How Did Europe's Financial Crisis Start?

Michele Norris talks to Michael Mackenzie, U.S. markets editor at the Financial Times, about Europe's deepening debt crisis: how it started, what the global markets can expect and what that all means for the U.S.

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MICHELE NORRIS, host: As we just heard, the eurozone crisis has been unfolding for more than a year. But the story involves so many different countries with different levels of economic health and very different political agendas that it's easy to lose sight of the problem, where it began and how we've come to this point.

To give us a refresher on the fundamentals of the eurozone crisis, we've called on Michael Mackenzie, the U.S. markets editor for the Financial Times. Mr. Mackenzie, welcome to the program.

MICHAEL MACKENZIE: Thank you.

NORRIS: Now, for clarity's sake, I'd like to think of the crisis as a spiderweb. And let's start at the center. I'm assuming that the spider in this web right at the center would be Greece. Explain what would happen to that web if Greece does finally default.

MACKENZIE: Well, a default from Greece would amount to a debt restructuring, whereby they would reduce the amount of debt they're going to pay back to borrowers and people who hold their bonds. So, the market's sort of thinking about a 50 percent haircut, as it's known. So, various banks in Europe who own Greek bonds would take a 50 percent loss as would the European Central Bank, which owns a lot of their collateral. And the European Central Bank, or the ECB, as it's known, has become a major player in the bond market.

NORRIS: This is a very big web and it stretches all the way across the ocean to the United States.

MACKENZIE: Yes.

NORRIS: First, what is it that the U.S. is doing that might be helping or even hurting matters? And what effect could one or more European defaults have on an already shaky U.S. economy?

MACKENZIE: Well, I think one of the more noticeable things you see here in the U.S. is that U.S. investors aren't particularly money market funds who lend money for short periods of time to European institutions such as banks have backed away since June. They've essentially not been rolling over these commercial paper transactions to the European banks. So, they're allowing them to expire and they're taking their money and they're pushing them into U.S. government securities, such as Treasury bills.

That's denying European banks a source of funding. And it's one of the reasons why European banks have been scrambling to find additional sources of dollar funding. That hasn't helped matters. But again, for a U.S. investor, memories of Lehman Brothers are very fresh in their mind. We saw back in 2008, anyone who had invested and lent money to Lehman Brothers thinking that the Federal Reserve and the U.S. government would back that bank, that simply didn't occur. You lost money.

So right now, U.S. investors have been flirting with their feet and moving money away from any kind of exposure to European banks and financial institutions.

NORRIS: So if we do see defaults and chaos and uncertainty, could you give us a quick picture of what the best-case scenario would look like and the worst-case scenario as well?

MACKENZIE: Well, the best-case scenario is that it would be relatively quick. You'd see a fairly dramatic reaction for so-called risk assets like equities. But at the same time, you know, someone like Warren Buffett likes to say, when everyone's fearful, that's the time to buy. In a way, Greece would have a lot of pain short-term, but ultimately, by reducing its overall outstanding debt, you do ultimately come out a lot better and a lot faster.

The worst-case scenario is that you have this supposed global contagion, all banking stocks get hit. Lots of banks here in the U.S. have exposure to banks in the European Zone, and there's just an absolute breakdown across markets that takes a lot longer to resolve. And indeed, if it really is fearful, then the Warren Buffetts of this world will probably think twice and maybe delay before they step in and buy.

NORRIS: I have one last question before I let you go, Mr. Mackenzie. This is for the person who is listening to this conversation and they're squeezing the steering wheel right now because they're letting me talk about worst-case scenario. Is there anything that a regular Joe or Josephine should be doing right now in this kind of uncertain market?

MACKENZIE: I think the best thing is not to panic. And I think you invest in stocks for the long term, so your 401K is - you're just making those monthly contributions. And I think as you see, over time, you build that nest egg. I think that's really the key is don't panic.

NORRIS: I guess in your world it would be, keep calm and carry on.

(SOUNDBITE OF LAUGHTER)

MACKENZIE: Keep calm and carry on. Yes, exactly as the British Ministry of War so famously said back in the 1940.

NORRIS: That's Michael Mackenzie. He's the U.S. markets editor for the Financial Times. Mr. Mackenzie, thank you very much.

MACKENZIE: Thank you.

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