Tuesday, May 22, 2012

Spain and Greece will fall together or separately?


Europe's worst fear: Spain and Greece spiral down together

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LONDON: In a season of nightmare projections for Europe, this one could be the scariest: Greece leaves the euro currency union at the same time that Spain's banking system is collapsing.

In many ways, the market convulsion last week was a test run for those crises, as political deadlock in Greece and mounting fears over the health of Bankia, one of the largest consumer banks in Spain, converged. Moody's Investors Service downgraded the entire Spanish banking sector on Thursday.

Investors will be hoping that European leaders in Brussels, if not in Frankfurt, where the European Central Bank is based, can finally start to map out an action plan. It is not clear that policymakers have many good options.

The money available to Europe within its main bailout fund, about 780 billion euros ($997 billion) would not be enough to handle the twin calamities of a Greek euro exit and a Spanish banking implosion.

And despite recent statements from Germany and leaders of the Group of Eight industrialized nations to encourage economic growth in the eurozone, Europeans may have little desire to continue financing the debt disasters of other countries.

"When you have Greece and Spain happening at the same time, the problem becomes exponential and very, very dangerous," said Stephen Jen, a former economist at the International Monetary Fund who runs a hedge fund in London. "So far, the policy has been to buy time and build a firewall - but that just makes the cost bigger. There is just no good ending here."

The numbers do look dire.

Stephane Deo, an economist at UBS, estimates that the cost of a Greek exit to European taxpayers would be 225 billion euros, assuming Greece defaulted on the money it now owes to European public institutions.

But, he says, the real fear is that while that was happening, the slow-motion collapse of Spanish banks from toxic real estate loans could suddenly turn into a fast-moving bank run, as depositors pulled out their money.

With Spanish banks now holding deposits of 2.3 trillion euros, such a loss of confidence could be disastrous for Spain and for the highly interconnected global banking system. The financial world's assumption lately has been that it is sufficiently prepared to absorb the consequences of a Greek withdrawal from the euro. But if a Spanish banking collapse were factored in, Europe's long-dreaded "Lehman moment" might finally arrive. "The scale is just so much bigger, when you talk about Spain," Deo said.

Technocrats in Brussels will readily say that what is now keeping them up at night is Spain. They are trying to see beyond the tools that so far have kept a true crisis at bay: the two rounds of low-cost loans that the European Central Bank extended to commercial banks late last year and earlier this one, and the 780 billion euro bailout fund.

One potential new tool, according to Deo, would be for Europe to guarantee the bank deposits of at-risk countries like Spain. This would be similar to the way the U.S. government increased deposit insurance during the financial crisis in 2008 to head off a bank run. It would be an expensive undertaking, to be sure, and one that would have to be bankrolled largely by a reluctant Germany.

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