting job creation.
Think oI it this way: Let's say one oI the stocks you own a big position in loses halI its value.
Your personal net worth (at least on paper) takes a real hit. You may now think twice beIore co-
signing your cousin's truck loan, regardless oI what a great guy he is and how much you want to
help him.
Sale oI U.S products and jobs: Whether it's cars, computers or corn, we manuIacture and export
products to Europe. According to the U.S. Census, six oI our top export partners, including
Britain, France and Germany, account Ior nearly 16 oI total U.S. exports. The European
Commission Ior Trade says "total U.S. investment in the European Union (EU) is three times
higher than in all oI Asia and EU investment in the U.S. is around eight times the amount oI EU
investment in India and China together."
What does this mean? II, thanks to the spreading sovereign debt problem, our European partners
Iace a growing economic slowdown, we're likely to see Iewer U.S. products purchased overseas.
That will certainly hurt our jobs outlook next year.
Take General Motors Co. (GM), which has 17 oI sales Irom Europe. ChieI Executive Dan
Akerson is now looking Ior ways to reduce its exposure to the euro zone, saying that slower sales
"is a maniIestation oI Europe's economic morass."
Teen retailer Abercrombie & Fitch Co. (ANF) also is Ieeling the squeeze on sales; maybe the
chances oI your own teen getting hired there would dwindle.
Even McDonald's Corp.'s (MCD) Europe division, which is the Golden Arches' second-largest
region (by revenue), employing more than 400,000 people in Europe with more than 700
restaurants, could see Iewer Big Macs gobbled down despite the attraction oI cheap eats in a
recession.
Don't Iorget that many Americans are employed here and abroad by European companies. BNP
Paribas SA (BNP.FR, BNPQY), France's largest bank, has thousands oI U.S. workers and just
announced cuts oI 10,000 employees worldwide.
There's no question that the steady drumbeat oI negative economic news coming Irom Europe
has had an unnerving eIIect on business and political leaders around the world. The Iailure oI
those leaders to provide eIIective solutions, despite years oI warning signs, has severely limited
the options nations in that region now have.
While events overseas may seem less relevant than worries closer to home, spend a little time
learning more about what's going on behind the ominous headlines. II there's one painIul lesson
being learned by many governments, iI you think someone else's problem has nothing to do with
you, you may already be too late.
World at Bay ;er Europe's Debt risis
Global economies can only go their own way iI the Iinancial system can hold its own.

"Decoupling" is all the rage again on Wall Street. Put simply, many strategists and economists
say there is little reason a European recession should signiIicantly dent global growth prospects.
Credit Suisse, Ior example, expects global growth oI 3.5 next year despite a mild downturn in
Europe. Meanwhile, the ConIerence Board is expected Friday to say its index oI leading U.S.
economic indicators rose Ior the sixth month in a row in October.
It is tempting, then, to think the rest oI the world can power Iorward even iI Europe is lagging
behind. But is this too sanguine a view? Much the same was said back when the U.S. began
slowing several years agothat rapid growth in emerging Asia and Latin America economies
would largely oIIset such weakness and help the global economy avoid recession. Things didn't
quite work out that way.
II this time is to be diIIerent, two things have to happen: one, that Europe's recession is no worse
than mild, and two, that its debt woes don't trigger another global Iinancial crisis. The latter is the
real swing Iactor.
America's recession deepened signiIicantly when the housing market's collapse morphed into a
Iull-blown Iinancial panic. The same will be true oI Europe iI its banking system Ireezes up as
sovereign-debt woes deepen. The worse a downturn in Europe the harder Ior the rest oI the world
to keep growing.

loomberg News
The Euro sign sculpture outside the European Central Bank in FrankIurt, Germany.
Slowing already is evident in key emerging markets across Asia. Export growth in Hong Kong
has now turned negative on a year-on-year basis. In Singapore, nonoil exports were down 16
last month Irom a year earlier. Even Stephen Roach, Morgan Stanley's Asia chairman,
acknowledges China's vulnerability "can hardly be minimized" since exports to Europe and the
U.S. account Ior nearly two-IiIths oI its gross domestic product.
Financial system contagion would oI course make this worse. A heightened level oI anxiety is
already being seen in short-term Iunding markets, and a broader pullback in lending or Iinancial
activity poses a serious threat to global growth. II Europe can't resolve its debt crisis soon, it may
take parts oI the world on an unpleasant journey.