THE fear of contagion is widespread in panicky financial markets. As the latest impasse over the Greek bail-out’s latest instalment continues, an even bigger restructuring of its massive public debt is looming. And the worry remains that a swingeing write-down in Greece could precipitate a bigger crisis in the euro area as banks in other countries come under even greater pressure.
Such concerns are certainly bubbling at the Global Economic Symposium being held in the city of Kiel in northern Germany. They are not confined to Europeans. Plenty of American and Chinese are alarmed at the latest lurches in the euro area’s debt crisis. They, too, fear that a Greek default could be Europe’s Lehman moment, which would—as in autumn 2008—send financial shock waves around the world and trigger another global recession.
But speaking at the conference, Edward Lazear, who was President Bush’s chief economic adviser during the financial crisis, argued that the contagion effects of Lehman’s fall in September 2008 had been exaggerated. He likened the crisis to popcorn rather than dominoes. If the heat is on, removing one kernel from the pan will not stop others from popping. The problems affecting banks in 2008 were rooted in their bad lending rather than their exposure to other banks and the interconnectedness of the financial system. Hence the solution had to be to cool the pan down by stuffing banks with capital.
At any rate, the comparison of Lehman in September 2008 and the euro crisis in fall 2011 is rather stretched. In 2008 the bad debts were widely distributed across the private sector, whereas the dodgy public debt in the euro area is concentrated among a few sovereign borrowers. Much of the fear in 2008 arose because of uncertainty about valuations and exposures, whereas the sovereign holdings of banks and potential losses on them are well identified.
Still, Mr Lazear’s analysis does suggest a path out of the mess. At the moment European politicians are tying themselves up into knots to find a way to turn €440 billion—the size of the euro area’s rescue fund once it has been fully ratified—into as much as €2 trillion. That quest is rooted in the belief that something of this scale is needed to combat contagion fears. If Mr Lazear is correct the better thing to do is to strengthen banks now so that they can survive a Greek default. That task is certainly manageable for banks in countries where national governments cannot step up to the mark. Once the rescue fund is fully ratified later this month, it will be able to help this way.
Of course, there are plenty who would disagree with the popcorn analogy. Alistair Darling, the British finance minister who led the way (through necessity) in recapitalising banks in October 2008, has stressed their interconnectedness. But there is one striking piece of evidence that does suggest that recapitalisation could be the answer. Ireland’s bond yields have fallen a lot in recent months. Some argue that this is because the Irish economy is staging a decent recovery. But another factor may be renewed confidence in the financial system: the government decided earlier this year to sort out its banks once and for all.
Such concerns are certainly bubbling at the Global Economic Symposium being held in the city of Kiel in northern Germany. They are not confined to Europeans. Plenty of American and Chinese are alarmed at the latest lurches in the euro area’s debt crisis. They, too, fear that a Greek default could be Europe’s Lehman moment, which would—as in autumn 2008—send financial shock waves around the world and trigger another global recession.
But speaking at the conference, Edward Lazear, who was President Bush’s chief economic adviser during the financial crisis, argued that the contagion effects of Lehman’s fall in September 2008 had been exaggerated. He likened the crisis to popcorn rather than dominoes. If the heat is on, removing one kernel from the pan will not stop others from popping. The problems affecting banks in 2008 were rooted in their bad lending rather than their exposure to other banks and the interconnectedness of the financial system. Hence the solution had to be to cool the pan down by stuffing banks with capital.
At any rate, the comparison of Lehman in September 2008 and the euro crisis in fall 2011 is rather stretched. In 2008 the bad debts were widely distributed across the private sector, whereas the dodgy public debt in the euro area is concentrated among a few sovereign borrowers. Much of the fear in 2008 arose because of uncertainty about valuations and exposures, whereas the sovereign holdings of banks and potential losses on them are well identified.
Still, Mr Lazear’s analysis does suggest a path out of the mess. At the moment European politicians are tying themselves up into knots to find a way to turn €440 billion—the size of the euro area’s rescue fund once it has been fully ratified—into as much as €2 trillion. That quest is rooted in the belief that something of this scale is needed to combat contagion fears. If Mr Lazear is correct the better thing to do is to strengthen banks now so that they can survive a Greek default. That task is certainly manageable for banks in countries where national governments cannot step up to the mark. Once the rescue fund is fully ratified later this month, it will be able to help this way.
Of course, there are plenty who would disagree with the popcorn analogy. Alistair Darling, the British finance minister who led the way (through necessity) in recapitalising banks in October 2008, has stressed their interconnectedness. But there is one striking piece of evidence that does suggest that recapitalisation could be the answer. Ireland’s bond yields have fallen a lot in recent months. Some argue that this is because the Irish economy is staging a decent recovery. But another factor may be renewed confidence in the financial system: the government decided earlier this year to sort out its banks once and for all.
Origin
Source: Economist
No comments:
Post a Comment