LONDON (Reuters) - Here are factors behind the failure of euro zone policy makers to contain the spread of the Greek debt crisis through financial markets, drawing on the lessons of past financial crises.
LACK OF PREEMPTIVE ACTION. An International Monetary Fund study of the Asian financial crisis of the late 1990s, published in 1998, said early action by policy makers was crucial in preventing crises from building.
In 1998, when a Russian debt default caused global jitters about sovereign credit risk and hit hedge fund Long-Term Capital Management, which had assets of over $120 billion, quick action by the U.S. Federal Reserve appeared to prevent a wider crisis. Within several weeks, the Fed organized a bailout of LTCM; it cut interest rates three times in three months. Another IMF study found, “The Federal Reserve actions may have staved off a far more dramatic crisis.”
Because of the reluctance of Germany and some other euro zone governments to participate, this week’s 120 billion euro ($140 billion) bailout of Greece was assembled about six months after the crisis began building. By that time Greece’s 10-year bond yield had soared above 10 percent, effectively shutting it out of the debt market.
The European Central Bank took one preemptive action this week, suspending its minimum credit rating standards for Greek government bonds used as collateral in its money market operations; this will allow continued use of the bonds if Greece is downgraded by more rating agencies. But the ECB, seeking to protect its reputation for conservative monetary management, said on Thursday it had not even discussed taking the one radical step that some analysts believe is necessary to calm the markets: buying government bonds from the market.
The delay in taking action has narrowed policy makers’ options. Some analysts think restructuring Greece’s 300 billion euro debt is inevitable to cut the problem to a manageable size, but the markets now seem too unstable to negotiate that without causing fresh panic. German Finance Minister Wolfgang Schaeuble said on Thursday any restructuring of Greek debt would cause “exactly the kind of conflagration that we could no longer control”.
BAILOUT MAY BE FOCUSED TOO NARROWLY. The Asian crisis snowballed over five months in 1997 as first Thailand, then Indonesia and South Korea requested and obtained IMF aid. Markets began a broad-based recovery only after the IMF had dealt with all the major weak spots in the region.
Stephen S Roach, chairman of Morgan Stanley Asia, said of the Greek crisis this week: “In some respects what is going on in southern Europe right now feels a lot like what went on in south eastern Asia in summer 1997 with the crisis in Thailand. It then spread.
“You can’t stop pan-regional vulnerabilities by addressing the weakest link if there are lots of weak links. It’s difficult to stop the bleeding with a package directed at only one country.”
So far, euro zone policy makers have insisted there is no question of any need for bailouts of Portugal, Ireland and Spain, widely seen as the next potential “dominoes” in the crisis. More bailouts would be controversial among euro zone taxpayers; officials may also fear talk of more bailouts would scare markets. But if policy makers do not admit the possibility, they risk seeming blind to the scale of the danger.
FINANCIAL FIREPOWER MAY BE NOT BE ENOUGH. Markets began turning around during the global financial crisis of 2007-2009 after policy makers promised sums of emergency aid that seemed more than sufficient for almost any scenario.
For example, the U.S. Troubled Asset Relief Program, which was used to aid banks, the auto industry, insurer AIG and many other recipients, totaled $700 billion when it was approved by Congress in 2008. The Treasury has since said it does not expect to deploy more than $550 billion, and has actually disbursed less than $400 billion.
The 110 billion euro ($140 billion) package of emergency loans for Greece is billed as a three-year bailout but may not be large enough to cover the full three years. Economists at several European financial firms estimate Greece’s borrowing needs through end-2012 at 120 billion euros; Germany’s Bild daily cited a government estimate of 150 billion euros given to the parliamentary finance committee.
Greece will therefore need to resume borrowing from the markets some time in the next three years. Analysts fear that given the scale of Greece’s debt problem, this may not be possible. After the Russian default of 1998, it took two years for the first Russian entity, a bank, to return to the international debt market; Argentina has still not done so after defaulting in 2002.
DISAGREEMENTS AMONG DONORS. The U.S.-led bailout of Mexico in 1995 was complex and controversial, including contributions from the IMF, the Bank for International Settlements and the Bank of Canada. It faced public opposition within the United States, where Congress balked at passing it, and some European creditors expressed concern that their interests could be hurt. However, Washington took unchallenged leadership of the bailout, which convinced markets that Mexico would be rescued. President Bill Clinton bypassed Congress by invoking emergency powers to provide $20 billion.
The Greek bailout has been marked from the start by difficult negotiations among euro zone governments on the language of the aid pledge, the structure of the deal, and whether and how to involve the IMF. ECB policymakers opposed the role of the IMF before expressing approval of it when the bailout was announced. These disagreements have left markets wondering whether the commitment of key donor countries such as Germany to the bailout could fade over time, especially if Greece does not hit fiscal conditions in the deal.
Since the announcement of the bailout, policy makers have continued to sound at odds on some issues. Germany has asked its commercial banks to contribute to the bailout and said other European banks are likely to contribute too, but French and Italian officials have said banks in their countries are not being asked to do so.
Euro zone governments have stressed the Greek bailout is a one-off deal and they do not have an explicit, permanent mechanism for bailouts, meaning the rescue of another weak country such as Portugal could require additional months of negotiations. The European Commission is to propose a permanent mechanism for handling crises on Wednesday, possibly drawing on a German proposal for a European Monetary Fund, but its creation may require controversial changes to the European Union Treaty that would require many months.
BLAMING THE MARKETS. Euro zone policymakers and officials have repeatedly blamed excessive speculation, rather than countries’ fiscal weaknesses, for much of the markets’ volatility. They have demanded a “crackdown” on speculators and on Friday, the Committee of European Securities Regulators launched a consultation process to introduce mandatory transparency rules for derivatives linked to foreign exchange, equities, interest rates and commodities.
“To some degree this is a battle between the politicians and the markets,” German Chancellor Angela Merkel said on Thursday. “But I am firmly resolved — and I think all of my colleagues are too — to win this battle.”
Many analysts view such rhetoric as counter-productive, by suggesting policy makers are more concerned with scoring political points than in addressing root causes of the crisis.
Editing by Jason Webb