The Next Global Credit Crisis: Why U.S. Banks and Greek Debt Will be the Toxic Trigger

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Will a hidden link between the Greek debt situation and the U.S. banking system ignite the next global credit crisis?

The odds of the "next" global credit crisis are increasing with each new day, and with each new revelation. And escalating fears are hitting worldwide stock markets hard.

Just yesterday (Thursday), Greece's leaders revealed that the country's socialist government is on the brink of collapse. Greek protesters – angered by brutal austerity measures that will almost certainly heighten the country's record 16.2% unemployment rate – are rioting in the streets of Athens.

On Wednesday, Moody's Investors Service (NYSE: MCO) warned France's three largest banks that their exposure to Greek debt could lead to credit-rating downgrades. There are even concerns that the European Central Bank (ECB) may be technically insolvent – meaning it wouldn't survive a global financial meltdown.

Investors are right to be worried.

But with the European banking system's financial woes currently dominating the headlines, those investors might be very surprised to discover that it's actually the U.S. financial system that may end up as the real weak link in the event of a Greek debt default.

And investors don't even know this link exists.

The Scary Facts About Greece's Finances

Since last May, when the International Monetary Fund (IMF) and Eurozone members ponied up $159 billion (110 billion euros) for a Greek bailout, Greece has had to implement radical austerity measures. Terms of the bailout forced Greece to boost taxes and slash government spending. There was a public outcry, but the country's citizenry largely went along; it had no choice.

One in three Greek workers is employed by the government. As austerity-mandated layoffs have progressed, Greece's unemployment rate has zoomed from 11.7% in the first quarter of last year to the record 16.2% rate recently reported.

And given that government spending is still at 46.8% of gross domestic product (GDP), additional budget cuts will be coming – meaning Greece's national jobless rate is certain to increase.

So is the national anger level.

The sometimes-violent demonstrations on Wednesday forced Greece's Socialist Party Prime Minister George Papandreou to reach out to the opposition party in an effort to form a coalition government.

He was quickly rebuffed, is reshuffling his cabinet and will call for a vote of confidence. A no-confidence vote – pretty much a foregone conclusion at this point – would require new elections to be held quickly.

The Surprising Trigger for the Next Global Credit Crisis?

This kind of leadership chaos is unnerving to stock-and-bond investors around the world – especially since Greece needs an infusion of $85 billion (60 billion euros) by mid-July to remain solvent.

And Wednesday's announcement by Moody's isn't helping. In addition to its warning that France's three biggest banks may be downgraded, the U.S.-based credit-rating firm made it clear that there were other banks in France, Germany and the rest of Europe that could face the same treatment in the event of a Greek debt default.

All of this is widely known. But the largely untold "rest of the story" is this: If the European banking sector implodes, the U.S. financial system could take an unqualified beating.

B ig U.S. banks have been lending generously to banks across Europe. C lose to 29% of their lending books during the past two years have gone to their heavyweight European counterparts. While they have pulled back considerably as a result of recent turmoil, U.S. banks are widely believed to have $41 billion of direct exposure to Greece.

The amount of exposure to the rest of Europe is not easily quantifiable.
And this U.S. financial system link doesn't end there: U.S. money-market funds have a hefty European exposure, too.

A recent report in The Wall Street Journal said that the three large banks Moody's is threatening to downgrade – BNP Paribas SA, Credit Agricole SA, and Societe Generale SA (PINK ADR: SCGLY) – get a significant amount of their short-term funding from America's money markets.

According to The Journal, about 12% of the loans made by our biggest money-market funds were made to those three banks.

The interconnectedness of U.S. banks and money-market funds to global banks, many of whom are now at risk from a Greek default, is a sobering revelation.

Even the European Central Bank won't be immune.

Bad News for the ECB?

According to Open Europe, a U.K. think tank, the ECB will be close to insolvency if Greece defaults – or even "restructures" – its outstanding debts.

The ECB has $116 billion (82 billion euros) of equity capital against a balance sheet just shy of $2.84 trillion (2 trillion euros) of "assets" consisting of bonds, loans and "credits". Of that amount, it holds $637 billion (444 billion euros) of debt paper from the so-called "PIIGS" countries of Portugal, Ireland, Italy, Greece and Spain.

Of that total, approximately $270 billion (190 billion euros) are Greece's crumbled paper. Open Europe estimates that a 40% to 50% haircut on Greek debt would come close to wiping out the ECB's capital base. And the spillover from the contagion – the next global credit crisis – would sink the central bank almost overnight.

Lorenzo Bini Smaghi, an ECB executive board member, doesn't buy the conclusions reached in Open Europe's rapidly circulating report – telling the WSJ.com blog that they are "fundamentally flawed."

For instance, on the subject of the ECB's holding bonds that might fall precipitously, Bini Smaghi said that "not being a liquidity-constrained institution, we can act as a buy-side counterparty in markets where sell-offs are taking place, and our investment in those markets can be held to maturity, so that only default risk could threaten our profit and loss accounts."

In terms of collateral, the ECB board member said that "assets held as collateral only constitute a guarantee, not a direct exposure. Accordingly, related price decreases could only induce Euro system losses if those decreases took place after the default of the counterparty."
But here's what's frightening: In dismissing claims that the ECB could fail, Bini Smaghi makes arguments that repeatedly rely on the premise that there won't be any actual defaults.

When talking about the bonds the central bank holds, he opened up the proverbial can of worms by saying that "only default risk could threaten our profit and loss accounts."

Doesn't he realize that default is exactly what's on the table?

It's the "Euro system losses" that would take place as a result of a Greek default that has the global investing community frightened to death. European contagion spells global contagion.

French President Nicholas Sarkozy is in Germany today (Friday) to meet with German Chancellor Angela Merkel. Not surprisingly, the topic will be the Greek debt crisis. President Sarkozy will be pleading with the German Chancellor to back off Germany's call for Greek debts to be "restructured."

The rift between France and Germany, the strongest members of the European Union (EU), could be the straw that breaks the Union's back. That could certainly mean that the next global credit crisis is fait accompli. And it would also represent a definite end to the global recovery.

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Short-Side Fortunes, Shah shows the "little guy" how to make massive size gains – sometimes in a single day – by flipping large asset classes like stocks, bonds, commodities, ETFs and more. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. Franklin D. | June 17, 2011

    Cool info !
    maybe Bilderberg c.s. will indeed let us go down simultaniously !
    never thought of it that way, the net is closing in on us but first there must be a even bloodier war in the M.E. so I think they will keep Greece afload for a while longer. Dutch central bank president Wellink (member of the trilateralcommission) wednesday said the E.750 billion rescue package needs to be doubled in order to prevent collapse of the euro. When he says a thing like this, somewhere in the corridors, this is allready being pre-cooked and will soon be implemented. They will have to flood the system with more fiatmoney to keep it running untill the bitter end.

  2. Jackie | June 17, 2011

    Zorba the Greek to the rescue!

  3. King Ralph | June 17, 2011

    A lot of ifs. Then again if they reach an accord none of that happens at least in the immediate future.

  4. Scott | June 17, 2011

    I believe all this but you did not tell us where to hide . Real cash would be better than Money Markets . Gold /Silver . Dividend stock shares . Strong state Muni Bonds . Where do you suggest ?

  5. Terry | June 17, 2011

    Greek mess show's how Socialism just doesn't work. Central planning and out of control unions are just killing their country. Now we are doing the very same thing here in the US

  6. Robert Spoley | June 17, 2011

    It would appear that Obama's learning curve is flat and horizontal. We are doing the same thing as Greece. We can not get oursrlves out of this debt hole by borrowing more money. We have to stop spending at the federal level —- NOW —- NOT LATER.

  7. Fuat Odar | June 17, 2011

    Great Article

  8. Arthur Robey | June 17, 2011

    The economy runs on oil.
    Oil extraction rates peaked in 2005. That marked the end of growth and the begining or decay.
    Growth was an exponential function on the way up, and will be exponential on the way down.
    An excelent book to read is "Limits to Growth. The 2000 update."

    No. I mean really read it. Not mouth the urban myths that have been promulgated by the uneducated.

    Everyone has an opinion on Darwin's "Origin of the Species", but how many people have actually read it?

  9. Roy Maddock | June 17, 2011

    If the financial crisis as you discuss in your occurs, what do you feel would be the impact on the 1 month Libor Rates? I am looking at a variable rate home loan tide to the 1 month Libor rate and I'm worried that their rates would sky rocket. Currently they are very low. Thank you,
    Roy Maddock

  10. Chad | June 17, 2011

    Question: IF THE U.S IS HURTING AS BAD AS THEY ARE, WHY IN THE WORLD ARE THEY SENDING MONEY OVER SEAS IN TO A COUNTRY THAT IS WORSE OFF. ISN'T THAT CALLED BAD INVESTING? ARE THEY HOPING TO FEND OFF A BIGGER CATASTROPHY, WHERE INSTEAD THEY JUST MADE A BIGGER ONE?

  11. Curtis Horn | June 17, 2011

    No more bail outs. These incompetant leaders continue to make the same mistakes. Let Greece default. Let Spain and Port. go down the drain. Let the dust settle and strart from scratch. Countries need a budget to keep debt down. This will be painful mainly for citizens who had nothing to do with default but after the riots and bankruptcies we can get global debt back in line. Germany has had enough of it's neighbors "Euro system losses". Let the games begin and protect yourself.

  12. Richard Lefcourt | June 17, 2011

    What's to stop the ECB from doing a "Bernanke" by simply revving up the paper-money printing presses? True, the stronger ones, Germany and France, may scream, but do they really have a choice? Boy, the gold miners look richer each day, no?

  13. armando salinas | June 17, 2011

    sounds serious,but it looks like the Germans will back the Eureo,still there seems to be a tricky next two years.Excellent analysis-

  14. Farok Ardesher | June 17, 2011

    You said that BIG U.S. Banks have lent money like crazy to the Europeans.I am not asking WHY but HOW??? If Bank of America has over 100,000 FORECLOSED properties on its books and say it loses $100,000 on each property (Probably more if its California) that's $10 BILLION that it is not reporting on its books. Do these BANKS have enough capital to lend to Europe.It seems that the crisis of 2007-2009 has taught us NOTHING, ZILCH, ZERO.

  15. Gordan Finch | June 18, 2011

    Remember it was AIG´s ultimate owner Zurich financial Services, who created this appalling crisis and until this myriad of fraud, deception and corruption is split up and sold off further shocks will follow. ZFS spawned greed, Zurich Insurance, is its public face, yet so few of the public realise they are patrons of this corrupt organisation. It deceives millions into believing that the company or insurer they use is a different company, but it usually is Zurich Insurance regardless of the trading name. See below,

    Typical example letter from case files off the internet around 2009

    AIG is not alone in using strategies such as deny-delay defend to enhance its bottom line at their customers’expense.What sets AIG apart, however, is the way it has so callously sought to take advantage of its policyholders’ misfortunes. In 1992, on the day Hurricane Andrew landed in Florida, AIG Executive Vice-President J.W. Greenberg, son of then-CEO Maurice Greenberg, sent a company-wide memo saying, “We have opportunities from this and everyone must probe with brokers and clients. Begin by calling your underwriters together and explaining the significance of the hurricane. This is an opportunity to get price increases now.
    We must be the first and it begins by establishing the psychology with our own people. Please get it moving today.

    Similarly, the September 11th terrorist attacks were to most people a terrible tragedy.

    To Maurice Greenberg, the “Opportunities for his 82-year-old company have never been greater. In the immediate aftermath of the attacks, Prices for insurance soared by what Greenberg described as “leaps and bounds.” “It’s a global opportunity,” the CEO said at the time. “It’s not just in the United States, but rates are rising throughout the world. So our business looks quite good going forward.”Greenberg also said of the increased awareness of the need for insurance that the attacks prompted, “AIG is well positioned—probably as well as it's ever been in this marketplace. AIG executives are unapologetic about their reputation for opportunism. “We’ve always been opportunistic.
    When we see opportunities, we will never change. At AIG it’s part of our culture. AIG’s opportunism has also crossed the line into fraud. According to the Federal Bureau of Investigation (FBI), insurance fraud totals more than $40 billion and costs the average family as much as $700 per year. However, while the insurance industry only talks about fraud committed by its policyholders, what interests the FBI is the increase in corporate fraud by the insurance companies themselves, leading the agency to establish it as one of its top investigative priorities. No company is a better example of this kind of fraud than AIG. In 2006, AIG paid $1.6 billion to settle charges of a
    Variety of financial shenanigans that had commentators describing AIG as “the new Enron. Two years later, five
    Insurance executives were found guilty of fraud. The fraud accusations were traced back to longtime CEO Maurice Greenberg, who was ousted from the company he had led for 38 years. Greenberg was identified by
    Prosecutors as an “unindicted co-conspirator,” and notified that the Securities and Exchange Commission, which
    had already fined the company $126 million, was likely to pursue civil charges against him for two separate incidences of fraud. AIG was also fined millions of dollars by state insurance regulators, and faces charges that they bilked pension funds out of billions of dollars. But that was not the end of the AIG fraud saga.
    Greenberg, who once described civil justice attorneys as “terrorists,” launched an epic battle of lawsuits and counter suits with his former company. Suddenly, the $1.6 billion AIG paid to settle claims of fraud seemed to pale in comparison to the charges being exchanged between those who knew better than anyone the true extent of the fraud.
    AIG now claims Greenberg “misappropriated” $20 billion, and Greenberg in turn says AIG concealed $4 billion in losses. In 2006, AIG was implicated in the manipulation of local government bond issues. At least $7 billion worth of “phantom bonds,” which were intended to aid the poor and supply computers to inner city schools, have instead only benefited companies such as AIG. In one such “phantom bonds” case in Florida, an AIG unit conspired with other financial services firms to extract fees from a $220 million bond issue that was intended to promote affordable housing for low income families. Unbeknownst to the local government agency involved, AIG’s deal meant the less money that actually went to affordable housing, the more money AIG and its fellow companies would make. AIG and its co-conspirators eventually took $12 million in fees. Not a penny went to the affordable housing. The deal also violated U.S. tax laws, which would eventually force AIG to settle with the IRS. AIG was involved in similar deals in Georgia, Oklahoma, and Tennessee.

  16. Vess | June 19, 2011

    The notion that the ECB could become insolvent is ridiculous. It's just as impossible as the Fed becoming insolvent. What Bini Smaghi is hinting in so many words, the ECB CAN PRINT MONEY! Therefore, regardless of the losses on its balance sheet, it cannot become insolvent. The euro will fail before the ECB becomes insolvent.

  17. genel blog | June 19, 2011

    thank you so much,
    greetings.

  18. chanc | June 20, 2011

    Such a high industrialized nation acted so cheaply and bankrupted whole country and in fact whole world by borrowing so much money without repaying back and I think it is fitting to call the Americans living in US as richest beggars.Finally the culprit have been found and the Americans financial system made the whole world victim.To come out this trouble takes decades and the truth has been revealed the US will be hard hit financial crisis just like Japan had faced for almost 20 years.So one cannot depend on US any more in the world that the US will help.In fact all the powers has to been taken out of US the bodies like UN, WHO and IMF and it is already been proven that the American are the cheaters, and so all these years the Americans cheated the rest of the world in a secret.Americans did not survive responsibly from 1774 that is roughly 250 years or so while the third world countries did survive well for over thousands of years example India.Americans are cheaters.

  19. Mark | June 20, 2011

    Great article..interesting to note that Greece has a Socialist Government. Too much social welfare & hand outs to people who are non productive. Union problems, uncompetitive businesses & Government spending. Typical of a Socialist Government.
    Until they drop the Euro & go back to there own currency again they will never be competitive again. That way they can start again. What a mess…

  20. Jim Bernard | June 24, 2011

    All the worlds economic problems are related to vast amounts of money owed to Private Banks.

    Who needs the private banks ?

    Abe Lincoln would simply instruct various federal treasuries to send say $500 in credit to the bank accounts of most people via electronic transfer.

    They could do that forever as credit costs nothing -yet those receiving that credit could spend normally as if it was a salary income.

    This would sideline the banks and their huge debts, and the world would enter a new era of prosperity.

    That is how Abe Lincoln financed his side of the american civil war after rejection private bank loans of more than twenty per cent interest.

    Empowering the federal treasuries to compete with the banks, is not just an answer, it is the only answer.

    Jim

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