Anxiety about Europe's debt crisis last month caused U.S. stocks to suffer their worst month in more than a year. Yet many experts say fears that Europe will deal a sharp setback to the U.S. economy are overblown.
They note that trade between the U.S. and Europe is comparatively small. U.S. banks do lend to their European counterparts and hold billions in investments in those banks and other European firms. But U.S. banks have enough capital to withstand losses from a European crisis, analysts say.
In addition, the European Union is preparing a $1 trillion bailout for weak member-states. And its central bank has begun buying government debt to protect European banks — and their U.S. counterparts — from the risk of default by EU countries.
The anxieties that have spooked U.S. stock markets could linger a while. The Dow Jones industrial average has fallen more than 12 percent since late April. But the foundations of the U.S. economy remain secure, experts say.
"The physical linkages with Europe just aren't big enough to undercut the U.S. economy," said Ethan Harris, head of North American economics at Bank of America Merrill Lynch.
Here are some risks to the U.S. — and why they may be too alarmist:
The risks: If European countries default on their debt, big U.S. banks with operations in Europe could suffer. U.S. banks don't hold much national debt of Greece, Spain and other countries. But they do have investments tied up in big European banks — those most at risk in case a European country defaults.
The European Central Bank has warned that European banks might have to reduce the value of assets on their books by $239 billion over this year and next. Such losses could prevent the banks from repaying their debts to U.S. financial firms. And if U.S. banks fear such defaults, cross-border lending could dry up.
For all of Europe, U.S. banks have $1.1 trillion at stake. That's roughly 38 percent of the $3.1 trillion in loans and derivatives U.S. banks have with all foreign banks. Derivatives are investments whose value depends on the price of underlying assets, such as stocks or mortgages.
Substantial losses from investments tied to Europe would cause U.S. banks to reduce lending. A deep credit crisis could reduce U.S. growth by 1.5 percent and possibly cause another recession, Goldman Sachs said in a recent note.
The reality: The threat from Greece, Spain, Italy and Portugal — the weakest eurozone countries — itself is small, says Harris of Bank of America Merrill Lynch. U.S. banks' exposure to those countries is $165.9 billion — just 5.4 percent of all loans and derivatives U.S. banks have with foreign banks. And U.S. lending to Europe accounts for only about 10 percent of total U.S. bank assets of nearly $12 trillion.
Even in case of another credit crisis, few predict anything like the damage caused when banks lost billions on subprime loans after homeowners defaulted on their mortgages. Since then, banks have added billions more in capital. They are better able to withstand Europe's problems, Fed Governor Daniel Tarullo has said.
In addition, the European Central Bank has begun buying European government bonds. This could limit the losses for European banks should one or more EU countries default.
The risks: Thirty percent of U.S. exports of goods and services — or $461 billion — last year went to Europe, according to the Bureau of Economic Analysis.
Economic troubles in Europe could sap demand for U.S. exports, slow hiring and drag on the U.S. economy.
Exports could be hurt in two ways: A stronger dollar relative to the euro makes U.S.-made goods and services costlier to foreign buyers. So foreigners buy less. Secondly, budget cuts by European nations further reduce the ability of European customers to afford U.S. products.
Europe's crisis could also hurt the U.S. indirectly: Asian economies are big exporters to Europe. If ailing European economies cut back on imports from Asia, Asia's demand for U.S. goods might then slow, too.
The reality: Weaker export growth wouldn't derail the U.S. recovery, Harris says. Exports account for only about 12 percent of U.S. economic activity. And U.S. exports to Europe equal only 3 percent of U.S. gross domestic product — less than the size of the U.S. auto industry.
By contrast, U.S. sales of goods and services to Asia, whose economy is far stronger than Europe's, accounted for 27 percent of all U.S. exports last year. Exports to Asia would help blunt some of the reduced U.S. export business to Europe. China's currency is pegged to the U.S. dollar, so Chinese customers could still afford U.S. products even if the dollar kept rising vs. the euro.
The risks: About $942 million in U.S. mutual fund assets as of Dec. 31 were in European stocks and bonds, according to Lipper, a Thomson Reuters company. Those assets don't include U.S. investors' holdings of individual European stocks and bonds.
Perhaps the bigger market threat posed by Europe's crisis is psychological. If debt troubles spread to more EU countries and beyond, investors could collectively decide to abandon stocks. That would batter Americans' retirement investments, slow consumer spending and hurt the U.S. economy, said Harris of Bank of America Merrill Lynch.
The reality: The nearly $942 million in fund assets invested in European stocks and bonds make up only 8.5 percent of the $11 trillion in total U.S. mutual fund assets. Meanwhile, investors in the U.S. and abroad who seek safety are pouring money into U.S. Treasuries. That's helping to push down long-term interest rates, which are tied to those Treasuries. It's also causing a sell-off in stocks.
Yet consumers are benefiting. The average rate on a 30-year fixed-rate loan is 4.79 percent, barely above the record of 4.71 percent. And 15-year loans are at their lowest level on record. The falling rates allow homeowners who qualify to refinance, cut their payments and have more money available to spend.
As the dollar rises in value compared with the euro, oil prices are falling, too. Lower interest rates and lower oil prices could lead consumers to borrow and spend more and invigorate the economic recovery. Money could start to flow back into stocks.
"The U.S. may actually be an unwitting beneficiary of the crisis in Europe," James Bullard, president of the Federal Reserve Bank of St. Louis, said in a speech last month.