Four years and a couple of trillion dollars worth of rescue packages after the eruption of the sub-prime crisis in 2007, we are nowhere near resolution of the “North Atlantic Financial Crisis”. The Great Recession may have ended in late 2009/early 2010 but global growth has not really recovered and the world is now staring at the possibility of a “Eurozone Financial Meltdown”. If that does happen then it could be a more prolonged recession this time around.
In the aftermath of the 2007 meltdown, economies with three traits were at risk: (a) those whose banking systems had huge exposure to toxic assets; (b) those who had an unsustainable debtdeficit situation; and (c) those who had a large chunk of sovereign debt held externally. The Eurozone with a single common currency but different country-specific configuration of debts and deficits turned out to be the most vulnerable. If Iceland (not a member of the European Union) was the first to show signs of a major problem, Ireland followed soon after and then it was Greece
with the most severe financial and economic challenges. With the assurance of an implicit EU guarantee, the speculators in the government bond market became more active in repricing the
debt of weaker economies and they started believing that the Greek problem was, after all, a problem of Germany as well since the latter was the biggest economy in the single currency area.
Since contagion was a real issue, what started with Greece slowly spread to Portugal, Spain and even Italy.
The International Monetary Fund’s (IMF) “Global Financial Stability Report” (GFSR) of September 2011 has noted, “After four years of financial crisis, public balance sheets have been saddled with onerous debt burdens… Lower tax revenue, weaker growth prospects, and large-scale support for ailing financial institutions have driven public finances into precarious territory. In many cases, these challenges have been added to a legacy of fiscal irresponsibility, as some governments lived beyond their means during more benign times” (p 4). While railing against fiscal irresponsibility has been the mantra of an institution which has been dubbed as “It’s Mostly Fiscal”, mention of irresponsible financial institutions or the role of speculators in the crisis is conspicuously absent in the GFSR.
Which are these irresponsible states? While the crisis has brought to the fore the rift between the core and the periphery of the Eurozone, of late the differences between them seemed to
have blurred. The crisis has spread from Europe’s peripheral countries like Greece and Ireland to the mainstream advanced European economies like Italy. While noting that “Sovereign
strains have spilled over to the EU banking system, increasing systemic risks”, the GFSR holds political uncertainty and the perception of a weak policy response responsible for the erosion
of market confidence. Political uncertainty seems to have emanated from the tension between the centre and the periphery at one level, and between accepting the need for fiscal rectitude versus saving an individual economy at another.
How do we see the immediate future? While it is convenient for market fundamentalists to blame the lack of political will for any and every economic malaise, as of now there is not much evidence in Europe of the ability of all economic actors – public and private – to bite the bullet. Various options are being talked of. A huge IMF-EU rescue package, a fresh round of debt restructuring and belttightening on the part of the affected countries are all blowing in the wind. While Germany is extremely mindful about the sanctity of the Eurozone and the need for fiscal prudence, the exposure of French banks to Greek sovereign assets makes them vulnerable to a default. Private sector investors are worried that voluntary private sector participation in any Greece-style debt restructuring could set a precedent for other Eurozone IMF programme countries. This has taken the spreads on credit default swaps to abnormal levels.
A number of competing views seemed to have emerged on the ideal package of policy intervention. There is an influential branch of opinion which feels that Greece, with an unsustainable debt
position, should default, leave the Euro, and reintroduce the drachma while the market players too bear some of the burden of their irresponsible lending. Another view is that the EU itself needs
to do much more. The 21 July summit of the Eurozone leaders decided to lengthen the maturity of future European Financial Stability Facility (EFSF) loans to Greece to the maximum extent
possible, from the current 7.5 years to a minimum of 15 years and called for private sector involvement. This sentiment has found an echo in the communiqué of last week’s meeting of the International Monetary and Finance Committee of the IMF, which noted, “Euro-area countries will do whatever is necessary to resolve the euro-area sovereign debt crisis and ensure the financial stability of the euro area as a whole and its member states”.
But there continue to be confused signals from Europe. The reported split in the Euro countries over the terms of Greece’s second €109bn bailout, with as many as seven of the Eurozone’s
17 members arguing for private creditors to take a bigger share in write-down on their Greek bond holdings, needs to be juxtaposed against the German parliament’s recent approval of the expansion of the bailout fund for heavily indebted European countries.
The scenario as of now looks quite chaotic. In the days to come, whether the centre will hold or things will start to fall apart in the Eurozone will be closely watched. In all the pan-European
political wrangling over an expanded and modified EFSF, private sector involvement in restructuring, recapitalisation of European banks, exposure of the financial institutions to downgraded
sovereign debt, and the clamour for fiscal prudence (read, increased taxation and reduced social expenditure), the travails of the affected people have become a casualty.