WASHINGTON — For the second time in two years, European debt troubles threaten to slow the momentum of the fragile recovery in the United States.
Although American financial institutions have taken steps to protect themselves from Europe’s long-simmering problems, the likely slowdown in Europe could damage consumer and business confidence in America and strengthen the dollar, making United States exports less competitive.
“Financial contagion can lead to the very rapid global spread of recession,” said Chris Varvares, senior managing director for Macroeconomic Advisers, a forecasting company. “If trouble intensifies and spills over to equities and other U.S. risk assets, we could see a soft patch.”
Economists say Europe’s troubles would need to worsen significantly before putting the United States economy, which has been strengthening lately, at risk of a new recession.
The European Union and United States economies are the two biggest in the world and their financial institutions are deeply intertwined. They have the single largest bilateral trade relationship, together accounting for nearly a third of global trade flows.
On Thursday, the European Commission announced that it foresaw little or no growth in the European Union in the fourth quarter of the year, and a slight 0.1 percent contraction for the euro zone, the 17 countries using the euro currency. It forecast a scant 0.5 percent annual growth in 2012 for the union and warned that the Continent might be slipping into a “deep and prolonged” recession. As recently as this spring, the commission forecast that Europe would grow 1.75 percent for 2012.
Speaking on Thursday at the Asia-Pacific Economic Cooperation summit meeting in Hawaii, the Treasury secretary, Timothy F. Geithner, said: “The crisis in Europe remains the central challenge to global growth. It is crucial that Europe move quickly to put in place a strong plan to restore financial stability.”
He added, “We are all directly affected by the crisis in Europe.”
United States financial institutions have tried to inoculate themselves by drastically cutting risk to the euro zone debt markets, partly in response to urging from policy makers. For instance, prime money-market funds — a common and higher-yielding alternative to bank deposits, and the site of a freeze in the financial markets in October 2008 — have reduced their exposure to euro zone banks by more than half since May, according to a JPMorgan analysis released this week. “Most prime fund managers are allowing existing euro zone exposures to run off,” the analysts wrote.
But these measures may not be enough in the event of a bank failure or bond market panic, which could have broad and unpredictable effects on global markets.
“I don’t think we’d be able to escape the consequences of a blow-up in Europe,” Ben S. Bernanke, the chairman of the Federal Reserve, said Thursday in Texas while answering questions after a speech.
Even with the recent moves, the United States financial system still has billions at risk to European institutions.
In an extensive report to lawmakers in September, the Congressional Research Service estimated that the exposure of banks to Greece, Ireland, Italy, Portugal, and Spain — some of the most heavily indebted euro zone economies — amounted to $641 billion. It added, “a collapse of a major European bank could produce similar problems in U.S. institutions.”
It further estimated American banks’ exposure to German and French banks at in “excess of” $1.2 trillion, equivalent to about 10 percent of total commercial banking assets in the United States. Similarly, the Bank for International Settlements reports that at midyear banks in the United States had $757 billion in derivatives contracts and $650 billion in credit commitments from European banks.
“Europe is very clearly in a Bear Stearns environment,” said Stephen Wood, chief market strategist at Russell Investments, referring to the investment bank that collapsed in early 2008 without setting off broader financial panic.
“The question is: ‘Do they get to a Lehman environment?’ They’re not there yet, but the dark clouds are beginning to gather. Right now, we’re seeing the U.S. dollar and U.S. markets benefiting, relatively, as safe havens,” Mr. Wood said. “But that wild card, that sword of Damocles, is going to be what the capital market implications are if there is a major credit event in Europe.”
Because Europe’s troubles have been developing for more than two years, financial firms have had more time to prepare than they did for the 2008 crisis, when the collapse of Lehman Brothers almost caused credit markets to freeze. This preparation could prevent a repeat of the 2008 global crisis, even if the European troubles deepen.
Still, the woes in the euro zone will probably weigh on the broader American economy, economists say. Consumer confidence has nearly returned to its lows during the worst of the recession and financial crisis, in late 2008 and early 2009.