2010-05-21 09:58

WASHINGTON - Europe's debt crisis may pose a threat to the United States and world economies, said a US Federal Reserve high rank official on Thursday.

"A deeper contraction in Europe associated with sharp financial dislocations would have the potential to stall the recovery of the entire global economy, and this scenario would have far more serious consequences for US trade and economic growth," Daniel Tarullo, a Federal Reserve Governor said in his testimony to US House Financial Services subcommittee.

He said the timing of Europe's problems on the heels of the global financial crisis is a "potentially serious setback."

If the crisis were to crimp lending and the flow of credit globally, triggering more financial turmoil, that would endanger both the US and global recoveries, he said.

The Fed decided on May 9 to restart emergency swap agreements with the central banks in Europe, Canada and Japan.

He noted that in a worst case scenario, financial turmoil "could lead to a replay of the freezing up of financial markets that we witnessed in 2008." That contributed to the worst global recession since the 1930s.

"If sovereign problems in peripheral Europe were to spill over to cause difficulties more broadly throughout Europe, US banks would face larger losses on their considerable overall credit exposures," Tarullo said. "US money market mutual funds and other institutions, which hold a large amount of commercial paper and certificates of deposit issued by European banks, would likely also be affected."

But Tarullo said that US is in "a very different position" from European countries whose debt instruments have been under pressure.

He said that the US needs to act in a timely manner to put in place a credible program for sustainable fiscal policies.