Europe is again on the brink after the Greek revolt against austerity. If Greece defaults will it be 2008-09 all over again?
In 2008, of course, the collapse of Lehman Bros brought the global financial system to the verge of a complete collapse.
Wholesale funding markets froze, banks wouldn’t deal with each other, governments were forced into bailing out institutions at a cost of trillions of dollars, they guaranteed bank borrowings and deposits and were forced into massive fiscal stimulus and quantitative easing programs.
There was a flight away from risk and a massive shift in savings towards the guaranteed banks and US Treasuries. Companies with too much leverage or those relying on access to debt markets were instantly in trouble.
The global financial crisis was a truly global event and problem. The current euro zone crisis is far more of a European affair.
The euro crisis is getting out of control, despite some softening in the austerity demands by Germany’s Angela Merkel overnight.
Since the outcome of the Greek elections the weekend before last, more than 3 billion euros has been withdrawn from Greek banks as Greek savers prepare for the capital controls and forced conversions that would accompany a return to the drachma.
That’s an acceleration of a longer-term trend – since the original financial crisis erupted in 2008 Greek banks have lost nearly a third of their deposits. In one day earlier this week about 800 million euros was withdrawn, presumably to be tucked under mattresses.
If that trend continues, Greek depositors will pre-empt the collapse of the Greek banking system that would occur if Greece defaulted and/or exited the euro zone. There is also a very real risk that depositors in other vulnerable economies – Ireland, Portugal, Spain, Italy – might take their own pre-emptive action in the knowledge that a Greek default will see the markets turn on their economies.
There is the potential for crisis and chaos to envelop Europe, with inevitably wider consequences. The rest of the world, including Australia, is, however, better prepared in 2008.
The big difference between Europe and the rest – as discussed previously – is that the US, the UK and to a lesser extent Australia have confronted the vulnerabilities. In the US and UK, the government acted swiftly, decisively and painfully to shore up their banks and other systemically important institutions with taxpayer funds.
Their banking systems are now in far stronger shape, which means their issues are now predominantly their public finances and weak economies rather than the inter-mingled fiscal and financial system crises bedevilling Europe, which relied on buying time rather than decisive action as its response to the crisis.
Australia entered and exited the original crisis in a relatively sound fiscal position, has more scope to respond to a new crisis through easing fiscal and monetary policy than any other developed economy and had and has, with Canada, one of the strongest banking systems in the globe.
Former Reserve Bank board member and prominent economist Warwick McKibbin said today that the government would have to completely reverse the fiscal strategy – the return to surplus – outlined in the federal budget if Greece exited the euro zone. The reality is that the federal government does have the capacity to do that if it becomes necessary.
The Reserve Bank has, with the cash rate at 3.75%, the capacity to do what it did in 2008 and 2009 to push interest rates down significantly.
The original crisis did highlight vulnerability in our banking system and the reliance of the four major banks on offshore wholesale funding. Since then, however, they have materially reduced that vulnerability by focusing on customer deposits, terming out their wholesale funding to reduce their exposure to short-term debt and significantly building their liquidity.
CBA’s Ian Narev said today that the bank had raised all the wholesale funds it needed for this year, which means that it could sit on the sidelines if wholesale funding markets closed or funding costs spiked. In fact, going by the recent half year presentations of CBA’s peers, the majors have probably already raised close to 80% of this year’s $90 billion or so wholesale funding requirement.
They also have the capacity to issue covered bonds up their sleeve and around $400 billion of liquidity, as well as arrangements with the RBA that would allow them emergency access to even more liquidity if they need it. The guarantee of bank deposits up to $250,000 is in place and the federal government could reinstate its wholesale funding guarantees if it became necessary.
The majors are also holding a lot more tier-one capital than they were in 2008, generally around the 10% of risk-weighted assets level. On the UK’s Financial Service Authority approach, the four Australian majors have capital adequacy ratios that average 13.5%, or about 24% more than the average major UK bank.
A Greek implosion that exports contagion and crisis throughout Europe – and the incestuous relationships between under-capitalised European banks and sovereign debt issuers that means the potential for a pan-European banking system crisis is quite real – would have an impact on the global economy and would send ripples through the global financial system.
This time, however, the rest of the world is somewhat more experienced and better prepared for a crisis than it was in 2008, when the global financial system narrowly skirted oblivion.
This article first appeared on Business Spectator.
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