Transcript of a Keynote Speech I delivered In Berlin on the 15th Sept 2010
The world has been rocked by the most major financial and economic crisis in recent history. This exposed several aspects of financial system dysfunction. These not only increased the instability of the financial markets but also impeded their normal functioning as tools to allocate economic resources efficiently throughout the real economy.
A sense of a worsening crisis has hit the EU. Sovereigns and banks are being shut out of funding markets. They find it increasingly hard to refinance their maturing bonds at affordable interest rates.
In the panic following Lehman’s collapse in 2008, EU governments took national level initiatives to provide emergency support to banks through capital injections and funding guarantees. Given that so many sovereigns are themselves unable to borrow at sustainable rates this national level approach will not work at this time.
The interconnectedness of the EU banking system is so high that the inability of banks in troubled countries to fund and recapitalize themselves through the markets is weighing all EU banks down.
Europe’s dance of death between sovereigns and banks has now turned frantic and much more dangerous. Troubled countries, such as Italy and Spain, continue to weigh their banks down. Growing problems in French, Cypriot and Belgian banks are putting pressure on the countries.
As Mohamed El-Erian argues, action is needed on multiple fronts to stem the worsening crisis but I don’t fully share his priorities.
“The Euro Area crisis has turned systemic and no sovereign or financial institution is immune to getting sucked in. The worsening problems in Greece are increasing the likelihood of a collapse of the deal agreed just in July and the large aggregate exposures of EU banks to Italian and Spanish sovereign debt have put a question mark over the solvency of individual banks as well as the EU banking system as long as these countries don’t have access to refinancing at reasonable costs. In addition near term growths prospects have collapsed increasing the likelihood of losses on assets and lowering expected profits.”
Given how important additional ECB support is to helping stem the panic in the Euro crisis at this stage, it is useful to look at how much it would actually help. An increasing number of shrill commentators have been implying that enhanced intervention from the ECB may be a 'silver bullet'. It will be no such thing. We at Re-Define have been calling for the ECB to do more since before this call became fashionable but we have no illusions about what such an intervention can achieve.