The essence of the linked article above is that European banks are “too big to fail and too big to save” (by Europeans alone), which will require capitalization by USA. That’s one issue.
Thus, a formal default of AIG would have exposed European banks’ large gap of regulatory capital, with possibly devastating effects on their ratings and market confidence. Which explains why AIG’s problems had sent shock waves through the share prices of European banks. Thus, the US Treasury has saved, inter alia, the European banking system. However, as AIG is to be liquidated, European banks will have to quickly shore up their regulatory capital.
The second issue is the failure of risk “load sharing” within the global markets relative to the specific “toxic loans” from USA housing market:
The near miss of AIG, followed closely by the mother of all bailouts now planned in the US, provides a vivid illustration of the nature of the links between global financial markets. One key link has been risk-sharing. European (and other) financial institutions held a large share of the assets based on US residential mortgages and thus shared in the losses that arose when the US housing market turned sour. This type of risk-sharing is exactly what financial globalisation should be able to provide. The US banking system would be in an even worse shape had all the losses from US sub prime-based securities been concentrated in the US.
The European banks are excessively over-leveraged – 30% to as high as 60% compared with 20% USA and on the order of <10% for prudent regulatory code to limit risk exposure. Part of this derives from what the article calls “toxic loans”, but a large part of it is not. This speaks directly to the point of confusion I was raising earlier – how 11% (Hoss’s number) of the domestic mortgage market can translate into this level of destabilization – to the point where the European banks require massive capitalization. The answer is it can’t. The European banks are carrying their own bad debt levels. My question is where did it come from? It can’t all be “toxic loans” from USA. The numbers don’t add up. (The proposed bailout is $1.0T (estimated), which is 7% of USA GDP or 3% of USA plus Europe GDP or 2% of world GDP.)
Last issue; the downside of nationalizing financial institutions (in addition to what Eggplant wrote above, all of which I would agree with):
But at the same time the balance sheet of the Federal Reserve has now been loaded with so many assets of dubious value that the Fed itself may soon no longer be solvent; hence the Fed’s request for a recapitalisation by the Treasury. This means that the US Central Bank has lost its independence, since it now survives on a life-line from the US government.
An independent central bank committed only to the goal of price stability used to be considered an essential cornerstone of a modern macroeconomic stability-oriented policy framework. In the US, this is giving way to a situation in which the central bank has ended up in the pockets of the finance ministry as a consequence of its frantic efforts to re-establish normal operating conditions in financial markets. In all likelihood, the large increase in US government debt under way will be matched by increased monetary financing of the deficit.
One can intuitively correlate institutional independence with the macro-economic (process) stability required to mitigate volatility that destroys confidence, cripples trading and lending momentum, and devalues real assets. We have seen all of this since the oil spikes in July. Repeatedly we have been told that the metrics are broken and the markets cannot be “anticipated” in any rational sense. The implication is that global markets – and the financial institutions that support them – are not functioning properly – from some theoretical deficiency in the thinking or from corrupt and/or incompetent management. The one explanation that I heard is comparing USA (and now by extension Europe) to the decade-long period of adjustment that Japan experienced as they cleaned up their banking system.
