Financial Times
May 24, 2011
In May 2010, the eurozone debt crisis exploded and markets plunged. A default by Greece, Portugal, Ireland and even Spain on their government bonds was feared. Investors were worried that losses on the billions of euros of debt owned by banks would be devastating for still-weak economies. Indeed, the impact on the post-2008 recovery was so severe and global that the Federal Reserve decided to spend an extra $600bn to prop up the US economy.
Is this happening again in May 2011? Certainly concerns about a debt restructuring in Greece, Portugal, Ireland, Spain and even Italy are again in focus. Banks remain a key transmission mechanism between government bonds and the real economy. Losses on bond holdings feed through to reduced earnings and eat into capital. That, in turn, reduces banks’ ability to lend to companies and individuals, knocking back growth prospects.
The recent performance of European bank bonds, as worries on sovereign debts have escalated, seems to paint a relatively benign picture. Banks’ borrowing costs have edged up, but not to the extent they did last year.
It would be a mistake to conclude that the eurozone debt woes are therefore less of a threat. European bank bonds have rallied on relief that burden-sharing in failed banks would not be as onerous as feared, muddying the picture.
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