Saturday, November 5, 2011

Greek crisis not as bad as 2008 - yet

Nov 5, 2011

Things could still get far worse as political will, policy options crumble
 By Robin Chan

GREEK politics this week may have seemed like a comedy of errors to some, but there is nothing funny about the global outlook if the long-simmering euro zone crisis is not addressed urgently.

So far, the crisis has not evolved to the magnitude of the global financial crisis of 2008 and 2009, which saw Wall Street giant Lehman Brothers collapse, global markets plunge, and economies around the world cascade into a sharp and broadbased economic recession.

But as events in Europe take improbable and dramatic twists and turns, the impact on the financial system and economies around the world is becoming more and more pronounced - and bleak.

Europe now appears headed for a recession, which could easily send the global economy deep into the doldrums.

And the longer Greece delays a decision on its euro zone future and reforms to its economy, the higher the risk of contagion spreading to Spain and especially Italy, which is in a precarious state.

As an HSBC report noted yesterday, far from ring-fencing Greece, the contagion and associated credit crunch risks appear to be intensifying. If this happens, the crisis could claim much more significant victims than the likes of Wall Street brokerage MF Global, which collapsed in the past week, and Europe's Dexia Bank, bailed out earlier this year. It could be 2008 all over again.

There are three reasons why things could still get much worse.

First, euro zone debt problems are widening. As it stands, Greece, Portugal and Ireland are rotten apples that must be contained to stop contagion from spreading.

The three economies are small, and combined they are still less than the size of Spain which has a gross domestic product (GDP) of US$1.4 trillion (S$1.8 trillion).

The amount of debt is relatively small. Greece has sold US$62 billion in debt - small beer compared with the credit default swap market which ballooned to a whopping US$62 trillion in 2007 in the lead-up to the last crisis. US home loan lenders Fannie Mae and Freddie Mac also held US$5.3 trillion in mortgage assets, which led to billions of dollars of write-offs, which led to the collapse or nationalisation of many a bank in Europe and the United States.

If the problems are confined to the peripheral economies of Portugal, Greece and Ireland, the world can live with that.

But contagion is spreading to Spain and Italy as well. The latter has an economy double the size of Spain and US$2.2 trillion in debt. The Spanish government's exposure to Greek debt totals US$502 million while Italy's totals US$2.4 billion, according to the Bank of International Settlements.

As German Chancellor Angela Merkel has remarked: If Italy's debt stays at 120 per cent of its GDP, it won't matter how high the protective wall is, it won't help win back market confidence.

Already, credit spreads on Italian government bonds have blown out relative to equivalent German debt - a sign of confidence flowing out of Italy - with fears it could follow in Greece's footsteps.

The second key reason that things could get worse is that governments' ammunition may be running out, with another crisis following so soon after the last.

Back in 2009, central banks around the globe slashed interest rates and splashed out more than US$6 trillion combined to resuscitate the economy.

Worryingly, Bank of America-Merrill Lynch economist Chua Hak Bin noted that the scope for policy responses is not as great as it was in 2008.

Monetary policy has its limits, as US interest rates are at record lows in the US, while Europe's are near zero, and have just been cut on Thursday.

The US may be about to launch a third round of quantitative easing, effectively printing more money, but the first two rounds have not boosted growth much or eased unemployment.

United Overseas Bank head of research Jimmy Koh said the easier solution would have been for the European Central Bank to write a blank cheque to bail out the troubled economies, as the US did for banks at the height of the last crisis.

[This was in effect what SG govt did when they guaranteed and backed local banks.]

But European leaders are not willing to do so and have chosen to use the expanded €1 trillion (S$1.7 trillion) European Financial Stability Fund, a rescue fund to limit contagion, hoping to tap global investors including from China and Singapore.

But with the Greek outlook gravely uncertain, investors are hardly keen to step into the fray. A US$3 billion bond sale has been delayed.

The third big worry is that strong and coordinated political leadership seen in 2009 appears to be lacking.

Mr Koh noted just a handful of key players including US Federal Reserve chairman Ben Bernanke made the big, urgent decisions to avert the US financial meltdown. But in the now two-year-old euro zone crisis, there are 17 national leaders, all with differing agendas, leading to a convoluted decision-making process.

[In a crisis, a coordinated  leadership is vital to effective action. Which is why armies are not led by committee. Or in the case of the US-Vietnam war, when it is led by committee, they are less effective.]

The shock referendum called, then withdrawn, this week, by Greek PM George Papandreou drew the ire of Dr Merkel and her European counterparts, as politics is increasingly clouding an already complex policy process in Europe. The bizarre turn of events also dominated the high-level G-20 meeting in Cannes which markets had looked to for hope.

There, Singapore Prime Minister Lee Hsien Loong warned the euro crisis is already on a bigger scale than the 2008 financial crisis and that the risk of a sudden and unpredictable global contagion has risen. His message that political leadership is critical to solving economic problems must not go unheard.

Hope is dimming. The US Federal Reserve has downgraded the US' long-term growth forecast, while Singapore is preparing for below trend growth.

Most now realise that even if Greece is bailed out, there will be a recession in the euro zone and a long road to recovery.

But that will be better than a collapse of banks and even states and a global recession - a scenario that while once far-fetched, has now become ever more likely as the crisis deepens.

It is not too late to avert that disaster. The prescription is clear, but the decisions are much harder to make.

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