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November 24, 2010 3:21 AM EST
Just like how Federal Reserve Chairman Bernanke kept on assuring markets in 2007 that the subprime mortgage crisis would not bring down the overall economy, European Central Bank (ECB) President Jean-Claude Trichet is saying the same thing about peripheral sovereign debt crises in Europe.
However, Desmond Lachman, a resident fellow at American Enterprise Institute (AEI) said Trichet is glossing over and downplaying the risks posed by these crises in the peripheral European countries.
Trichet emphasized that Greece and Ireland, the two hardest-hit countries that already required bailouts from the European Union (EU), each only constitute less than 2 percent of the overall euro zone economy. Moreover, Spain, Portugal, Ireland, and Greece -- the countries in the worst fiscal shape -- make up less than 15 of the overall euro zone GDP.
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However, Trichet downplays the fact that these countries owe extraordinarily high levels of debt, said Lachman. Furthermore, that debt -- totaling around $2 trillion -- are primarily held by European banks, whose exposure are equivalent to 20 percent of the euro zone GDP.
Moreover, Spanish banks are among the most exposed to Portuguese debt, according to Marc Chandler, head of Global Currency Strategy at Brown Brothers Harriman. Spain and Portugal are seen as the next vulnerable targets for sovereign debt scares (after Greece and Ireland already had theirs), so this connection adds a whole new dimension to the concept of "contagion."
A wave of sovereign defaults in these peripheral countries "would deal a serious body blow to the European banking system at the very time that the European banks are yet to fully recover from their 2008-2009 loan losses," said Lachman.
Indeed, European banks are still struggling with the aftermath of the global financial crises and have not restructured nor recapitalized as well as U.S. banks have, according to Nicolas Veron, a senior fellow at Bruegel, a Brussels-based think tank.
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