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Europe Could Learn From US Debt Scramble

Last summer, some of America’s largest banks secretly stocked their cash machines with the maximum possible supply of notes. The reason? In July 2011, the bankers feared that the US might be about to suffer a technical default, because Congress could not agree on measures to raise the debt ceiling.

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So, they decided – after collective discussions – to keep those ATMs stuffed with greenbacks to ensure that consumers would never panic about running out of cash if that “worst-case” default scenario transpired. It is a sobering – and illuminating – point to ponder, amid the tortuous dramas now surrounding the future of the euro zone.

In public no senior European or American banker currently wants to admit they are preparing for another “worst-case” scenario, namely the break-up of the eurozone, or exit of one member (such as Greece).

After all, at this week’s meeting of the World Economic Forum in Davos, euro zone leaders have stressed their profound commitment to keeping the single currency intact. And the consensus among the senior bankers I have spoken to this week is that the most likely scenario for the euro zone for the foreseeable future – say, with a 70 percent probability – is continued “muddle through”; the ECB’s liquidity moves have staved off fears of an imminent crisis.

Nevertheless, almost nobody seems to expect a truly positive “solution” soon, and most think that a break-up or exit scenario remains entirely possible (say, with a 20-25 percent probability). Thus, even amid their soothing public rhetoric, most large banks are now secretly preparing contingency plans – just in case.

In some ways, this echoes what secretly occurred in America last year. In the first half of 2011, large banks such as JPMorgan and Bank of New York Mellon are thought to have each spent about $50 million ensuring that their contracts were legally watertight in the event of a US default, and that repo deals and financial markets were continuing to function (along with those ATMs.)

This time, some large banks may be spending far more, since the task is dramatically more complex: they have to review the fine print of all legal contracts for any euro exit, and to ensure that financial market transactions are watertight, or at least hedged. Many large banks are also trying to make sure that their liabilities in peripheral countries are matched with assets inside the same country – rather than across the euro zone as a whole.

However, there is one crucial distinction with last year’s “dry run” – and it is not reassuring. Back in the summer of 2011, when US default loomed, the senior managers in the largest banks spoke extensively with each other about their preparations. They then communicated these collaborative moves in extensive detail to the US Treasury, the Federal Reserve and other regulators.

For its part, the government never offered active feedback, far less direct leadership in these preparations; after all, it would have been politically suicidal if news had leaked that the Treasury was preparing for a default. Nevertheless, the sheer fact that this dialogue was under way was profoundly reassuring for many market players; a plan was there.

In Europe today, however, it appears that there is little – or no – similarly collaborative move. Or if there is, it is so utterly secret that not even senior bankers know about it yet. On an individual level, most large banks insist they are well prepared (though many express concern that the exchanges or settlement systems seem less organised). But nobody appears to have spoken extensively to anyone else, far less to any central government group.

Why? One problem is that the banking landscape in Europe is far more fragmented than in America. Another is weak European banks are now too distracted, or cash-poor, to prepare for a vague risk. There is also a deep reluctance among some eurozone bankers to admit they are preparing for a worst case, which would risk undercutting their own politicians. And some bankers argue that if a truly serious crisis materialised (such as the exit of Italy, say) it would be so devastating and complex that planning would be pointless.

But, to my mind, this leaves Europe missing a big trick; precisely because there was that “dry run” last summer, there are very useful lessons to learn, and preparing for the worst does not necessarily make it happen. Europe’s leaders would do well to study that “dry run” – and then pray that the worst case does not materialise; any more than it did in the US last year.