Playing a Dangerous Game: The Reticence of US Support for the Euro

Article excerpt

In recent months, US officials in the White House and the Treasury Department have been harshly criticized in Europe for their tepid response to the Euro Crisis. As Greece dangled over the abyss of default and nations across southern Europe fell victim to crippling sovereign debt crises, the US response ranged from mild vocal support to statements that financial aid will not be provided. Most notably, top Treasury Department officials have made it clear that no additional funding will be given to the International Monetary Fund (IMF) to augment European financial commitments. This strikes many European leaders as both wildly hypocritical given the massive bailouts the United States doled out to similarly situated US companies in 2008, and oddly masochistic given the inextricability of US and European financial fortunes. Despite the obvious benefits of a bailout for Europe, however, an examination of the political forces at work on Capitol Hill and the different options facing the Obama administration--whether or not they choose to bail out Europe--reveal the logic behind the White House's stance. Given the low political payoffs to aiding Europe and the high electoral costs of being portrayed as a big spender, the Obama administration's decision to avoid an expensive bailout is the only sensible choice.

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Dangerous Games

The argument in favor of a US bailout is fairly straight-forward. Many commentators argue that just as the financial contagion spread from the United States to Europe in 2008 and 2009, particularly after the collapse of Lehman Brothers, the fallout from a European default could send shock waves through the international financial system and into US markets. While many US citizens, especially those in strong opposition to a US bailout of Europe, see the problem as one of sovereign debts and government deficits, the risks facing the United States have far more to do with the integrated nature of the financial system. Just as thousands of businesses across Europe regularly receive financing for new capital investments from US banks like Goldman Sachs and Morgan Stanley, US businesses often receive the same sort of financing from European banks like Deutsche Bank and BNP Paribas.

Gaming the System

These banks, however, have hundreds of billions of dollars of exposure to risky European sovereign debt; in other words, they are holding bonds issued by financially questionable nations like Greece and Portugal. A default by one of these nations would bring the value of these bonds to near-zero levels, wiping out significant portions of the real wealth of these banks. Such declines in the values of assets held by these banks restrict their ability and desire to lend because their financial positions become more precarious; when banks have little wealth, they are less willing to take on risk and thus less likely to lend. The problem for the United States is that a credit crunch precipitated by a European default would not be contained within European markets. The integrated nature of the international financial system means that such losses would reverberate through US markets by reducing US firms' access to credit, inhibiting their ability to invest and slowing the recovery. Not only would the loss of European lending reduce the quantity of credit available to US firms, the loss of this competition would allow US banks to lend at higher interest rates, increasing the cost of borrowing and giving firms good reason to hold off on their investments. This is the last thing the still stumbling US economy needs as it attempts to boost job creation and aggregate demand. Given these risks, it comes as no surprise that both European economists and US commentators have criticized the decision by the Obama administration officials not to provide additional funds for a European bailout.

Despite the risks posed by a sovereign default across the Atlantic, the political factors at work in the United States have essentially tied Obama's hands and made any large-scale bailout infeasible. …