Five ways the European debt crisis could affect the U.S.

ByRichard Wolf, USA TODAY
October 27, 2011, 6:54 PM

WASHINGTON -- The financial crisis that began in the United States in 2008 swept across the Atlantic to Europe. Now U.S. political and financial leaders are hoping a tentative deal to relieve Europe's debt crisis will prevent a similar stampede in reverse.

They had reason to smile Thursday. Meeting for the 14th time in 21 months, Europe's leaders announced a 50% reduction in Greece's loan repayments to private lenders, a $1.4 trillion rescue fund to keep credit flowing to other troubled nations and a bank recapitalization program designed to boost reserves by the middle of next year.

The deal had an immediate effect on financial markets, with the Dow Jones industrial average closing almost 3% highter Thursday.

But behind the rhetoric, many details remain to be worked out. Banks must agree to the latest bailout for Greece, which still would leave its gross debt at 120% of its economy by 2020, down from 160%. The rescue fund firewall relies on leveraging the European Financial Stability Facility rather than new government contributions. And European banks still could remain short of capital for the next eight months, threatening the flow of credit to consumers.

Despite the initial enthusiasm surrounding the deal, potential for future problems remains. The effects of Europe's ills have damaged U.S. interests, from multinational companies to major exporters. Individual investors have plenty of reason for concern, as the enthusiasm from earlier agreements has given way to pessimism and stock market dives. And a year from now, Europe's financial troubles could affect the U.S. presidential election.

"The economic health of Europe is vital to the prosperity of the United States," says Daniel Price, managing director at Rock Creek Global Advisors, who was President George W. Bush's top deputy for international economics.

Struggling with its own domestic economic woes even as the government reported 2.5% growth in the third quarter, the Obama administration has heaped pressure on European political leaders to solve their crisis before it gets worse. At first confined to Greece, then Portugal and Ireland, the sovereign debt crisis now threatens Italy, Spain and the European banks that hold much of those countries' IOUs.

President Obama has kept in steady contact with German Chancellor Angela Merkel and French President Nicolas Sarkozy, the two linchpins of the 17-member eurozone, in the days leading up to next week's G-20 summit. On Thursday, he called the latest agreement "an important first step."

"It will definitely have an impact on us here in the United States," Obama said. "If Europe is weak, if Europe is not growing, as our largest trading partner, that's going to have an impact on our businesses and our ability to create jobs here in the United States."

One role the United States can play is to countenance the use of the International Monetary Fund's $380 billion in lending authority. It also can seek contributions to the rescue fund from China and other developing but thriving nations.

"I can assure you that the IMF will continue to play its part in supporting the efforts made today to address the challenges facing the euro area and to restore growth to its full potential," IMF Managing Director Christine Lagarde said.

Despite the latest pronouncements from leaders of the 17-nation eurozone that the crisis affecting underfinanced nations and overextended banks will be fixed, some U.S. financial institutions and multinational companies have been preparing for the worst.

What worries experts most about the European crisis isn't what they know, but what they don't. And any crisis of confidence will only exacerbate the problem.

"It is implausible that the European financial system implodes and the U.S. is not infected as a result," says Peter Orszag, vice president of global banking at Citigroup and a former White House budget director.

Here's a guide on five ways the European debt crisis could affect the United States:

1. Banks 'tethered at the hip'

European banks are at the center of the crisis, having become overextended in debt-ridden countries or in the countries that will be asked to bail them out.

"Our big banks are tethered at the hip to their banks," says Mark Zandi, chief economist at Moody's Analytics. "They're all at risk. They're all exposed."

The largest exposures aren't in the most troubled nations sharing the euro, such as Greece, Portugal and Ireland. U.S. banks have about $700 billion in outstanding loans in Great Britain, which isn't directly affected. They have about $300 billion each in France and Germany, the leaders of the eurozone. And they have about $50 billion each in Italy and Spain — countries that could be dragged into default if the crisis escalates.

Still, the nation's biggest financial houses have billions of dollars in credit risks in the five most endangered nations of Greece, Portugal, Ireland, Italy and Spain.

Bank of America's exposure in those five countries was $16.7 billion at the end of June, JPMorgan Chase's exposure was $14 billion and Citigroup's was $13.5 billion, according to their quarterly filings with the Securities and Exchange Commission. Morgan Stanley, Wells Fargo and Goldman Sachs had exposures of $3 billion to $5 billion. The banks also reported they had attempted to reduce their exposure to bad debt by buying insurance.

The impact here could be felt on several levels: Employees of European banks such as UBS and Deutsche Bank could see their jobs threatened if a recession hits the continent and those employers retrench. U.S. banks could further tighten credit to small businesses in the United States.

In the end, the International Monetary Fund could be asked to help recapitalize European banks to guard against defaults — and much of the IMF's money comes from the U.S.

Even so, "this is a much smaller problem than anything we faced in the fall of 2008," says Sebastian Mallaby, director of the Center for Geoeconomic Studies at the Council on Foreign Relations.

2. Nation's largest trading partner

More than 20% of all U.S. exports go to Europe, making it the nation's largest trading partner. About 14% go to the 17 eurozone countries, behind only Canada and Mexico.

Total exports to the European Union were $177 billion in the first eight months of 2011, up 15% from last year. Even so, the U.S. is running a $65 billion trade deficit with the EU.

Germany and Great Britain are by far the biggest trading partners. Exporters' exposure in the southern peripheral nations at the heart of the crisis isn't as great. Italy imported only $14 billion in goods and services from the U.S. last year; Spain, $10 billion. The total for Greece: $1 billion.

Exports to Italy rose this year as the financial crisis rekindled. During downturns in 2008-09 and earlier in the decade, the total drop in exports to Portugal, Italy and Ireland never exceeded $3 billion a year, according to U.S. Census Bureau statistics.

The real worry for U.S. business is that financial panic might cause a broad recession throughout the eurozone, quelling the appetites of French and German consumers and businesses for U.S. products. Standard & Poor's predicts Europe will avert a recession and that the U.S. is at serious risk only if Europe has a severe downturn, deputy chief economist Beth Ann Borzino said this week. JPMorgan Chase economist Joseph Lupton said the company believes Europe is already in a new recession, but the United States is moving tentatively in a better direction.

"The downside risks are still there," Lupton says, pointing to next month's deadline for a congressional panel to recommend at least $1.2 trillion in deficit reduction measures. "But I think recession risks have been greatly trimmed after what has been a few weeks of solid data."

Industries that are most dependent on European trade include chemicals, transportation, computers and electronics. Companies such as Microsoft, IBM and Hewlett-Packard are heavily invested, as are aerospace companies such as Boeing.

If orders in Europe slow for aircraft or computers, "that can ripple right back into economic activity here," says Kent Hughes, director of the Program on America and the Global Economy at the Woodrow Wilson International Center for Scholars. It "could suddenly have a real impact on what we think of as the everyday Main Street."

Other experts say the impact might not be great. If exports to Europe dropped by 20%, it would represent 5% of the nation's overall exports. And because exports make up about 15% of U.S. gross domestic product, that would mean less than a 1% decline in the economy.


if you work for a company that relies on European exports, "then clearly you're vulnerable," says Nigel Gault, chief U.S. economist at IHS Global Insight.

3. Companies 'battening down hatches'

It may take a year or more for the full effect to be felt by exporters. But for companies directly invested in Europe, the impact could be swift.

The eurozone is the biggest market for U.S. companies with direct investments. More than half of the sales of American-owned foreign affiliates are in Europe.

Needless to say, a recession across the pond would cut consumption for their products. Earnings would take a hit as well.

Even now, "a lot of companies are sort of battening down the hatches in terms of their capital budgets," Orszag says.

The European crisis has been a drain on U.S. automakers for most of the year. It has all but ended General Motors' hope of breaking even in 2011. Ford on Wednesday reported a third-quarter loss of $306 billion in Europe. Fiat, which owns Chrysler, is posting losses there and is looking to its U.S. subsidiary for help in weathering the crisis.

"The European market has been dragging everyone's balance sheets down," says Rebecca Lindland, research director for IHS Automotive. "Ford and General Motors are feeling that just as much as anyone else does." That means fewer profits that can be reinvested in American jobs, new models and more efficient factories.

Less known is what investments U.S. companies have through more complex financial arrangements, such as hedge funds, credit default swaps and insurance.

"We have to presume that there may be other things hiding in the closet here that we don't know about," says Bruce Stokes, senior trans-Atlantic fellow for economics at the German Marshall Fund of the United States.

And because foreign investment goes in two directions, one of the most immediate effects of a European recession on U.S. workers would be felt at European subsidiaries here, such as BMW or UBS. "That could be the biggest hit," Gault says.

4. Investors catch a break

If banks, multinational companies and exporters had taken a bath in Europe, average investors at least could have come in for a shower.

Global equity markets are highly reactive to events in Europe and, if anything, tend to overreact. Witness what happened last week, when a whiff of a plan from Germany and France sent the Dow Jones industrial average into the black for the year. On Thursday, the latest deal sent it soaring past 12,000.

"This significantly reduces the chance of financial panic, and thus the risk of a double-dip U.S. recession," says David Wyss, former chief economist of bond-rating agency Standard & Poor's and a visiting fellow at Brown University. Although the markets recognized that "a catastrophe has been avoided," says Uri Dadush, director of international economics at the Carnegie Endowment for International Peace, "I'll be very interested to see how long this ebullience lasts."

U.S. money market funds already are moving assets elsewhere. About 19% of prime money market funds' assets are in eurozone countries now, down from about 33% last November. They have eliminated virtually all lending to banks in Italy and Spain.

If the situation gets worse before it gets better, sectors that could take a hit in the stock market include financial, technology, aerospace, defense and commodities, experts say.

What to do? A flight to U.S. Treasuries could help, but that will reduce their yields.

At the least, risk-averse investors might want to reduce their risk, says Jacob Kirkegaard, senior research fellow at the Peterson Institute.

"If you believe Europe is going to get a lot worse than it is today, then certainly that is what you should do," he says. "That would be the only rational thing to do."

5. 'Dramatic effect' on elections

If average workers and investors in the United States got dragged down, could the president be far behind?

For Obama, the U.S. financial crisis that preceded his election set the stage for three years of economic volatility. But at least in 2009 he took office with a mandate from the voters, a Democratic majority in Congress to push through his growth and regulation programs, and four years until his next election.

None of that exists today — another reason why Geithner and other administration figures have pushed European leaders to close the deal reached Thursday morning. European shocks earlier this year roiled markets and created more instability in the United States. All of that means more instability for a president who already says he's the underdog in the 2012 election.

"It's very much out of the control of this administration," says Sabina Dewan, director of globalization and international employment at the liberal Center for American Progress. Still, she says, any repercussions from Europe's crisis "will be perceived to be the fault of the administration, when it is not."

That keeps the pressure on Obama to seek additional assurances at next week's meeting of G-20 leaders in Cannes, France. "The key now is to make sure that there is strong follow-up, strong execution of the plans that have been put forward," Obama said.

That presumes the U.S. has any influence in the wake of a financial crisis that began here in the first place.

"Lecturing from American leaders at this point simply doesn't work," Mallaby of the Council on Foreign Relations warns. "We don't have the moral standing to say to people, 'Listen, guys, we know how to run an economy. Here's how you do it.'"