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Why Europe Shouldn’t Dismiss U.S. Advice on Debt Crisis

Daniel Gross

When Treasury Secretary Tim Geithner crashed a gathering of European finance officials in Poland last week, his suggestions were generally ignored, and his very presence at the confab was mocked. Now, this wasn't the first time an American venturing into Europe will be met with something other than open arms. (I frequently wonder if there is a word for "hospitality" in the Swiss dialect of German). On the one hand, an American policymaker presuming to lecture others about how to handle a debt problem in the fall of 2011 would be a little like a Russian nuclear official holding forth on nuclear plant safety a few months after the Chrenobyl debacle. American banks distributed subprime bonds throughout the world, the failure of institutions from Lehman to AIG helped cause a global economic meltdown, and the U.S. sports trillion-dollar plus deficits that are paralyzing its political system.

On the other hand, consider this. In the fall of 2008 and 2009, the Fed and Treasury didn't just save the bacon of the U.S. financial system; they saved the jamon, jambon, speck and prosciutto of the Europeans. Let's count the ways. The Federal Reserve and Treasury gave AIG cash so it could post collateral, make good on credit default swaps, and continue to serve as a counterparty for trade. Twelve of the top 20 recipients of collateral for AIG credit default swaps were European banks, and the top two were Societe General ($4.1 billion) and Deutsche Bank ($2.6 billion). Of the top 16 banks that received payouts on credit default swaps, 11 were European and four were German. All in, Deutsche Bank and Societe General received $11.8 billion and $11 billion, respectively, in indirect payments from the U.S. via AIG.

There's more. In the summer of 2008, when the U.S. taxpayers formally stood behind the securities of mortgage giants Fannie Mae and Freddie Mac, it was a saving grace for all institutions around the world that held them, including plenty of European banks. As this Commerce Department report notes (see page 118) Europe's private holdings of U.S. corporate bonds and agency bonds came to nearly $1.8 trillion in 2010; private institutions in Europe likely have hundreds of billions of dollars worth of Fannie Mae and Fre ddie Mac, whose value is upheld by U.S. taxpayers.

European banks also got direct aid. Thanks to the diligent work of reporters and lawyers from Bloomberg and Fox Business, the Fed was forced to divulge which banks came to the central bank for more than $1 trillion in short-term emergency loans in 2008 and 2009. As Bloomberg reported: "Almost half of the Fed's top 30 borrowers, measured by peak balances, were European firms. They included Edinburgh-based Royal Bank of Scotland Plc, which took $84.5 billion, the most of any non-U.S. lender, and Zurich-based UBS AG (UBSN), which got $77.2 billion. Germany's Hypo Real Estate Holding AG borrowed $28.7 billion, an average of $21 million for each of its 1,366 employees." Other big borrowers included Belgium's Dexia and Societe Generale.

So in dissing American policymakers, the European financial establishment is biting that hand that has been feeding it. But in acting with hauteur toward American interlopers, the Europeans are also overlooking the fact that the U.S. bailouts have worked quite well, and at a relatively low cost. True, U.S. financial regulators and politicians have let financial firms off far too easy. But the Bernanke-Paulson-Geithner two-step -- (1) guaranteeing everything; and (2) nudging and pushing borrowers and lenders to get their financial houses in order -- seems to have worked. In the fall of 2008 and winter of 2009, the Fed and other government entities guaranteed pretty much every asset in sight -- commercial paper, money-market funds, debt issued by banks -- and Treasury provided banks with cheap capital. But the stress tests in March 2009 lit a fire under banks — to cut costs, slash dividends, fire workers, find efficiencies, and raise new capital, frequently on tough terms. In addition, TARP came with strings that many banks regarded as onerous — a five percent interest rate, warrants, and an occasional tendency for government officials to comment on executive compensation. In June 2009, 10 of the largest banks showed up at Treasury to pay back about $68 billion. We've been documenting ongoing TARP exits, and the latest update can be seen here. Treasury now boasts that on an "investment" of $245 billion in aid to banks through TARP, taxpayers have already received $255 billion back in principal, interest and dividend payments. Three years after the system went into distress, the central bailout programs are winding down. The banking system is still dependent on various forms of government assistance, but it is showing signs of recovery. In the second quarter of 2011, FDIC-insured banks earned $28.8 billion.

In the accompanying video, my colleauges Henry Blodget and Aaron Task discuss the European banking crisis.

In Europe, by contrast, the banking system is just now starting to reckon with serious problems—namely the private sector's exposure to public-sector debt. A prospective default of Greek sovereign debt would kill the Greek banking industry. But it would also harm French and German banks that, even now, own lots of Greek government debt. And yet there's no U.S.-style sense of urgency. European leaders speak loudly, delivering statement in the language of diplomacy and morality, but carry small monetary sticks. It's been obvious for some time that Greece lacks the ability, systems, and interest in collecting a sufficient level of revenues to fund its borrowings. And, yet, at this late date, European banks still own 52 billion Euros in Greek bank debt.

Rather than guarantee everything and put real pressure on borrowers and lenders to get their houses in order, the Europeans have chosen to guarantee some stuff (provisionally and reluctantly), and to sit around, hold conferences, take half-measures -- and then slag on Americans who offer advice.

Daniel Gross is economics editor at Yahoo! Finance.

Email him at grossdaniel11@yahoo.com; follow him on Twitter@grossdm.

His most recent book is Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation