International Monetary Fund chief Christine Lagarde has warned that a “vicious circle is gaining momentum” in Europe and the US that could wreck attempts at a recovery and undermine rescue operations for Greece and other indebted EU countries.
She said “political dysfunction” was feeding policy indecision in a “dangerous new phase of the crisis” that could make a delicate situation harder to resolve.
Her comments, most of which were directed at eurozone’s chief policymakers, came as the world’s major central banks agreed to provide unlimited dollars to European banks to prevent a rerun of the Lehman Brothers collapse three years ago.
The Bank of England joined the Bank of Japan, the US Federal Reserve and the European Central Bank in a joint mission to provide dollars more cheaply than international money markets.
Stock markets reacted positively to the initiative, with the FTSE up 2% at 5337 and the German Dax and French CAC both up 3%. Banking stocks rose sharply, with BNP Paribas up as much as 22%.
Many of Europe’s weakest banks are expected to make use of the funds after finding their access to dollar loans cut off in recent months. US institutions withdrew loan facilities while the Greek situation remained unresolved, analysts said.
The European commission added to the gloomy outlook after it said the economic situation would deteriorate towards the end of the year with growth slowing to a standstill in the last quarter. It cut its 2011 growth forecast for the UK to just 1.1% from the previous estimate of 1.7%.
Lagarde, the former French finance minister, repeated her warning that eurozone banks vulnerable to a Greek default needed to boost their capital.
Exposure to Greek debt
French banks have come under the spotlight following an unprecedented lending spree to the Greek government and Greek banks. A default by Greece on its debts would leave them with a large hole in their finances. Société Générale has a total exposure to Greek government and commercial debts equal to €6.6-billion, and BNP Paribas has €8.5-billion, according to their disclosures to the European Banking Authority. Crédit Agricole has a total exposure of €27-billion.
Insurance policies sold by French banks in the form of credit default swaps (CDSs) could also result in large losses. Many of the CDS contracts offered by French banks have, in turn, been insured with other eurozone banks, which could be dragged into a crisis by the need to honour these as well as absorb their own losses on loans to Greece.
Echoing analysts who argue the core problem for the eurozone is the lack of reserves to buffer against loan defaults, Lagarde said there was a need for governments to increase their support for the banking system.
“Balance sheet pressures are knocking the wind out of the recovery,” she said. “There is still too much debt in the system. Uncertainty hovers over sovereigns across the advanced economies, banks in Europe and households in the US.
“Weak growth and weak balance sheets — of governments, financial institutions and households — are feeding negatively on each other, fuelling a crisis of confidence and holding back demand, investment and job creation. This vicious cycle is gaining momentum and, frankly, it has been exacerbated by policy indecision and political dysfunction.”
She added that while governments needed to cut their own debts this should not be at the expense of growth, in a barely disguised warning to the US, the UK and other governments with slowing economies that they risked social unrest without more aggressive policies to tackle unemployment.
“I see a number of interweaving strands here — entrenched high unemployment, especially among the younger generation; fiscal austerity that chips away at social protections; perceptions of unfairness in Wall Street being given priority over ‘main street’; and legacies of growth in many countries that predominantly benefited the top echelons of society. These issues add more fuel to the confidence crisis.”
Analysts remained deeply divided over the fate of Greece and the eurozone. Some argued the concerted effort by the French president, Nicolas Sarkozy, and the German chancellor, Angela Merkel, this week to rally support for Greece and a second bailout facility, combined with the actions of central banks, had calmed investors and bought time for Greece to sort out its finances. Others said the efforts of the banks were a sticking plaster for a situation demanding government action.
Trevor Greetham, a fund manager at US investment firm Fidelity, said: “With sentiment very negative we are seeing a strong positive market reaction to the central bank initiative but liquidity action isn’t enough to take us back into bull market mode. The dollar move is a repeat of the joint action central banks took in December 2007, early on in the last crisis. Liquidity support will not remove solvency fears as these relate to Greek default and its possible knock-on effects.
“It’s also worth remembering it is the slowdown in global growth over 2011 that is putting increasing pressure on the European periphery and lead indicators suggest that slowdown is still in place.” – guardian.co.uk