Fears of contagion triggered by a Greek exit from the euro swept through the eurozone yesterday, wiping billions off the value of European stock markets and fuelling fears of a repeat of the economic carnage seen in the wake of the Lehman Brothers collapse.
Moody’s, the credit ratings agency, unveiled a downgrade of four Spanish regions as shares in Bankia, the bank part-nationalized this week, plunged by a quarter as the government was forced to deny a report customers had withdrawn €1billion from the bank over the past week.
The downgrade followed its decision to downgrade 26 Italian banks while fears of a bank run surged on Wednesday after the Greek officials revealed depositors had withdrawn as much as E1.2 billion from bank accounts on Monday and Tuesday.
“Rather than the beginning of the end, it could be the end of the end,” Barry Eichengreen, economics professor at the University of California and an acknowledged expert on the euro, told Emerging Markets.
“Once bank runs like this start, they can be stopped only with overwhelming force, something that the Greek government doesn’t possess and the European Central Bank doesn’t seem to be willing to deploy.”
Stocks markets across Europe fell by more than 1% while the yields on government bonds issued by the in Italy and Spain rose sharply.
Concern spread to the US where the Dow Jones last night closed down 156 points, falling for the 11th day in 12.
Eichengreen said contagion was a “very real danger”, adding: “Everyone would be asking: if Greece can go, then whey not Portugal, Spain or Italy?”
Asked what the impact of a major euro crisis would be on the wider economy, he said: “No one can say with any confidence what the ramifications would be. I worry that they would be ‘Lehman Bros. Squared’.”
This week has seen a dire warnings of a break-up of the euro. Yesterday UK prime minister David Cameron said the single currency was “at a crossroads”, adding: “It either has to make-up or it is looking at a potential break-up.”
But in an interview with Emerging Markets, EBRD president Thomas Mirow said: “I don’t believe there is a realistic chance of a breakup of the euro area, but there is a higher probability of Greece leaving the euro.
“This would be very harmful for the country and potentially for the eurozone as well, although that would not put in question the eurozone as a whole.”
But Eichengreen said if Greece quit the euro, only the ECB would have the firepower to contain the crisis, by ensuring liquidity, reassuring depositors, and capping sovereign spreads.
Christian Schulz, a senior economist at German bank Berenberg, said the EU firewalls – the European Financial Stability Facility and European Stability Mechanism – had the potential to reach E750 billion including European commitments to the IMF. “The funds are there and the ESM has enough money to protect Spain, recapitalize the banks and prevent a bank run,” he said.
However Jonathan Loynes, chief European economist at Capital Economics, said this would not be enough in the case of a major financial crisis. “The expanded capacity of the EFSF and ESM is enough to meet both Italy and Spain’s financing needs until the end of 2014. But it falls well short of the amount needed to ‘backstop’ the Spanish and Italian bond markets.”
But Eichengreen said to “draw a line” under the crisis would require economic growth. “And growth will require very different policies,” he said.
Asked whether there were signs that Germany was prepared to relax their commitment to austerity, he said: “I wish it were so, but I’m doubtful. The crisis is moving very fast.”
“We are having the most graphic possible reminder that the euro in its current form is not viable. Monetary union without banking union is an engine for instability. Monetary union without at least a limited form of fiscal union is not viable.
“If the euro survives the next decade – and I’m still betting that it will – its institutional form will be very different.”