The Wall Street Journal just sent a Breaking News alert entitled “Fed Eyes Cash European Banks Have In US” which says “Federal and state regulators, signaling their growing worry that Europe’s debt crisis could spill into the U.S. banking system, are intensifying their scrutiny of the U.S. arms of the Continent’s biggest banks.”
The concern is that, as the financial crisis continues to shake the European financial system, European banks may siphon cash from their US subsidiaries to satisfy European needs, thereby leaving their US operations undercapitalized and lacking cash.
This would be the reverse of the 2008 near collapse of the financial system, where the banking crisis broke in the US first and spread to Europe. This time the fear is that the spiral will work in reverse: the crisis in Europe gets worse and home country banks take actions that weaken their US companies, which cause them not to be able to satisfy their obligations. At that point, because we have no more transparency now than we did in 2008 (i.e., who owes what to whom; who has what for assets; what are those assets valued at and why; what are the levels of liquidity to satisfy obligations; etc.), financial market participants act quickly to protect themselves, but at the expense of the system as a whole.
It’s wouldn’t take long for the financial system to be paralyzed with counterparty credit concerns just like in 2008. That easily and quickly causes cash hoarding, huge collateral calls, and an overall disintegration of trust necessary for the most basic financial transactions to be processed.
The good news is that regulators appear to be acting in advance of such things from happening. The bad news is that regulators believe such things might happen. The hope is that by acting early some, if not all, of those things can be prevented from happening. The best news is that regulators appear to have learned at least some of the lessons from the last crisis and are working together now to apply that knowledge.
Let’s hope they learned enough, acted quick enough and that their actions are enough.