Wednesday, 28 September 2011
While the crisis is often portrayed as a “peripheral” debt crisis concentrated in southern Europe and Ireland, it’s actually a “core” banking crisis in disguise, according to Richard McGuire, senior fixed-income strategist at Rabobank
In the decade following the euro’s 1999 launch, banks at the euro zone’s core — Germany, France and other wealthy northern European member states — channeled surpluses to fund peripheral deficits, he noted. A massive convergence of interest rates across the euro zone left little differentiation in risk between core and peripheral borrowers.
That’s left core banks, particularly in France, holding large chunks of sovereign debt that has turned sour as investors have factored back in the threat of default. But European leaders have so far proved unable to put in place a plan that can convince investors that the banks won’t be brought down.
While not rivaling the freeze that followed the 2008 collapse of Lehman Brothers, it has led to rising tensions in interbank markets as European institutions grow reluctant to lend to each other. It’s also led the ECB to take additional steps to ensure dollar and euro liquidity in the European banking system and spurred speculation the central bank could move next week to further enhance its liquidity-providing operations.
he way forward
So what needs to be done now?
First things first. Markets show Greece is seen as almost certain to default. And, in the end, many strategists expect bondholders to see write-downs of 50% or more rather than the 21% currently envisaged in the second bailout plan, unveiled by European leaders on July 21.
Policy makers can’t afford to dither any longer on moving to ensure that a default is orderly and that euro-zone banks aren’t allowed to fall prey to a domino effect of failures that could send the global economy into a tailspin.
And while German central bankers won’t like it, that probably means a bigger, immediate role for the European Central Bank.
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