Contagion - Why Problems in Italy Should Scare US Banks
In early 2010, top officials at the Federal Reserve began to wonder: how would United States banks hold up through the European debt crisis? Investors were fleeing Greece and Ireland, and starting to get nervous about Portugal and Spain, spreading contagion.
The conclusion from the stress tests that resulted was heartening to supervisors at the regulator, according to a person who was directly involved in the exercise: American banks didn’t have too much exposure to Portugal and Spain, so the contagion would not be a problem.
Unless it hit Italy.
“At the time, the results made us a bit relieved; our focus was on Ireland and Greece,” said this person, who spoke on the condition of anonymity because the Fed has a policy of not discussing supervisory actions. “But if Italy goes, God help us all.”
And that is why last week was so terrifying, scarier than either the stock market drop or the Standard & Poor’s downgrade of the United States credit rating: debtholders had abandoned Spain and Italy.
At one point on Friday, Italian bonds were trading at more than 400 basis points higher than Germany’s, a signal of panic. Italy has a huge debt load. If investors began to focus on that, it wasn’t clear what might stop the run.
By Wednesday, the fears were back, as French banks got hit especially hard. The problem is that Europe has tried repeatedly to fence off the problem, only to have it escape again to wreak havoc...