Europe at the edge

About ten days ago I wrote about the eurozone’s feeble attempt to save itself through acts of financial engineering so outlandish that they would have made a CDO-squared salesman blush. I mentioned a few market prices that would tell whether the bailout accomplished its objectives. It is worth checking in to see how they are doing.

The first is the spread of Italian borrowing costs over German borrowing costs. Since my last post on the subject, this cost has spiked by a whole percentage point. This is what a bank run looks like:

This is not just a problem for Italy’s longer-term debt. Spreads over German borrowing costs for two-year periods are even higher:

Which might explain why the biggest Italian banks have lost half their value in the past six months:

This has redounded to the major French and German banks:

Bad banking problems in France and Belgium have in turn affected the creditworthiness of their sovereigns. The doom loop continues.

The politicians continue to see this as a problem of confidence and liquidity. That is a mistake. The Europeans have a problem of insolvency and imbalances. The financial problems will continue until the real economy problems are resolved.

There are ways of resolving these problems while preserving the euro. There are even ways of resolving these problems that do not require large-scale writedowns of government debt. However, nothing so far suggests that the Eurocrats will opt for these outcomes. More likely: the coming financial crisis in Europe will force the needed adjustments through sovereign defaults and the dissolution of the common currency.

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About Matthew C. Klein
I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.

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