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  • mariocuturic mariocuturic Feb 16, 2012 10:02 PM Flag

    Heeding Lehman Lessons

    Heeding Lehman Lessons

    The concern among U.S. officials past and present is Europe risks failing to heed lessons from the failure of Lehman Brothers, which triggered chaos in which financial institutions lost or wrote off almost $1 trillion, the Standard & Poor’s 500 Index fell 40 percent in six months and the global economy slumped into the deepest recession since World War II.

    “The one thing we should take away from Lehman Brothers is you don’t want a big systemic institution to fail in a messy way, and you clearly don’t want that to happen with a member state,” Paulson told CNBC on Feb. 15. “So when you look at Greece, I think it’s important that if there is a problem that it’s well anticipated and it doesn’t happen in a sloppy sudden way.”

    The 2008 crisis-fighters still in office are also pressing European policy makers to bolster their defenses and will likely make their case when finance chiefs from the Group of 20 meet next week in Mexico City.


    Stronger Firewall’

    Federal Reserve Chairman Ben S. Bernanke said Feb. 2 that “there is an awful lot that remains to be done in Europe” given its banking system is under-capitalized. Treasury Secretary Timothy F. Geithner, who in 2008 was president of the Federal Reserve Bank of New York, is urging European governments to build a “stronger firewall” of cash to insulate larger debt-ridden economies such as Spain and Italy.

    There remains a “tangled web” in Europe, which means lawmakers and investors shouldn’t be sanguine about a Greek default, said Ethan Harris, co-head of global economic research at Bank of America Merrill Lynch in New York, who previously worked at Lehman Brothers.

    Bank for International Settlements data from toward the end of last year suggest French banks alone had a $56.7 billion exposure to Greece as a whole and $15 billion to its government, while the U.S. had ties totaling $7.3 billion and $1.5 billion respectively, according to Bank of America Merrill Lynch.

    “History shows that when a country defaults it usually causes a default on most foreign claims,” Harris said.

    Domino Effect

    The other concern is that as Greece goes so might others, potentially leading to the breakup of the single currency. In a January analysis of credit default swaps, Danny Gabay, director of London-based Fathom Financial Consulting, found if Greece defaults Portugal faces more than a 60 percent chance of following. If that happens then the odds narrow that Ireland, Spain, Italy and perhaps even France could tumble like dominos.

    “Letting Greece go or -- worse still -- forcing it out, will not solve anything,” said Gabay. “It is effectively the Lehman strategy. It is a systemic problem and is not confined to just one or even several of the errant countries.”

    “The contagion from the collapse of Europe’s banking system to the global financial system would be swift and devastating,” he said.

    For Kashkari, a Greek default now remains too big a risk. While the ECB’s issuance of three-year loans has stabilized banks, he says the central bank may need to directly fund some countries, or governments should increase the size of their rescue funds.

    Leaders already are scheduled in March to reassess the planned combined aid limit of 500 billion euros which takes effect in July when a permanent rescue fund begins.

    “How is the ECB and the EU going to protect Italy and Spain and build a firewall around them? We don’t have clarity on that fact yet” said Kashkari. “If the fears spread to Spain and Italy, those all of a sudden could become Lehman moments.”

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