The European Banking Crisis of 2011

The Real Time Economics blog of the Wall Street Journal pointed out today that the European banking sector needs to refinance $1.65 trillion in 2010-11. To put that in perspective, in the next 12 months, the US Treasury will refinance about $2.5 trillion of maturing debt [pdf], and will probably issue another $1.5 trillion in new debt[pdf]. Taking into account the differing time frames of those amounts, the financing demand of Euro-area banks is apparently 20-25% of the US Treasury.

The big deal with Greece this spring wasn't about whether or not Greece could repay its debt; it can't. All the European Central Bank (ECB) and the IMF did was to put the restructuring off for three years, in hopes that the holders of Greek debt — predominantly European banks — would be in better financial condition, and thus be better able to absorb the inevitable losses when that restructuring ultimately occurs. While the ECB-IMF package was widely described as a bailout of Greece, it was in fact a bailout of the European financial system. (It is in that way similar to the support given to AIG by the Fed and Congress, the actual beneficiaries of which were AIG's counterparties: Citigroup, Bank of America, Goldman Sachs, etc.) As those three years shrink to two, European banks will come under increasing scrutiny and that will be reflected in increased borrowing costs.

Greece had a lesson this spring on how quickly interest rates can rise. During the early part of this year, 10 year Greek debt yielded about 6%; it spiked above 20% just before the ECB-IMF package was announced, and now sits at 10% or so. If the market is unwilling to refinance at rates that allow these institutions to survive, then it will be up to the ECB to provide the necessary backing, basically the European equivalent of TARP. The ECB overstepped its authority in resolving the Greek crisis; it will have to do so again on a much grander scale should the market opt out.