* U.S. pressing for plan to recapitalize euro zone banks
* Officials worry messy Greek exit could hit U.S. recovery
* Crisis an unwelcome worry ahead of U.S. election
By Stella Dawson
WASHINGTON, May 31 (Reuters) – The Obama administration is
engaged in a fresh round of shuttle diplomacy to nudge European
Union leaders into decisive action to prevent Europe’s widening
crisis from undermining the U.S. and global recoveries.
Officials in Washington believe the U.S. banking system is
in sound enough shape, but they know from the collapse of Lehman
Brothers in 2008 and the Asia crisis a decade earlier that
financial crises have a nasty habit of delivering massive shocks
they cannot anticipate and that ricochet worldwide.
The message to EU politicians from U.S. Treasury and
International Monetary Fund officials hopscotching among
European capitals and holding meetings in Washington is
two-fold: recapitalize your financial system quickly to
stabilize banks, and then lay out a clear plan for the political
future of monetary union.
The officials fear that a messy Greek exit from the euro
zone or a bank run in Spain or Italy could unleash unknown
consequences, weakening an already tepid U.S. recovery just
months before Obama faces a tight U.S. presidential election.
U.S. officials are tight lipped on specifics of their advice
to Europe. But international financial officials and experts in
Washington who are in regular contact with the IMF and the U.S.
Treasury said there is a sense here that time is running out for
Europe.
“They’re saying – Whatever you do, fix it, and this time fix
it right,” said one financial industry official.
This urgency was echoed in Brussels on Thursday when
Europe’s highest ranking finance officials, European Central
Bank President Mario Draghi and European Commissioner for
Economic and Monetary Affairs Olli Rehn, issued blunt warnings
that EU politicians must act boldly, or risk collapse of
monetary union.
Spain too is pulling no punches. “It’s about the future of
the euro,” Deputy Prime Minister Soraya Saenz de Santamaria told
Reuters in an interview on Wednesday.
Spain has become the new focal point of the euro zone debt
crisis. Its banks face 1 84 billion euros i n losses and Madrid
has botched attempts to shore them up while it struggles to rein
in its budget deficit. Markets have taken fright, pushing yields
on Spanish government debt ever closer to 7 percent, the level
that forced Greece, Ireland and Portugal into EU/IMF bailouts.
Saenz was making the rounds in Washington on Thursday.
IMF Managing Director Christine Lagarde sent assurances that
there were no plans afoot or any Spanish request for IMF
financial support. Rather the focus of Saenz’s talks appear to
be on how to persuade Brussels to inject capital directly into
its banks, an issue she said she had discussed with U.S.
Treasury Secretary Timothy Geithner.
For months, U.S. officials have been telling their European
counterparts that recapitalizing banks directly with federal
money was an effective strategy it used to stabilize the U.S.
banking system in the 2007-2009 financial crisis. The IMF in
April called for direct EU capital injections.
Germany has balked at the EU shouldering any more
liabilities, aware that as Europe’s largest economy, it would
foot the bill. But the alternative that U.S. and IMF officials
paint, deep recession and monetary collapse, could persuade them
otherwise.
CLOCK TICKS
Time is clearly running short.
Money has rushed out of stocks globally and into the safety
of U.S. Treasuries, pushing yields this week to historic lows,
and the euro currency has tumbled over 7 percent against the
dollar in the past month in a flight to safety.
Investors have lost confidence that EU leaders can muster
the political will to fix two fatal flaws in monetary union – no
centralized banking authority to prevent a bank run and no
central fiscal authority to backstop banks or countries.
Without these powers, the message coming from Washington is
that a single market and a single currency will remain
vulnerable, and that no amount of fiscal austerity, the
preferred medicine from Germany, can save monetary union.
“The day of reckoning is arriving,” said one Washington
insider with deep experience in international finance.
After the G8 summit in Camp David two weeks ago, U.S.
President Barack Obama hailed a broad consensus among European
leaders around a four-pronged strategy for resolving the
European debt crisis.
In perhaps the clearest path laid out publicly to date, he
said Europe must recapitalize its banks; adopt a growth strategy
to reinvigorate their economies; provide monetary support to
help countries like Spain, Italy and Greece implement tough
austerity measures; and continue with fiscal discipline.
Since EU leaders returned home, however, there has been
little visible progress. A high-profile dinner in Brussels last
week to discuss the path forward delivered no tangible results.
Meanwhile the banking crisis in Spain has escalated.
No wonder markets have turned volatile, said Hung Tran,
deputy managing director of the Institute of International
Finance, the lobby for major banks which negotiated the EU/Greek
debt restructuring.
“What is needed now is for leaders to agree on basics steps.
They need to use the European Stability Mechanism (its new
bailout fund) to recapitalize the Spanish banks. If that
happens, it could calm market conditions,” Tran said.
Obama held a conference call on Wednesday with Germany,
France and Italy to follow up on the G8 talks. And U.S. Treasury
Under Secretary for International Affairs Lael Brainard is
visiting Athens, Frankfurt, Madrid, Berlin and Paris this week
in a pre-planned trip to offer U.S. advice on the crisis.
“We are there largely because this is a very active, live
debate and people who are navigating their way through an
extraordinarily complex range of challenges want us there,”
Brainard told Reuters in an interview this month.
In Athens, her message was stern. She told Greek parties
running in fresh elections on June 17 that Greece faces no
choice but to make the difficult economic reforms laid out in
its EU/IMF bailout package, or its financing will be cut off,
according to political and financial sources in Athens and
Washington.
If Greece runs out of money, it would be forced to quit the
euro, unleashing huge market uncertainties.
Such a deep crisis might prove the catalyst for Europe to
make big political changes needed to save monetary union,
Washington insiders say. However, the shockwave would be
substantial, and something the White House, Treasury and Federal
Reserve would rather avoid.
In a foretaste of what could come, JP Morgan estimated on
Thursday that since March alone, Europe’s problems have spooked
investors to the extent that stocks have fallen six percent,
wiping out $1 trillion in U.S. household wealth. This loss of
buying power, plus a stronger U.S. dollar, which hurts exports,
has shaved roughly half a percentage point from U.S. GDP growth
this year, it said.
“If the euro zone continues to unravel, not only will it
have serious consequences for the euro zone, but it will have
serious and even severe consequences for the entire global
economy, including the United States,” former Treasury Secretary
Robert Rubin told the Council on Foreign Relations this week.
