Tuesday, April 20, 2010

The Greek saga drags on

Quiet on the blogging front? Never apologise, never explain.

Free Exchange quotes an interview from Der Spiegel:

Schäuble: [W]e have experienced a financial crisis from which we in Europe must draw a clear lesson: We cannot allow the bankruptcy of a euro member state like Greece to turn into a second Lehman Brothers.

SPIEGEL: You are exaggerating. In past years, it's happened again and again that a country couldn't pay its debts, and yet that hasn't led to a collapse of the global financial system. Why should this be different in Greece's case?

Schäuble: Because Greece is a member of the European monetary union. Greece's debts are all denominated in euros, but it isn't clear who holds how much of those debts. For that reason, the consequences of a national bankruptcy would be incalculable. Greece is just as systemically important as a major bank.

The point is that many financial institutions hold a mix of sovereign debt to match long term liabilities. Many Euro area bonds trade in step with each other, with a spread correlating to perceived risk. A Greek default will increase the yield on everyone else's bonds, and this could lead to a second, more serious financial crisis. The first one was resolved by backing it with the might of the dollar: it's not clear if the unique conditions of the Euro area could create a credible European equivalent.

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