It’s the European banks they’re worried about.

Just as the collapse of the US housing market three years ago and Wall Street’s subsequent credit crunch sent shock waves around the world, federal officials fear the European debt crisis could hurt big banks there and trigger major problems here, perhaps dragging the US into another recession.

“Like Europe was vulnerable in the crisis of ’08, the US is vulnerable now,” said Nicolas Veron, a senior fellow at the Bruegel think tank in Brussels. “At this point, there are big risks in Europe, but the situation has not exploded.”

Federal regulators are closely monitoring events in Europe. Many banks there are saddled with large holdings of bonds from troubled nations such as Greece, Italy and Spain, but regulators in the decentralized European Union have less power to stem a crisis should it arise.

“We’ve been in close communication with our counterparts in Europe on the situation there for many months. It’s clear they’re working hard to address the situation,” said a US official who was not authorized to speak publicly and requested anonymity.

“They face a difficult challenge, but we believe they have the ability and the will to meet their obligations.”

Exacerbating the European problem are the lower financial cushions held by many banks. Most notably, regulators there did not require banks to raise large amounts of capital as US regulators required after conducting tough bank stress tests in 2009.

“In the US, even though the housing market remains a problem, there’s a general feeling the core of the banking system was restored to health by mid-2009,” Veron said. “The Europeans never found the nerve to address their banking situation.”

US officials have been worried about the potentially toxic combination of soaring sovereign debt from some key European nations and exposure to it by banks there that have not been required to buttress their finances enough. 

(Los Angeles Times)