The spread between secured and unsecured lending in the interbank markets as measured by the spread between 3-month Euribor and 3-month Eoniaswaps has taken a dangerously similar path to before the collapse of Lehman Brothers.
Figure 1: 3mth Euribor spreads 2011.
Figure 2: 3mth Euribor spread 2008.
One obvious difference from the charts is that the 3-month Euribor/Eurorepo rate is wider in 2011 than the Euribor/Eoniaswap spread was in 2008 when the two spreads were almost identical. This indicates a high demand for high quality Euro-denominated secured lending in the short-term money markets and suggests that banks are storing hoarded cash in repo.
In 2008, policymakers unleashed a number of measures from extreme monetary easing to massive recapitalisation of the banks to convince the markets that governments would be ready to do whatever was necessary to save the banking system on which the rest of the economy depends.
The concern of moral hazard was overlooked because it was deemed that the patient was too critical to wait for a rewriting of banking regulations which could have taken many months of negotiation. Months that the banking system did not have. Without doubt, reform of the banking system was needed but ending the panic in the markets was more important and less damaging to the wider economy than no action at all.
Europe’s leaders must look back and learn from the credible and decisive actions in 2008 if the ongoing damage to Europe’s economies is to be mitigated. With loans likely to be in place for many years, the lenders will still have plenty of ammunition to ensure Europe’s weakest reform.
Firstly, the Euro-Zone economy needs a lender of last resort and for a less painful convergence, Germany must ease back from its immovable insistence of price stability. Flexibility of policy is surely needed to find the best solution to the crisis.