Bailouts Don’t Prevent Contagion

The euro is getting pummeled on speculation that rating agencies could downgrade Spanish debt. The NYTimes published an article criticizing the slow pace of the country’s reforms which has in turn fueled rumors about a possible request for a bailout.

The market is obsessed with contagion fears and unfortunately, bailouts don’t always prevent contagion. If you recall, the 1982 Mexico bailout did not stop the spread to Brazil, Venezuela and Argentina, and the IMF rescue package for Thailand in October 1997 did little to stop the spread to Indonesia and Korea.

Here’s some insightful comments from JPMorgan:

The bailout does little to answer questions on Ireland, Spain and Portugal; is the new “safe zone” having a line of credit that takes you out of the capital markets for 3 years? Their public sector debt burdens are not as bad as Greece, but they suffer from some of the same (or larger) corporate debt burdens and productivity gaps vs core Europe.

It’s hard to keep track of all the EMU pillars being discarded at once (no bailouts, changes to ECB collateral rules, Eurozone rating agency). Will ECB purchases of sovereign bonds be next? The Fed and Bank of England have done this in spades; but Europe is different. German Constitutional Court rulings in 1993 asserted powers to review ways in which European institutions might be exceeding rights conferred to them. Furthermore, the US and UK do not have to grapple with a history of monetization of government debt as a contributor to military, economic and social disaster (1923). That may be why Merkel remarked last month that “Europe is not only a community of peace, it is a community of stability”.

euro greece bailout contagion Kathy Lien

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