The Greek crisis is spreading to the banking sector

By MoneyWeek Editor John Stepek May 06, 2010

John Stepek

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The situation in Greece turned nasty yesterday, with three bank workers killed amid violent protests in Athens.

And things don't look like they'll get better quickly. All eyes are now on the European Central Bank meeting later today. Will the ECB simply do nothing? Or might it hint at going for the "nuclear option" of directly buying government debt from vulnerable countries?

Meanwhile, the euro has continued to fall, and markets across the globe have slipped – the FTSE 100 is now showing a loss for 2010 so far.

It's little wonder that markets are panicking. Because now questions about banking sector solvency are rearing their ugly heads for the first time since the Lehman Brothers collapse...

What's spooked the banks?

As the situation in Greece gets worse, banks are apparently becoming wary of lending to one another again. The dreaded words "counterparty risk", that we all learned so much about in the wake of Lehman Brothers, are cropping up in press reports.

Says David Oakley in this morning's FT: "Banks are now more reluctant to lend to each other than at any point since the problems of Greece first blew up last October." One key risk measure – the spread between overnight and three-month lending rates – has hit an all-time high.

What's spooked the banks? It's simple. Lots of them hold government debt from the likes of Greece, Portugal and Spain. French and German banks own about €80bn worth of Greek government debt alone, says Barclays. If these countries feel the need to "restructure" their debt (that's a polite euphemism for 'stiff their creditors'), then clearly that'd have a knock-on effect to Europe's financial institutions.

The cost of insuring the banks with the most exposure to Greece against default has risen too. Don Smith at interdealer broker Icap tells the FT: "No one expects a large number of banks to collapse in the coming days or even months." But, he says, the ECB needs to get serious about helping out these economies.

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Trouble is, it's easy for pundits to call on the ECB to "do something." Yet Europe's central bank is not like the Bank of England, or the Federal Reserve. It has a lot more political and legal restrictions on what it can do.

Already, Bundesbank President Axel Weber is drawing lines in the sand. According to Bloomberg, he's warned that the Greek crisis doesn't merit "using every means" – in other words, he's not keen for the ECB to start buying up government bonds. "Measures that damage the fundamental principles of the currency union and the trust of the people would be mistaken and more expensive for the economy in the longer term."

Markets are running out of control

Yet as Ken Wattret of BNP Paribas put it: "There's a risk that the ECB doesn't do anything because they feel it's too soon to act. But something desperately needs to be done to inject confidence into markets that are running out of control."

The trouble is that as investors start to panic, their imaginations run away with them. As Gillian Tett points out in the FT, Europe is facing its "Bear Stearns" moment. The €110bn bailout package has merely reminded investors that "we are now in uncharted waters." Just as Bear Stearns' collapse showed investors that even Wall Street banks could go to the wall, Greece's woes have shown that it's not just "small, emerging market nations" that go bust. "Greece has shattered the limits now, and nothing seems unimaginable any more."

The euro is doomed

So there's a lot of pressure on the ECB to act. But regardless of what the bank does, it can't be good for the euro in the long run. If it does nothing, then it might be good for the euro's short-term reputation as a 'sound' currency, but the Greek situation is only more likely to spread and undermine the eurozone as a whole.

If on the other hand, the ECB somehow manages to circumvent Weber and decides to pursue a policy of quantitative easing, then the euro will have shown that it's no more a "hard" currency than sterling or the dollar or any of those other QE currencies.

And perhaps more to the point, the Germans will not be happy. Cultural memories of the Weimar Republic run deep, and if the ECB starts playing fast and loose with the currency, I can see the Germans looking for a way out. And that could be the most sensible option, as my colleague Merryn Somerset Webb has pointed out in the past: Why Germany should dump the euro.

As one of our new writers, Simon Caufield, has said, "the horrible truth is that the euro is doomed. It simply cannot survive in its current form". The massive gap between the conservative northern economies and their hugely uncompetitive southern neighbours is simply too great. Simon has uncovered a way to bet against the euro in the longer term, without having to spread bet. He'll shortly be launching his True Value newsletter. If you'd like to be among the first to hear when it comes out, then sign up here for regular updates.

Our recommended article for today

How to take cover as Europe implodes

The eurozone is looking more fragile every day. And then there's the uncomfortable question of our own national debt. So where should you be looking to secure your wealth? Merryn Somerset Webb explains.

Comments (10)

Published in Economics | More articles by John Stepek

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  • 1. Roger

    (06 May 2010, 11:38AM)  Complain about this comment

    Why worry about Euro? The Euro should reshape to include just Germany, France and a couple of other countries such as Belgium, and kick all the PIGS out and exclude UK for a long time.

    In empire building, doing too much in too short a time does not make sense. The same thing as in corporate world.

    The PIGS economy means nothing to the world, so just ignore them. I am sure a new born Euro will be stronger and better.

  • 2. Stephen, Preston UK.

    (06 May 2010, 12:13PM)  Complain about this comment

    Clearly the Greek fiscal position is going to weigh on the Euro.

    Is it really different though to the situation in the US where California (and other states) are effectively bankrupt? Since this has not really impacted the Dollar, it isn't obvious why even a Greek default should impact the Euro. This is especially so if you consider that Greek GDP is only a few percent of Eurozone total GDP, relatively a smaller problem than California going bust.

    The real issue is that banks have lent to the Greeks (and others) too cheaply, for too long and their customer is now unable to pay. The consequence should be losses for the banks and punitive terms for Greek borrowing in the future. Anything else provides moral hazard.

  • 3. IJ

    (06 May 2010, 03:01PM)  Complain about this comment

    Roger - do you really think the economies of Italy or Spain, let alone the entire "PIGS" as you call it / them, mean nothing to the world?

    ps - I'm never quite sure whether the I is for Italy or Ireland, but let's face it: it's a silly acronym either way..

  • 4. IJ

    (06 May 2010, 03:15PM)  Complain about this comment

    I agree Stephen that the Germans and French would have let Greece hang were it not for their banks' exposure. But that being the reason they haven't, you'd think a default would have pretty nasty consequences for several assets, including the Euro, and another flight to the perceived safety of the dollar, no?

    I'd emphasise "perceived" here, as I also agree that the situation doesn't seem that different to the US if you look at the numbers. The difference then seems to be confidence. People just have more faith in the US than in Europe.

  • 5. Michael

    (06 May 2010, 08:15PM)  Complain about this comment

    Dear oh dear. Chicken Lickens. You think the IMF, China et al are going to sit back and watch the euro implode? Some 30% of their foreign reserves are in euros. Think it through. Europe is a seriously important export market for the East which would take a bath if its currency imploded. You think they’d sit back & let that happen? The logistical nightmare associated with disentangling the euro would dwarf the current challenge. It would be Lehman’s x 10, probably more. Do the math. The euro is a young currency. Its teething problems will be resolved but project Europe is too precious to those whose know their history & more importantly are in governance. Have a bit of faith in the IMF, ECB & co. Moneyweek didn’t recruit every erudite mind out there you know. A few got work in these institutions. Sure we have problems. We are in the midst of the worst financial crisis in living memory. We’re going to have some turbulence. But we’ll muddle through it. Always have. Always will.

  • 6. Kerome

    (06 May 2010, 08:50PM)  Complain about this comment

    Please. These articles of doom and gloom over the Euro may be very much du jour, but it's hugely overblown. Spanish debt as a proportion of GDP is a mere 43%, compared to the UK's 70%+ -- that is a gigantic buffer zone, which if necessary can come from Germany who can borrow from the markets at a decent percentage or from the ECB. Even if Portugal runs into some difficulty, which is admittedly more likely with 80%-ish debt, a very large amount of Portuguese debt is held by Spanish banks and the rot will stop there.

  • 7. Stephen, Preston UK

    (07 May 2010, 11:41AM)  Complain about this comment

    Well, as of today, it is Sterling that is under pressure and the Euro is recovering ground against both Sterling and USD. Frankly there hasn't been much pattern to the last year or so of currency movement except knee jerk reactions to news as it emerges. The last few days its been the Euro and Greece, now its Sterling and a UK hung parliament. Everything's a disaster!

    Or is it? Even if there is a Greek default, they will probably have access to the capital markets again within months. At least that is what has happened for the majority of sovereign defaults in the recent past. It'll be bad, of course, but the end of the world? I don't think so.

    The truth is that there isn't a compelling story anywhere for the major currencies. Debt burdens are universally appalling, fiscal deficits are bad and not being addressed, economies are not growing through value added activity and finally the credibility of monetary systems is being damaged by QE and all its brothers and sisters.

  • 8. liber

    (07 May 2010, 06:20PM)  Complain about this comment

    Can Swiss franc last in such a strong level of currency for longer time? CHF is the strongest currency in last 30years! (maybe even longer).
    And Switzerland (Swiss banks) lent to Greece almost the same amount of money than Germany (although Germany is 10 times bigger country).
    I think all this credit (bank) crisis could break strong CHF.
    ?

  • 9. JPM, Zenium Ltd

    (09 May 2010, 10:52PM)  Complain about this comment

    This is suicide socialism. Greece cannot service its debt so what's the Eurocrats answer? Give it more debt!

    This is quite simply kicking the can down the road and everytime they do the can gets heavier and harder to kick. Until the inevitible happens and all the bankrupt European Govts go into complete meltdown together.

    As big investor Jim Rogers says, he "cannot believe adults behave like this!"

  • 10. Rupert Richardson

    (13 May 2010, 07:42PM)  Complain about this comment

    I'm probably being very stupid, here, but if I "restructure" a loan, my creditors come and take assets to the value of what I owe. If Greece can't pay, why don't the creditor banks say: "Fine. Instead of cash, we'll take over bits of Greece; hospitals, government buildings, even government services etc." We call it "privatisation". When Greece is owned by Germany/France/RBS/whoever, then they'll become tenants. Probably too silly: who'd want the Greek Armed Forces anyway?

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