Friday, December 31, 2010

2010 Best of the Blog, XI

. Friday, December 31, 2010

Readers: Over the next week or so we'll be re-posting some of our favorite posts from IPE@UNC from this year, interspersed with new content. Partially because blogging is so ephemeral, and some of our posts are worth revisiting. Partially because it's winter break and we've got eating, sleeping, and catching up on research to do. Nominations welcome.

From May 10, "Parsing the Euro Bailout":

Well. The much-anticipated Euro bailout plan has been revealed, and it's impressive: just short of $1tn, $625bn of which comes from Euro governments, and the rest from the IMF*. Why so large?

Officials are hoping the size of the program — a total of $957 billion — will signal a “shock and awe” commitment that will be viewed in the same vein as the $700 billion package the United States government provided to help its own ailing financial institutions in 2008.

Yes, that's part of it. But the reason why TARP was so big was so that it wouldn't actually have to be. In other words, the U.S. government hoped that by making an enormous commitment to secure illiquid/insolvent institutions that were susceptible to runs, it would prevent those runs from even occurring, thus saving the actual financial commitment in the long run. To some extent this happened, as only about half of TARP's funds were ever disbursed (even after extending loans to non-financial firms, like the auto makers). I'm sure that Euro governments are hoping for the same thing; if the commitment is perceived as being sincere, then part of the follow-through may become unnecessary.

Euro governments aren't the only ones hoping to instill confidence:

Underscoring the urgency of the situation, President Obama spoke to the German chancellor, Angela Merkel, and the French president, Nicolas Sarkozy, on Sunday about the need for decisive action to restore investor confidence. And in a sign of the spreading anxiety, the United States Federal Reserve, along with the European Central Bank and the central banks of Canada, Britain and Switzerland, announced the establishment of instruments known as swap lines. The swaps are intended to ease pressure on European banks and money markets by providing more liquidity. ...

The actions by the United States represented significant concern that the European crisis could spill over and hinder the American recovery.

Why might that be? Well, who owns all the sovereign debt of Greece and the other PIIGS? Already-weakened banks in the U.S. and Europe. U.S. banks are exposed to European banks to the tune of $3.5tn (yes, trillion), and if Greece or any other countries default, those European banks will go under and take U.S. banks with them. Obviously that can't be allowed to happen. The recent ratings downgrades of Greece's debt have already dealt a blow to banks' capital ratios. A default or restructuring would be devastating.

But this new bailout cash has only been pledged, not actually raised, so here's what I'm going to be watching over the coming days:

In a statement after their meeting, the ministers emphasized that the [funds] would expire after three years and that its use would be strictly dependent on “national constitutional requirements.”

The language most likely reflected the reservations of some governments to providing even more money than is available in bailout packages already approved.

Remember that TARP did not pass the House the first go-round. Europe now has to pass several of them in several different countries. There are strong domestic political pressures in some countries (notably Germany and Britain) to not bail out the PIIGS at all, and it might be very difficult to muster enough domestic support to actually procure this huge level of funds. Perhaps more distressing is the fact that Greece could end up defaulting anyway because of domestic politics there. A lot of national polities have to play ball in order for this to work the way it's supposed to work, and I'm not sure whether that will actually happen.

One thing is clear: one way or another, the eurozone will never again be as it was from 1999-2009. The mandate of the ECB is already shifting, the likelihood that one or more countries will leave the monetary union is still somewhat high, and the rise of economic nationalism throughout the zone indicates that there is less camaraderie than previously thought. Something's gotta give.

*Presumably the IMF funds will also be coming from Euro governments, although I'd be interested to see if that's actually the case. How will voters respond if the U.S. is spending $100bn to bail out Europe? Not well, I imagine.


2010 Best of the Blog, XI
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