Greece, Italy and Spain appear to be hopelessly in debt to a handful of big European banks and some U.S. banks and hedge funds, such as recently-failed MF Global, which bought some of the debt as the European banks sold it off to reduce their risk.
The goal of Europe's governments is to help a handful of large loan-originating European banks save themselves from losses on the high risk loans. How Europe helps its banks will have a great impact on both the U.S. secondary owners of the debt and the trading and service profits of U.S. financial institutions that do business with their European counterparts.
If Europe does not succeed in getting the questionable sovereign debt paid, its banks and the U.S. hedge funds which gambled on a bailout will take a huge haircut. But U.S. banks and hedge funds are also going to take a permanent hit, even if Europe succeeds in getting the current debts paid and even if the U.S. banks and hedge funds are not directly involved with European sovereign debt.
That's because the governments of France and Germany are pushing, and will probably get, a new "small" tax or "fee" on all financial transactions -- to be used to build up a fund to help poor nations such as Greece reduce their debts. The fees would be levied on all financial transactions, including those where a U.S. financial institution-- such as Goldman or Chase-- does business with a euro block institution.
In other words, the euro countries will be going to the banks and hedge funds of the U.S. and other non-euro countries to build up a fund that can be used in the future to help bailout European banks which get in trouble in the future by making sovereign loans.
Claiming there is much at stake for the United States, President Obama said in Europe last week that the most important task for the world's leaders is to resolve the European bank crisis before it spreads to other countries. He offered to partner with Europe to help solve the crisis. That sounds like the White House won't be doing much to discourage our participation in Europe's bailout fund.
But if "partnering" means standing idle while Europe uses new financial taxes and fees to build a rescue fund to bail out the next batch of bad sovereign loans, the only question for investors is whether today's European efforts will prevent a Greek default and save hedge funds such as MF Global, or whether they will hurt the future earnings of all financial institutions including those of the U.S., or both.
Beyond the threat of contagion from the crisis, if a default on sovereign debt causes losses at U.S. banks and hedge funds which subsequently acquired it, the European bank emergency could affect the U.S. by altering geopolitical balances. China has apparently been asked to help Europe build a $1.4 trillion bailout fund that would protect Italy and Spain in the event of a Greek default.
The U.S. is in no political position to offer voluntary financial assistance to Europe’s banks, while its own economy continues to stagnate and its banks can’t / won't make loans to their business and consumer clients. Participation by China would expand its influence and potential losses in Europe, potentially at the expense of the U.S. -- which would then be left to laugh at China's ensuing losses when the inevitable defaults occur.
The Chinese are many things and often outside the rule of law, but they are not fools. The chances of China bailing out the sovereign loan-originating European banks (and thus the U.S. hedge funds that bought debt from them) are slim to none. Today, the originating banks and everyone else holding such loans are-- more than ever-- looking for a bigger fool to buy them now that Greece may be backing away from acting as a conduit for the money needed to bail out the current holders of the questionable debt.
To the extent that the originating banks succeed in moving the debt off their balance sheets, things will get even worse: the more the European banks unload their questionable sovereign debt, the less pressure there will be on the banks' governments to help get the debt paid and the more pressure there will be in Europe for a financial transaction tax and penalties to help fund the inevitable next bailout.
So MF Global is not the only U.S. financial fish caught on the euro hook. In the days ahead, U.S. investors are likely to see both a significant writedown of sovereign debts that will fall heavily on U.S. hedge funds such as MF Global, and a European financial transactions tax or fee that will fall on non-euro financial institutions -- such as all major U.S. banks and financial institutions-- to the greatest extent the European politicians can devise .
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
