Monday, 10 June 2013

IMF Greece Report Was Flawed. EU Did Even Worse.

In an internal report released this week on its involvement in Greece in the past few years, the International Monetary Fund takes on the European authorities much more bluntly than usual. Greece came to the IMF in 2010 later than it should have and needing more resources than could readily be provided -- primarily because of foot-dragging by its euro-partners. The Western Europeans also resisted Greek debt restructuring for far too long, creating a major handicap for the rescue program.
All of this is undeniable, but also relatively easy for the Europeans to dismiss. And dismissiveness was exactly the reaction from Mario Draghi, president of the European Central Bank, and from the European Commission. Their line is: Mistakes were made, and now we are on the road to recovery -- so why worry?
In fact, the IMF staff fully understands -- but cannot speak openly about -- a deeper and more serious weakness in the euro area that threatens not just Greece but all of peripheral Europe today. European banks are woefully undercapitalized -- meaning they operate with very thin cushions of equity financing (and therefore fund their balance sheets with 95 percent or 97 percent debt). As a result, they have only a very limited ability to absorb losses, creating the potential for insolvency to spread throughout their financial system -- and around the world -- in unpredictable ways.
The Europeans live in fear of encountering their own Lehman Brothers moment, when a relatively moderate fall in debt values triggers widespread panic and another round of collapse in the real economy.
For this reason, when a significant debt restructuring was first proposed for Greece, the financial elite of the euro area was united in their opposition. German and French officials were among those most worried by what could happen if Greece defaulted or even had an orderly restructuring.
The American financial system is no picnic, with our Dodd-Frank financial reforms substantially stalled by Wall Street lobbying, but even our worst-run big banks are in much better shape than most of their European counterparts. Deutsche Bank, BNP Paribas and Credit Agricole routinely operate with $50 billion to $100 billion in equity capital, with balance sheets in excess of $2.5 trillion. Risk has been mismanaged within those institutions and by their regulators. Deutsche Bank, the worst of a bad bunch, is frequently referred to by market participants as a very large hedge fund. It is not meant as a compliment.

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