Academic journal article ABA Banking Journal

Assessing Europe's Debt Plan

Academic journal article ABA Banking Journal

Assessing Europe's Debt Plan

Article excerpt

The realization that another global financial crisis was looming, driven by concerns about government debt in some European countries, recently spurred European leaders to implement a three-part plan. First, the plan calls for the establishment of a massive lending facility. Individual countries and the European Commission have committed to a 500 billion euro facility and the IMF will kick in an additional 250 billion euros. Governments that are unable to tap private capital markets would be able to draw on the facility.

Second, in order to bring liquidity back to government bond markets, the European Central Bank will buy government bonds, at least on a temporary basis. In addition, the Federal Reserve reauthorized swap lines with the ECB, the Bank of Canada, the Bank of England, and the Swiss National Bank in order to facilitate the dollar funding needs of foreign banks.

Third, highly indebted governments, including those in Italy, Portugal, and Spain, have announced that they will take further steps to bring their gaping deficits under control.

Will the plan work?

The market's initial reaction was very favorable. The yield on the 10-year Greek government bond retreated significantly when the plan was announced. By providing a large backstop facility, European leaders hope to convince investors to continue financing governments that are facing liquidity problems. Not a euro cent of the 500 billion facility put in place by European leaders has been spent yet, and leaders hope that not a cent will ever be spent.

In that respect, the European plan is similar to the TARP program. The combination of the TARP funds and the subsequent "stress tests," which showed that nationalization of the nation's major banks was not necessary, gave investors confidence to buy financial stocks again. …

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