UPDATE 3-Fed’s Tarullo says Europe crisis threatens US economy

(Adds comments on Fed actions, fiscal lessons)

By Pedro Nicolaci da Costa

WASHINGTON, May 20 (BestGrowthStock) – Europe’s debt crisis poses a
“potentially serious” risk to the U.S. economic recovery
because it threatens global credit markets and large American
banks, a top Federal Reserve official said on Thursday.

Fed Governor Daniel Tarullo said Europe’s debt woes, if not
contained, could cause financial markets to freeze and spark a
global crisis akin to the market meltdown of late 2008.

Until last week, Fed officials had been playing down the
possible impact to the United States from Europe’s turmoil.

“The European sovereign debt problems are a potentially
serious setback,” Tarullo told two congressional
subcommittees.

Thursday marked another turbulent day in global financial
markets. U.S. stocks (Read more about the stock market today. ) plunged nearly 4 percent and investors
fled from risky assets around the world. The euro, which this
week hit a four-year low, was again under pressure, and the
cost of inter-bank dollar borrowing hit a fresh 10-month high.

Investors’ anxiety still centers on Greece, but fears have
grown that even the roughly $1 trillion emergency fund put
together by the European Union and International Monetary Fund
will not be enough to solve Europe’s debt problems.

“Investors are aware that this package cannot ultimately
relieve the need for real, and likely painful, fiscal reforms
in the euro area,” said Tarullo.

The remarks were an unusually detailed pronouncement on
economic matters from a Fed governor who tends to focus on
regulatory issues.

“If sovereign problems in peripheral Europe were to spill
over to cause difficulties more broadly throughout Europe, U.S.
banks would face larger losses on their considerable overall
credit exposures,” Tarullo said. “In addition to imposing
direct losses on U.S. institutions, a heightening of financial
stresses in Europe could be transmitted to financial markets
globally.”

To some extent, financial markets are already showing signs
of increased strain, buttressing the view of those who believe
the Fed will likely leave U.S. interest rates near zero percent
until sometime next year.

The U.S. economy has been recovering relatively quickly
since hitting a bottom in the summer of 2009. Gross domestic
product, the broadest measure of total economic output, jumped
at a 3.2 percent annual rate in the first quarter.

But that recovery could be pressured by a reduction in
global trade if the European outlook worsens, Tarullo said.

Ted Truman, a former Treasury official who is now a senior
fellow at the Peterson Institute, and who testified to the
congressional subcommittees following Tarullo, said the threat
is very real.

“The risk is that the European situation will spiral out of
control, spread within Europe beyond Greece and push Europe
back into recession, and further damage the U.S. and global
economy and financial system,” he said.

In conjunction with the European stabilization package, the
Fed reopened foreign exchange swap lines with central banks in
Europe, Canada and Japan to ensure dollar funding would
steadily be available to banks. Tarullo told lawmakers the Fed
is not planning to do anything else to tamp down the turmoil.

“We don’t have any other actions under consideration,” he
said in response to questions.

The Fed came under intense criticism for its role in
propping up financial firms during the U.S. crisis, and
lawmakers questioned Tarullo closely about why the Fed needed
to become involved in the European crisis.

“I’m disappointed that yet again American taxpayers find
themselves forced to pay billions of dollars in bailouts, only
this time we’re not bailing out profligate American companies,
but foreign governments,” said Representative Ron Paul, one of
the Fed’s harshest detractors in Congress.

Tarullo defended the swap lines, saying they are aimed at
providing short-term liquidity to stop dollar markets from
freezing.

“The Federal Reserve swap action is not a bailout for
anyone but certainly not a bailout for Greece,” he said.

Tarullo told lawmakers that while the United States must
take deficit reduction seriously, the seriousness of its own
fiscal situation does not compare with heavily-indebted
European countries.

The portion of gross domestic product that the United
States pays to service its debt is “substantially lower” than
countries in Europe battling debt woes, he said.

Stock Research

UPDATE 3-Fed’s Tarullo says Europe crisis threatens US economy