Fear of fear itself: Is this Europe’s Lehman moment?

Economist
June 23, 2011

Contagious diseases are usually dealt with by isolating the patient, lest he infect anyone else, and then by trying to treat the illness. Isolation is not always possible with physical ailments; with financial ills, it almost never is. With the Greek government perilously close to default, investors and policymakers are wondering whether European banks have caught something nasty. Many are comparing the choices facing the euro zone and the IMF to those faced by the American Treasury and the Federal Reserve in the days before Lehman Brothers collapsed in 2008, causing a seizure in the global financial system.

The comparison is not exact. The Greek government owes more than €300 billion ($435 billion); Lehman’s balance-sheet before its failure was $613 billion. The chief difference, though, lies in complexity rather than in scale. Wall Street’s fourth-largest investment bank was at the centre of tens of thousands of interconnected trades that were hidden from view and difficult to value. Its fall caused panic because others in the markets had no way of knowing who the counterparties to its trades were and whether Lehman owed them so much that they too might fail.

That ought not to be true of Greece. It has far fewer creditors: two-thirds of its debt is probably held by about 30 institutions. And whereas Lehman’s exposures were hidden from public view, Greece’s are largely out in the open and are also reasonably easy to value. The more light has been shone into the dark vaults of banks holding Greek government debt over the past year, the more markets have been reassured that few, if any, foreign banks are dangerously exposed.

According to public data collected by Barclays Capital, an investment bank, few foreign banks’ holdings of Greek government bonds are worth even 10% of their capital (Greek banks are a different matter: see chart 1). That means they should comfortably withstand the substantial losses that might arise if Greece said that it would repay less than 100 cents on the euro. Softer forms of default, such as extending the maturities of existing bonds, would probably cause almost no harm to the financial system, especially if the interest payments remained the same as when the bonds were issued.

More