–Key Is To Contain Contagion Effects To Core Countries

By Yali N’Diaye

WASHINGTON (MNI) – A U.S. Treasury official Tuesday warned that
given the interconnectedness between the U.S. and the European financial
systems, a decline in investors’ confidence in core Eurozone countries
would have “dangerous” consequences for the United States and the global
financial markets.

So it is crucial to contain the contagion effect to larger EMU
countries, Assistant Secretary for International Finance Charles Collyns
said during a testimony before the House Financial Services Subcommittee
on International Monetary Policy and Trade.

Europe, however, is aware of such dangers, and of the damaging
consequences of delaying action, he said lawmakers, who remain worried
about the U.S. indirect exposure to Europe.

“That is why we do think that they are going to take action in a
comprehensive way over the next few days to put in place a framework for
protecting the rest of the euro area from potential contagion from
events in Greece, strengthening the capacity of euro zone sovereigns to
continue to access markets at reasonable rates, and making sure the
European banking system is adequately capitalized and adequately
funded,” Collyns said during a hearing on “The Eurozone Crisis and
Implications for the United States.”

He pointed out that “there is clearly a deep commitment from
European leaders to reaching a strong agreement over the next few days
because there is a deep understanding that failure could have very
damaging consequences within the euro area.”

“The longer action is delayed, the more the dangers increase,”
Collyns continued.

Collyns said European banks have already made progress in
strengthening their balance sheets, citing write downs on the value of
the Greek debt while raising capital earlier this year.

Still, he said, they need more action to strengthen their balance
sheets, especially to strengthen their capital.

He stressed markets are not just concerned about exposure to
Greece, but also about other sovereigns that have come under pressure.

“For this reason, we understand that agreement is likely as part of
this comprehensive package on an approach to ensure adequate bank
capitalization and to provide a path to raise European bank capital to
at least 9% core Tier 1 capital relative to risk-weighted assets,” the
Treasury official said.

Collyns stressed the strong connections between U.S. and European
financial markets, especially those of the core euro zone countries.

Core countries, Collyns said, “are much more significant” in terms
of their trading relations and their financial relations with the U.S.
than peripheral countries such as Greece.

So “If there were to be a deterioration in investors confidence in
these countries, that would clearly have a dangerous impact on U.S.
financial markets” but also global financial markets.

Hence from the U.S. prospective, “the key issue is really
containing the contagion effect as investors are concerned about
possible implications of what’s happening” in peripheral EMU countries
for the larger economies amid an environment of slow growth and high
public debt.

While “U.S. direct exposure to the weakest countries in the
periphery is really quite minimal,” Collyns said, he stressed “the
exposure to financial institutions in the European core are very large.”

And “these are institutions that themselves are exposed to risk in
the European periphery.”

All of this within a context of “deep interconnectedness more
broadly between the American financial system and the European financial
system.”

“So any increase in volatility and market uncertainty about the
financial institutions in the European core very quickly translate into
increased uncertainty in US financial markets,” Collyns warned.

Against this backdrop, “The key instrument that is needed,” he
continued, is to impose “firewalls that break the connection” between
countries experiencing a difficult situation and stronger core
countries.

The good news is that Europeans are working to leverage capacity of
the European Financial Stability Facility to build this firewall.

In doing so, it is important to provide a mechanism in the days
ahead “that the markets can work with,” Collyns said, and to continue to
provide “adequate financing” to help countries meet their fiscal needs.

But the problems go beyond implementing such a “firewall.”

“Ultimately,” Collyns said, “the European crisis cannot be resolved
until countries around Europe are able to convince markets they are
going to be able to achieve the fiscal adjustments” and the reforms that
will restore sustainability,” he said.

He stressed the need for “fundamental economic reforms” in
countries such as Greece as well as a commitment to “massive fiscal
consolidation” and deep-rooted reforms to the economies that need it.

Asked to compare the U.S. to Europe, Collyns noted that “The United
States clearly has a serious fiscal issue over the medium term,” but it
is not facing the same short-term fiscal pressure as some European
countries.

Both the U.S. crisis in 2008 and today’s European problems come
down to a crisis of confidence, he said, that has led to a “huge”
increase in uncertainty that could lead to a severe damaging impact “if
not contained.”

But while there was an “overwhelming” response in the U.S. in 2008,
Europe’s constitutional constraints have made a “decisive response” more
difficult to put in place.

Collyns also underlined the important role the International
Monetary Fund has had and should continue to have in resolving the
European crisis.

The IMF is playing a “crucial” role, including through the
financial channel by providing financial resources and in the design of
the adjustment programs.

Going forward, “We believe that the IMF can continue to play a very
strong role” but it has to be in conjunction with EU’s commitment to
“the right policies” and to strengthen their fiscal position, Collyns
said.

He pointed out that United States’ financial contribution to the
IMF does not put U.S. taxpayers at a “material” risk of loss.

In addition, the IMF is an “ideal vehicle” for the US to make sure
the programs are well designed, he said.

In the current environment, also helping would be a reduced
reliance of emerging markets on exports, he said, while acknowledging
their increasing role in generating momentum for the global economy.

Emerging markets “could play an even stronger” role in supporting
global growth ahead, Collyns said, “by relying less on exports while
boosting their domestic demand.”

** Market News International Washington Bureau: 202-371-2121 **

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