Europe’s “Lehman moment” has passed, but a crisis of confidence remains. The lack of confidence is holding back our local economy.
The June 16 parliamentary elections in Greece passed without a steep sell-off in financial markets. Many traders stayed up all night that Sunday, fearing what the outcome would spark Monday morning.
A coalition of political parties willing to keep the Euro won the election, and panic was averted. For the time being, Europe has avoided a crisis.
The “Lehman moment” for the United States was a Sunday announcement in September 2008 that investment bank Lehman Brothers was filing for bankruptcy. There was widespread panic in the markets the next morning, and the event is cited by many as the trigger for the financial crisis and Great Recession.
However, in 2009, U.S. bank profitability returned and balance sheets improved. What turned things around was a comprehensive audit of major banks. In May of that year, the results of the Supervisory Capital Assessment Program (SCAP) were reported, a turning point in the recovery of the U.S. economy.
At the time of the announcement, volatility in the stock market was at record highs and prices at record lows. Since the announcement of these so-called “stress tests,” the stock market is 50 percent higher and interest rates have remained low.
The SCAP served to increase transparency in the banking system by identifying both strong and weak institutions. Transparency keeps the financial system working well. When credible tests on the health of the nation’s biggest financial institutions were reported, the financial markets breathed a collective sigh of relief.
The European banking system has had no such relief.
European bank regulators conducted similar stress tests, but these studies lacked credibility. In July 2011, the European Banking Authority published a report assessing the viability of 90 large European financial institutions against “deterioration in macroeconomic variables” such as gross domestic product, unemployment and house prices.
The problem with these tests was the definition of deterioration. The regulators used, for example, a potential write-down of Greek government debt of only 15 percent. But at the time Greek bonds were already trading at half their face value, and these bonds are now in default.
The European banking crisis has now moved to Spain. Despite the promise of 100 billion euros to bail out Spanish banks, investors are fleeing markets. Sparking the run is news that a required bank audit report will be delayed. Without a credible assessment of these institutions, it’s hard to know if 100 billion euros is enough.
A resolution of the European banking crisis will go a long way in helping the economy here. Too much capital is tied up in “safe” assets.
It’s a consistent pattern for all investors, banks included. In times of market turmoil, capital flows to the safety of U.S. government debt.
According to the Federal Deposit Insurance Corp., Idaho banks now hold more than 17 percent of their assets in U.S. government securities, compared with less than 14 percent at the same time last year.
European banks need to open up their books and let investors sort the good from the bad. Global, national and local economies will all improve when we get past this latest crisis of confidence in the banking system.
PETER CRABB Professor of finance and economics at Northwest Nazarene University in Nampa