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The euro crisis is our crisis, too

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No one at the Republican debate last night discussed the ongoing debt crisis in Europe. Indeed, the topic hasn’t gotten much play in any of the GOP debates. Moderators don’t want to ask about it. Candidates don’t want to formulate views on it. But the prospect of a euro zone implosion is a huge, alarming pitfall — not just for Europe, but for the United States as well.

Jock Fistick/Bloomberg

Kevin Drum offers up a nice, lucid summary of a big new paper (PDF) from Hyun Song Shin that’s been touted as a must-read by several economists. The paper traces the massive and ever-intricate flow of money between U.S. banks, European banks, and U.S. borrowers. The short version is that we’ve all become deeply intertwined. At the height of the subprime bubble in 2007, Europe’s “shadow banking system” turned out to be providing some $5 trillion in credit to U.S. borrowers — roughly the same as American banks.

Long story short, Kevin notes, that means Europe’s sovereign debt problems are our problems, too: “Translated, this means that as sovereign debt woes get worse, bank woes get worse too. And as bank woes get worse, sovereign debt woes get worse. The result is a vicious circle that produces a big credit contraction, and since European banks have become so important as funding sources to the U.S., it means a big credit contraction in the U.S as well.”

Or perhaps you prefer Tyler Cowen’s short summary: “If true we are doomed.” Indeed, this helps explain why, as Neil Irwin reports, the Federal Reserve is spending so much time carrying out stress tests to see how U.S. banks would cope with a sharper financial crunch in Europe. Debate moderators might be able to ignore the topic, but it’ll be harder for the economy and banking system to do so.

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