Financial Times
April 3, 2011
Last week’s widening in sovereign bond spreads and the results of stress tests on Irish banks have reminded us that the eurozone has made hardly any progress in actual crisis resolution – in spite of its pretentious grand bargain. Over the next few weeks, I will try to map out various scenarios of how the crisis might evolve. It is probably the toughest challenge the European Union has confronted in its history. The eventual outcome will depend on a complex interaction of politics, finance and economics.
In this column, I focus on the politics of crisis resolution, beyond the well-known fact that there is opposition in countries such as Germany and Finland to large-scale bail-out regimes. This opposition is serious, but such countries also face political constraints that pull them in the opposite direction. One of those is a keen interest in avoiding a messy default. As a result, they are torn between two conflicting positions: avoiding default and avoiding bail-out.
It is intuitively clear why they do not like bail-outs. But why are they so afraid of default? I can offer three reasons. The first is asymmetric risk aversion. If you take a decision to wipe out a bondholder, you personally get blamed if something goes wrong. Europe’s policymakers do not want to end up like Hank Paulson, who as US Treasury secretary brought the planet close to cardiac arrest.
The second argument is cross-border contagion. There is a threshold of multiple sovereign defaults beyond which the financial system cannot cope. European banks and insurance companies have large intra-eurozone exposures. A default might require an immediate and potentially crippling recapitalisation of the eurozone financial sector.
More
No comments:
Post a Comment