While the European Central Bank's commitment Thursday to lend U.S. dollars to euro zone banks has soothed investor fears, "it is no silver bullet," says John Higgins, senior markets economist with Capital Economics in London.
European banks have faced difficulty obtaining longer-term dollar-funding for a while. And the demand for dollars is symptomatic of a broader liquidity squeeze, he says.
Even if these banks face less of a liquidity problem today than they did in the crisis of late 2008, they have a greater solvency problem. This is reflected in the fact that the cost of insuring against a default by the banks is much higher, Mr. Higgins notes in a report published today.
The banks' solvency problems are connected to those of the euro-zone governments, who recapitalised the banks and transferred risk to the public sector during the financial crisis.
Today we are seeing the backlash of that move, not only because the banks own a lot of the debt issued by the governments, but also because the governments themselves are in a weaker position today to provide further support, he says.
Mr. Higgins concludes:
"How all of this plays out is unclear. But we expect a further near- to medium-term escalation of the euro-zone crisis involving the default of a sovereign in, and the possible departure from monetary union of, at least one country. If so, the solvency problem would very likely be swiftly accompanied by a re-intensification of the liquidity problem. After all, such an outcome would generate extreme uncertainty. And what bank would want to lend to another if it felt that other bank's solvency was threatened by exposure to defaulted government debt?"