A woman shouts anti-government slogans in front of riot police deployed in front of the parliament in Athens on Thursday.LOUISA GOULIAMAKI/AFP / Getty Images
Banks are growing wary of lending to each other again, raising the spectre of another global credit freeze.
Bankers don't know the extent of each other's exposure to dicey credits primarily in Europe, and fear the worsening debt problems will erode the value of government bonds held as collateral. There is added pressure because the credit ratings of the banks themselves tend to be linked to those of their governments.
"We're on the brink of getting another lockup in the banking system," said Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y. "I think that's the next phase of this."
A return to frozen credit markets would threaten the global recovery and put added strains on already weakened bank balance sheets.
This time, those who were severely burned in the 2008 meltdown are determined to move faster should the situation deteriorate.
The key three-month London interbank offered rate, or Libor, shot up to 0.42 per cent from 0.37 and swap spreads widened, signalling tighter money-market conditions. The level is still nowhere near that of the financial crisis, but such a sharp move is troubling.
More than half the Greek government bonds outstanding are held by French and German banks, typically as collateral for loans made to Greek institutions. But only a couple have revealed the extent of their exposure, and none has explained what impact a probable restructuring would have on already shaky balance sheets.
The lack of transparency and fear of losses mirror what happened in 2008, when banks simply lost confidence in each other, as the subprime disaster cut a swath through the global financial system and Wall Street heavyweight Lehman Brothers collapsed, saddling dozens of other financial institutions with hidden derivatives losses.
At the time, banks stopped lending to other banks, brokerages and hedge funds - and liquidity quickly evaporated.
"No one knew what the linkages were, what the exposures were on the mortgage-backed securities," Mr. Weinberg said.
Today, the fear is exposure to troubled sovereign debt and related derivatives - not only Greece's billions, but other European issuers caught up in the contagion.
"What I fear in the next phase of this is that we're going to see again a rise in Libor rates, interbank liquidity becoming unavailable and another round of credit crunch, on top of the existing credit crunch we already have," he said.
Bond rating agency Moody's Investors Service poured fuel on the flames Thursday when it issued a report warning that banks in Spain, Portugal, Italy, Ireland and Britain all face increasing risks from the European crisis.
The cost in the swap market of insuring European bank bonds from default hit the highest amount in more than a year. A key index of credit default swaps on more than two dozen banks and insurers climbed nearly 40 basis points. (A basis point is 1/100th of a percentage point.) Swaps protecting Spanish and Portuguese bank debt hit record levels.
But some market participants say the sovereign debt headaches of southern Europe do not pose the same systemic risks as the subprime mortgage fiasco did.
"I suspect that it's not going to be nearly as bad. These bonds were not packaged and sliced and diced like the mortgage-backed debt," said Arthur Heinmaa, managing partner with Toron Investment Management in Toronto.
But market reaction is bound to be strong after what happened in 2008. "People are going to say: 'The last time I didn't act swiftly enough.' Now, they're going to be far more careful," Mr. Heinmaa said.
Cat:e528746c-3414-401a-b14b-50247e3bdf01Forum:d0fa4e14-88d2-41f9-8a19-896bdff9544b