Friday, November 26, 2010

Does Germany really want a European financial crisis?

The Irish, Greek, and Portuguese banks are losing (have lost)  access to the debt, repo and interbank markets. They are dependent upon the ECB to provide them with funding as their short and long term debt matures. It is very unlikely that the markets will reopen, irrespective of the receipt of EU rescue funds. Germany’s insistence that creditors lose money in the event of a bailout has nailed shut the door to the capital markets.

The ECB is very uncomfortable about becoming the largest creditor to these countries and their banks (ECB loans are secured by the peripherals’ bonds, which are risky due to the German “bail-in” scheme).

The ECB’s emergency funding expires in mid-January, and board members are publicly advocating that the funding scheme expire on schedule, thus hanging the peripherals out to dry.

If the peripherals lose access to the ECB, they and their banks will have no choice but to default, imposing large costs on their creditors, including the ECB. This would create a world financial crisis on the scale of 1931.

Someone in Germany is going to have to blink between now and January.

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