This demand for a larger buffer would come when many of the banks are under pressure to come up with enough capital in case of losses on bonds issued by Greece, Portugal and other European governments wracked by financial crises. A prolonged period of default by the United States could trigger cascading bank failures that upend Europe’s vulnerable financial system and in turn wreak even more damage in the United States.
Investors have begun looking for a haven beyond the traditional financial centers in the United States and Europe, sending the price of gold up to a record high Monday amid fears that Washington will run out of money to pay all its obligations in two weeks. Gold has been up 10 days in row, increasing 1 percent Monday to $1605.20 an ounce on the Comex futures exchange.
Major European stock indexes fell by more than 1.5 percent on Monday as European leaders continued searching for a response to the continent’s fiscal problems.
In the United States, stocks were also down, although less sharply, as investors grew increasingly concerned that President Obama and Congress would fail to reach a deal to raise the borrowing limit before the Aug. 2 deadline, confronting the government with a possibly catastrophic default. Financial stocks were down the most.
The vulnerability of some European financial firms was underscored last week when the European Banking Authority released the results of stress tests intended to build confidence that euro zone banks are strong enough to withstand a new economic downturn. The headline results were encouraging — only eight banks failed. But 16 others barely passed, and regulators say the system as a whole needs to strengthen itself.
Notably, the tests did not examine the impact of a government default in Greece or other countries that share the Euro currency. Nor did the tests consider what would happen if the U.S. debt crisis mushrooms into a national default.
Europe’s banks held about $479 billion in U.S. public sector debt as of the end of last year, according to the Bank for International Settlements. Much of that was in Britain and Switzerland, which do not use the euro. Among the 17 euro zone nations, French banks held $65 billion; Spanish banks, $27 billion; and German banks, $18 billion.
Not all of that is debt issued by the federal government. In its reports, the BIS includes, for example, bonds issued by U.S. states or cities as part of the “public sector.” But Treasury bonds and notes are a popular investment for financial firms, representing a large, liquid market of securities that carry what has been considered an ironclad guarantee of repayment.