Considering the TARP fund liquidity injections in the U.S. financial sector in 2008, the E.U. has decided to bail out one of its member states, Greece, from insolvency. How can this even be considered?
Yes, the EU constitution is a whopping 7 years young and therefore demands a minuscule thread of adherence by member states, as we've seen in past weeks, but it still directly contradicts two clauses of the charter, which stipulate the EU has no role in assuming the debts of any one state or backing the credit of any such state so that it may issue debt.
In making an elementary comparison between the financial meltdown in the U.S. and similar insolvency in weaker E.U. member states, let's first answer a simple question. "In the case study of financial institutions failing in 2008, who would best represent Greece... Bear Stearns or Lehman Brothers?"
It would seem that the role of the maiden union state cry uncle, akin to Bear Stearns in Spring 2008 at the Hand of then Secretary Paulson, is now cast to Greece. However, looking at the sovereign debt situation as a whole, one could make the argument that it was first the UAE who bailed out the Dubai World Sovereign Fund on Thanksgiving night 2009. For humor's sake, let's assume that Greece is the Bear Stearns of 2010 and limit our scope to the EU. It is after all a united body making decisions sure to cause repercussions, which will be at least initially contained within its members' fiscal borders.
So then of course, the second major nation to go effectively bankrupt will be one of the remaining three PIGS (Portugal, Italy, Greece & Spain). Considering the leadership in all remaining states and the tie amongst them for impotence, incompetence and corruption it could be any of the three. However the next to go will spur a decision a lot like the U.S. Lehman (OTC:LEHMQ) deliberation in 2009.
Whether anyone wants to admit it or not, it's a good thing that Lehman was allowed to fail in 2009. Yes, I said it... growl and moan all you want, but we needed a shred of moral hazard to keep our capitalist hearts beating and Lehman was the sacrificial pig. Little Timmy Geitner would have danced the populist Obama jig right down the line bailing them out one by one, but luckily Bazooka Paulson was in the midst of a grudge match with one of the largest rivals of his alma mater, Goldman Sachs (NYSE:GS). The only mistake was to then concede defeat to the frozen credit markets rather than shuffling around a smoke and mirrors bailout plan which ended up profiting the biggest U.S. banks at the expense of tax payer funded backstops. But we digress...
Unfortunately for the world, France is charging ahead and towing the rightfully reluctant Germans towards TARP 2.0. Germany is by far the most solvent of the EU states and the most crucial to a working bailout of Greece, yet France's Sarkozy is pulling the reins. The interesting sub plot here stars the leader of the IMF, the institution that would normally intercede as lender of last resort, no other than a Mr. Dominique-Strauss Kahn, the French contender for Sarkozy's office in the next election. Alas, it's no surprise that Sarkozy wants to go to bat with the tax payer dollars rather than admit a fellow EU member is among the ranks of Mongolia, Togo, Haiti, and the long list of states faced with the decision to admit IMF intervention or crumble insolvent.
So will there be a Lehman equivalent EU state nearing a bond payment one dollar too high and an EU governance that tells them tough luck? Absolutely not. There won't be a Lehman equivalent in the EU because, (a) countries are more difficult to break up and sell off than firms; (b) the expansive and centrally funded social welfare systems of European states must continue to distribute capital to citizens, lest the union be disgraced by the impoverishment of its constituents; and most importantly, (c) a currency crises due to real or assumed default by any state will have systemically negative effects on the value of the Euro itself. This will force the cost of the central welfare programs to rise across the Union, thus in turn causing a negative feedback loop where the next weakest countries to fail will default and the Euro will in turn become even weaker.
The only option for EU leaders is to bail out as many as all four of the PIGS and hope that China keeps buying our stuff. If the Chinese engine starts to sputter, the gig is up and we will see one of the most atrocious currency crises in the history of money, beginning with underlying currencies of the sovereigns which have spent the most and recovered the least since the recession began.
The IMF currently has 163 billion SDRs (Special Drawing Rights) available to loan out in the event that a country needs loan assistance. Equating to almost 250 billion USD, the current lending capacity of the IMF could cover the cumulative deficits of the PIGS in 2009 (totaling $198 billion). Glancing at the visual below, one may see that when accounting for the PIGS' summed liabilities and net debt interest in 2009, the IMF itself may not have large enough reserves to cover the outlays of these four nations should vacant labor markets continue to stress the fiscal resolve of European social security.
Greece now has the support of France and Germany, but no one really knows how the drama will unfold when the April Bond payment actually comes due. Will Spain face a similar fate as Prime Minister Zapatero grapples to reign in government spending in the face of striking unions and 19% unemployment? Can the economies in Italy and Spain find a way to continue making bond payments should jobs not return before state coffers are drained?
These questions should make for the most current drama in the seemingly bottomless pit of systemic risk. The nasty twin brother of the benefits of interdependency, from economy of scale and scope of multinational firms and massive trade agreements, systemic risk has matured from private markets to macro trade agreements and this time there may be no lender of last resort.Disclosure: No Positions