BoE chief: Eurozone crisis threatens UK financial stability

27th June 2011

The new Financial Policy Committee, a Bank of England committee chaired by King, designed to warn of such threats, identifies the following issues.

The committee fears that UK banks have major "counterparty" exposure to its fellow European banks, and a default by Greece and other sovereign borrowers could lead to the collapse of these European banks.

It is also concerned that the European debt crisis could scare markets, making them less willing to lend to anyone they consider risky, including to UK banks.

Greater market fear could also lead to falling prices for risky assets like corporate bonds, forcing UK banks to write down the value of their loans and other assets, causing them heavy losses."

Even the insurance which the banks have taken out for such an eventuality may not work. The Guardian gives a detailed consideration of why credit default swap insurance may be worthless here.

It quotes Erik Britton, a former Bank of England economist and director of financial market consultancy Fathom, who is admittedly one of the more bearish experts, saying: "If banks have taken out insurance with a hedge fund, are they comfortable that they will pay out in the event of a default? There is a chance that they have taken cover that is worthless. The banks could be facing a loss [on one side of their investment book] and they won't be able to claim the insurance [on the other side]. Then they may have to recapitalise."

The news comes as Sunday's Observer reports that the Government is discussing with British banks how they may take a haircut on Greek bonds and that ultimately means more pain for taxpayers.

It reports: "Despite the assurance of David Cameron that the UK taxpayer will not pay towards the latest EU bailout of Greece, Treasury officials are working behind the scenes to persuade British banks holding Greek bonds to take a "haircut" now as the best way to avert a potential global crisis. Britain's banks hold about £2.5bn of Greek bonds."

Observer columnist Bill Keegan tells eurosceptics not to crow. 

He writes: "Certain elements here may crow about the woes of the euro zone, but it is our main export market and, although the devaluation of the pound has restored our competitiveness, we suffered several long periods of overvaluation and the blatant neglect of our manufacturing sector. We are still in heavy balance of payments deficit, despite the devaluation and the recession."

The boss of Goldman Sachs Jim O'Neill has urged Euro zone politicians and financiers to be bolder in tackling the crisis writing here in the Telegraph.  

The key paragraph runs as follows –  

"If Europe's policymakers were collectively truly committed to Greece staying in the eurozone and not defaulting, China might try to buy all of it given the current yields on offer. Unfortunately it doesn't look as though European leaders can agree on anything very much when it comes to EMU or anything else and this is the problem. The almost daily theatre of open debate between the governments of Germany, France, many of the others, the European Central Bank and the International Monetary Fund might be quite exciting but it is hardly inspiring much belief. In some ways it is a good job that Greece has not yet adjusted its policies to be running a surplus on its primary budget position as the temptation to announce it is not paying back might be too irresistible."

O'Neill's article provokes a lot of comment not all of it favourable to Goldman.

But EU_Hero, an unusual name from the Telegraph message boards, is in pensive mood. He writes: ""As Italy has showed for much of the past 30 years that I have been in this business, if you can keep growing and keep financing costs below your nominal growth rate, then you can just about cope with a lot of debt. Then I guess there's an easy, realistic answer to Greece's travails: 29% GDP growth :  poof – magic solution."

Expatnhappy is a more typical commenter.

"I am so tired of being told that the fear of another Lehman event means that Greece's inevitable default must be delayed by the imposition of further un-repayable debt. The answer is "so what"? Lehman did fail, there was an element of chaos for a bit, some banks got nationalised, far more should have been allowed to go bust. That is how capitalism works, folks. It is just because our politicians cannot face a crisis now if they can let their successors face a worse crisis later and because economists are so totally useless at what they do, that nothing sensible is ever done. Let Greece leave the Euro, devalue and default default. Nothing whatsoever will happen that should not happen, because the sums are not large enough to matter. Yes a bit more QE may be necessary for otherwise bankrupt nations to refinance their banks: so what? Capitalism should be allowed to work. Oh and Mervyn King, who for some reason is governor of the Bank of England, is, I am told, a "distinguished" economist. So distinguished that he signed, along with over 350 other "economists" a letter warning that Mrs T's triumphantly successful economic policy for slaying inflation could not possibly work and to whom (along with 98% of all other professional economists) the financial crisis of 2007 came as a complete surprise. Why do we pay these people any attention, or indeed, pay them at all, to do anything?"

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