Life After Achilles

After the briefest stint of optimism in the aftermath of the 2008 crisis, it seems the global economy has once again fallen ill. Stock indices have trended southward, growth projections have stagnated, and CDS spreads of staple financial institutions have surpassed even their 2008 highs. Furthermore, we now bear witness to a revolution that has taken a whole three blocks hostage in the financial district (tehe). In the midst of all this, our eyes turn to the poster child of the global sovereign debt crisis—Greece.

Ironically, there are few things more frustrating than the confidence of Greek politicians, who assure us that austerity measures taken are sufficient enough to avoid a national default. This is simply untrue, and the world won’t buy it. The root cause of uncertainty throughout the global financial markets spurs from instability in the European banking system. This instability comes from a failure of European banks to value the Greek debt they hold on their balance sheets. Any hope for stability, therefore, must begin with a solution to Greek debt. Unfortunately, this must begin with Greek default.

Prospects for resolution, though grim in some respects, should encourage those concerned for Europe. For starters, Germany and France have pledged their full support towards the health of European banks. Their claims appear to be sincere, and global markets have responded accordingly. Second, the value of Greek debt is much easier to determine than that of the mortgage backed securities of the 2008 crisis, whose value depended on innumerous variables ranging from credit of sub-prime borrowers to crony ratings agencies. Conversely, components of Greek debt are easier to rate. As a result, the imminent restructuring of debt will be an efficient process. This is doable, but not without difficult policy decisions.

Even though the path towards stability is ominous (banks will surely be hurt by the coming default of toxic debt), it is possible. The sole obstacle is the conviction of the European Central Bank. We can seen the cancerous effects of allowing a large bank to go under; at a time like this, principle must not take precedence over history. The ECB is notorious for being susceptible to political influence, which poses this important question. Will the ECB, as the Fed did in 2008, stand by the banking system and help them weather the storm of defaults? For the sake of the global economy, we must hope so.

by Abhi Kanakadandila