Last Updated May 17, 2010 4:09 PM EDT
Credit markets are turning tense, and even if it's not like the nail-biting days after the bankruptcy of Lehman Brothers, it's enough of a signal that more could go wrong. In the simplest terms, European banks are nervously gazing at one another, wondering who holds Greek bonds and how much, and limiting how much they loan to one another as a result.
This humdrum interbank lending greases the financial system daily, and things were getting back to normal before Greece got into trouble. Eventually, such jitters ripple through the system and limit how much businesses and consumers can borrow, or forces them to pay higher interest rates. Pounded by losses, banks simply close their vaults to the rest of us.
To be absolutely clear, there's no question that the Greek debt held by European banks is worth less than face value. Hardly a serious soul will deny privately that Greece will have to restructure its debt -- i.e. reduce the amount it pays back to its creditors. The CEO of Deutsche Bank, Josef Ackermann, said Greece will restructure last week. The chief economist of Citigroup, Willem Buiter, predicted Greek debt restructuring will happen, and called European governments "wimps" for good measure. I could go on. None of this will be acknowledged publicly by people in positions of official responsibility, but the train is headed inexorably in this direction.
Deutsche Bank researchers have said that Greek debt restructuring would cost European banks â‚¬50-75 billion, losses that would ripple through already-spooked credit markets.
This outcome is avoidable. If banks would write down their losses vis-a-vis Greece and recapitalize themselves to cover the losses, then a debt restructuring could take place with far less financial market chaos than would happen otherwise. The system would move on, and the contagion to other countries in Europe, like Portugal, Spain or Italy, would be slowed substantially. Greece, with a smaller debt load, would have a chance of getting back on its feet.
Bank executives, of course, hate this idea. Recapitalization comes either by issuing new shares, which waters down the value of existing ones, or tapping government rescue packages, which increases the political influence on their business. Executives might even lose their jobs if boards think CEOs led their banks into a dead end. But too often during the financial crisis, we've been guided by what bankers want, rather than what is needed for the good of the broader economy. Bank execs might lose their jobs if we act smartly? Tell the millions of unemployment people in this country that's a bad thing.
Periodically government officials have forced onto banks what might be unpalatable to them but the rest of us needed. In a historic meeting in the fall of 2008, the U.S. government forced capital into major U.S. banks to stabilize the system. Admittedly imperfect, and somewhat politicized "stress tests" determined which banks needed more capital, and required them raise the money before cutting the government lifeline.
In the fall of 2008, a moment arrive when governments grasped that the public interest lay in forcing bankers to do what they don't want to. Another such moment has arrived.
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