U.S. banks are using insurance to hide their exposure to the eurozone debt crises. But AIG didn't prevent the 2008 financial meltdown, and insurance products help this time, says economist Robert Reich.
For instance, JPMorgan says its exposure to French banks is 0, but it could lose up to $30 billion if some French and German banks fail, Reich writes in an article for The Christian Science Monitor, citing the Federal Financial Institutions Council. That amount is about $2 billion than the bank's total capital.
The bank claims it is safe from the debt crisis, Reich says, because it has probably taken out insurance against its loans to European banks and has collateral from them.
A few years ago, Wall Street though it was safe because it had insured its bets with AIG, but the insurance company couldn't pay up.
(Associated Press photo)
That's why a default of Greece or other eurozone country will create a wave of financial chaos much like meltdown cause by the failure of Lehman Brothers in 2008, writes Reich, now a professor of public policy at the University of California at Berkeley.
As of the end of last year, Wall Street had lent about $7 billion to Greece – small potatoes when it comes to global finance. But German and French banks, which have lent much more to Greece, will be in trouble if Mediterranean country defaults.
Wall Street, which has a total of about $2.7 exposure to the eurozone, will in turn suffer, points out Reich, who served in three national administrations and was a secretary of labor under President Bill Clinton.
Loans to German and French banks are just part of the problem, Reich warns.
"Wall Street has also insured or bet on all sorts of derivatives emanating from Europe – on energy, currency, interest rates, and foreign exchange swaps. If a German or French bank goes down, the ripple effects are incalculable."
Regulations and investors do not know how much exposure US banks have to European banks or derivatives. That murky picture shows that, despite complaints from Wall Street, the Dodd-Frank Act did not go far enough, Reich argues.
The Federal Reserve Bank of New York may request for more financial information from European countries, such as credit default swaps and foreign exchange swamps, in order to get a handle on risks they pose to U.S. banks, according to Bloomberg.
"The Fed is trying to understand what the pressure points are in terms of liquidity and potential risks that are imposed by foreign banks to domestic institutions in our financial system," Kevin Petrasic, a Washington-based attorney told Bloomberg.
"There is a little bit more sense of urgency as a result of what's going on in Europe."
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