Wrong medicine

Do Obama's Re-Election Chances Ride On A U.S. Bailout Of Europe?

by Alvaro Vargas Llosa

Europeans are starting to resent President Obama’s increasing tendency to preach to them about sovereign debt and push them towards a massive new “rescue plan” to solve their financial mess.  Just the other day, for example, at a press conference pushing his jobs bill, the president urged European leaders to come up with a “very clear, concrete plan” before the upcoming Nov.3-4 G20 finance meeting in Cannes.

Europeans are asking: “What lessons can we learn from the country that triggered this three-year crisis and whose budget deficits and debt levels are on par with our own?”

President Obama knows this well. But Europe’s problem has become his problem. And it could cost him his reelection.

The nightmare scenario that concerns the White House goes something like this:

First, efforts to prop up the Greek economy collapse. Greece’s default is no longer possible, but probable. The European banks that hold the toxic Greek government bonds so far have agreed only to a 21 percent write-off. If Athens defaults, the Greek bonds – as well as “paper” from other debt-laden governments, such as Portugal – will be worth almost nothing.

As in the days of Lehman Brothers, that will prompt banks to stop lending to one another. U.S. money-market funds that provide short-term credit to European banks will suffer major losses (about one third of their bank loans are in Europe.) And the operations of big U.S. companies that hold European bonds, or rely on short-term credit, will screech to a halt.

That will bring on phase two of the new crisis: The sluggish U.S. economy will swoon again, ushering in another full recession.

The White House then will decide that the United States has to rescue Europe in order to rescue itself!

Americans already are disgusted with the amount of money spent to bail out their own institutions. They would be incensed with having to subsidize another continent. And President Obama’s reelection chances would go from bad to worse.

This is why the White House and Treasury Secretary Timothy Geithner have been urging the Europeans to come up with a new rescue plan.

Because European banks are umbilically tied to the U.S. dollar, President Obama knows that the real rescue fund is not the one Europeans are currently debating, but the one he would be forced to come up with if wealthy Europeans – think Germany – abstain from spending colossal amounts of money to salvage their poorer partners and their own banks.

Unfortunately, Obama is recommending the wrong medicine (another European rescue plan) for the right reasons (so U.S. taxpayers aren’t forced to foot the bill.)

But we’ve been there before. The United States already has helped bail out Europe. As Bloomberg News found out through a Freedom of Information Act request, half of the money the Federal Reserve gave to the banks that were in trouble in 2008 and 2009 discreetly went to European institutions.

By some estimates, if Greece defaults and the European banking system seizes up, some $3.5 trillion will be needed to recapitalize the troubled banks. Does anyone seriously think the Europeans alone will foot that bill when the day of reckoning comes?

President Obama may try to avoid having to rescue Europeans in order to protect his chances of reelection for a while, but precedent tells us that Washington – and U.S. taxpayers – eventually will pay up in one form or other.

Rescue plans have failed these last three years. The Federal Reserve has tripled its balance sheet and trillions of dollars have been spent on stimulus efforts by Washington—all to no avail.

Europeans have only recently began to tackle their deficits, but even as they attempt a measure of fiscal restraint the European Central Bank is busy buying toxic Italian and Spanish sovereign bonds, after buying Greek, Irish and Portuguese bonds. And the Europeans have spent billions on “stimulus” as well.

I have no idea whether Obama will persuade the Europeans to engage in the mother of all rescue plans.

If not, it will be interesting to see whether he can avoid being dragged into a European rescue himself before November 2012.

One thing for sure: His solution for Europe is likely to create more problems than it solves.