The late Rudi Dornbsuch of MIT had a way of cutting to the chase, preferably in public and with a minister of finance present. He knew a huge amount about financial crisis, and could distill a lifetime of study and involvement in collapses succinctly: “it always takes longer than you think; but when it happens, it always happens faster than you can imagine.”
The latest credit default swap data for European banks bring Rudi’s perspective to mind – for the United States. We’ve debated this week what to do about U.S. banks, arguing about which unappealing options are less bad. In my view, the choice is not “nationalize vs. don’t nationalize,” but rather “keep our current partial nationalization/bottomless pit subsidy system vs. start down the road to reprivatization.”
But, honestly, this entire debate may be overtaken by events.
Economic developments in East-Central Europe are very bad. Almost everyone will get IMF loans but, be that as it may, there is a big contraction underway. Nonperforming loans will increase for the West European banks lending to East-Central Europe or lending to firms that are (or were) exporting. Prominent European governments will struggle to afford the implied bailouts – remember, back in October these governments made it quite clear they are on the hook if their banks come under pressure. At the same time, of course, we have a nose dive in property in Ireland, Spain, and the UK.
My point is not that Europe is in big trouble, with no plausible regional rescue mechanisms in place. This is completely obvious – the debate among prominent Europeans is now whether or not to send distressed eurozone members to the IMF, and on what basis.
Focus on this instead: the European banking and fiscal fiasco is a dagger pointed at the heart of major US banks, which have a great deal of exposure – one way or another – to much of Europe. Ask any U.S.-based “global bank”.
Treasury is constructing an elaborate transfer mechanism through which big banks can be kept in business, thanks to the public purse, without the taxpayer acquiring a majority of the common stock. The contortions required are striking. But this entire approach is predicated on a rosy stress scenario, which assumes the global economy cannot get much worse, at least in the short run.
It may soon be time to wake up.