Halloween is around the corner. So let’s conjure up a scary story.
This being a financial column, the gremlins in our tale won’t suck your blood. They’ll drain your 401(k) instead.
We’ll call our story Lehman II: With a Vengeance (and a Greek accent).
The 2008 prequel, as you’ll recall, started with the collapse of the Lehman Brothers investment house. That sent a nervous financial system into full panic, paralyzed credit, erased half the value of the stock market and deepened the Great Recession.
That movie took place in New York. The evildoers in our sequel will devour the European economy, before leaping the Atlantic.
Like all good sci-fi, we’ll start with fact before spinning off into plausible fantasy. Scene One will open with news clips of rioting Greeks, mad as hell about having to pay their debts.
Then we’ll show anguished French bankers wringing their hands over all the money they have in Greek bonds. Germans will shout “Nein!” to bailing out Greeks.
Next, a gray eminence of the financial system, his face bathed in creepy shadow, will intone that Doom is Nigh.
That’s all pretty factual. Right now, the European financial system is giving off signs of the apocalypse.
There’s an under-the-table run on European banks. American money-market mutual funds, long a main source of dollar funding for the Europeans, are fleeing the Continent. Other sources of bank funding are getting clunky or drying up.
There’s a run on the bonds of Spain and Italy, too, even though those two countries are quite solvent.
Worldwide, money is running for safety, mainly to the U.S. dollar. All that money is driving yield on the 10-year Treasury bond to the lowest levels since the 1940s. The euro is down 8 percent against the dollar since August. The Chinese yuan is weakening.
The American stock market is bouncing up and down, lately in synch with news from Europe. The memory Lehman Brothers haunts Wall Street.
In every good scary movie, there’s a scene in which the audience knows more than the characters. We know the devil is lurking in the cellar, but the cute teenagers wander clueless through the house. As they get close to the cellar door, we want to yell, “Don’t go there!”
Right now, financial officials in America, Canada and elsewhere are yelling at Europe. Treasury Secretary Timothy Geitner, the gray eminence of our tale, is warning of a “threat of cascading default, bank runs and catastrophic risk.”
In other words, “Don’t go there!”
True to the genre, European leaders are behaving like fickle teens. They’re arguing over who should bail out the Greeks, Portuguese and Irish. Not us, say the rich northern nations. Yes, you, says all Southern Europe, and America too.
Some German politicians are acting like the Bush administration when it refused to bail out Lehman in 2008. No bailouts for the irresponsible, they said. We know what happened next.
The European Central Bank is fighting, not the last war, but the war before that. It’s still fixated on the memory of hyperinflation in the Weimer Republic after World War I, when the danger now is an economy-eating meltdown.
Here’s how the plot might pan out. The Greeks, burdened by debts they can’t possibly repay, default. Greek banks, which hold lots of that debt, fail and depositors lose their money. Bank depositors in other weakling nations, Ireland and Portugal, see that and run to their own banks to pull money out. Those banks fail, putting pressure on Spanish and Italian banks. French banks, strong enough to withstand a Greek default, can’t stand a Spanish and Italian collapse. Everybody wonders who’s next. There comes a full-blown panic and credit freeze, bringing on a deep recession in Europe.
This hops the Atlantic in several ways. American banks have little exposure to European sovereign debt, but they lend quite a bit to European corporations. Three years after Lehman, derivative investments are still a black hole; no one knows our exposure there. Meanwhile, recession in Europe saps the profit of American internationals.
The upshot: falling American stock prices, tighter credit, a return to mild recession in the U.S., although nothing as bad as in Europe. Our banks, after all, are a lot stronger than they were in 2008.
What are the chances of our scary story coming true?
About 20 percent, says Paul Christopher, chief international investment strategist at Wells Fargo Advisors in St. Louis. He’s betting on sweet reason.
Despite all the caterwauling, he thinks Europe will give Greece the next payment in its bailout this month, putting off the crisis for another three months or so.
But the Greeks eventually will default. The trick will be to handle that in a way to prevent our movie from coming true.
That means pumping capital into the banks now so they can take any hit, while putting together a standby bailout fund in case things get further out of hand. Europe is assembling a $594 billion fund, but it probably needs to be $1 trillion.
The German Bundestag, after a big argument, voted to OK the smaller bailout figure last week. But to do anything in the eurozone requires 17 nations to agree.
Christopher thinks the nervous markets will force their hand over the next few months. That means a volatile time for investors until the final deal is struck.
Across town at Edward Jones, market strategist Kate Warne also thinks Europe will come to its senses. “They all see that the alternative is much worse,” she says.
They all remember Lehman. “No one wants to live that movie again. We want the movie to end differently,” she says.
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