Friday, June 15, 2012

The can can't be kicked much more in Europe

There is spreading apprehension over the potential impact of the Greek elections this weekend. This NYT piece is full of people making preparations for euro exit and disaster scenarios.

Because there has been time to prepare, some economists say, Greece’s departure from the euro will not be as much of a shock as the collapse of Lehman Brothers in 2008, which provoked a global financial crisis. Nor is it likely to be as abrupt. Even if a new Greek government eventually decided it could no longer stay in the euro union, no one expects an immediate, hasty exit.

Of course, the argument in 2008 was that Bear Stearns had been a warning for people to prepare for a bank failure. But the market had read that as the government bailing out banks and limiting the damage . No matter how much it was talked about, few thought the US government would actually let it happen.


And in a "crisis weekend", things can move too fast for arrangements to work out in an orderly way. Treasury had still hoped to sell Lehman to Barclays, but British regulators balked. And Paulson and Bernanke later claimed they faced serious legal restrictions on wht they could do in the Lehman case.


There are likely to be unforeseen problems. I'd put who holds CDS exposure to Spain and Italy at the top of the list.


The market is so priced for problems that anything which isn't a messy collapse, or any new kind of policy initiative could spark a short-term relief rally. But the underlying situation is getting critical. It's the banking system which is the heart of the issue, even more directly than sovereign debt (which it is tangled together with.)


If there is any doubt about government ability to prop up banks, whether for logistical, fiscal or political reasons, that could ignite a firestorm of counterparty risk fears and deposit withdrawals that runs ahead of regulators ability to cope. Bank runs on entire national banking systems are beyond the ability of most individual sovereigns to deal with, if there is any doubt they cannot suddenly absorb another 30% of GDP in debt. They can offer guarantees - but their government bond markets might implode. And that undermines the credibility of the guarantees.


Capital controls are also possibke - but would be a historic reverse to the post-Bretton Woods order. They might work temporarily to shore up the system, or at least make the problem happen in slow motion. But they would be seen as partial confiscation by frightened citizens, with immeasurable consequences for the legitimacy of the government.


The can has been kicked down the road so much that it is a torn and tangled scrap of aluminum, and it is now falling apart.



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