I'm Not Euro-Bashing

I'm often accused of Euro-bashing, but I like to think of it highlighting flaws in the system. Those of you who are familiar with this author know my views of European mechanisms. Basically, the problem with the European Union's institutions is that they do not have the political will to be effective, with many items requiring unanimous approval of all 27 countries. Now we are in the throes of a credit market crisis and once again Euro institutions come up short. The ECB has done what it can, flooding the Euro-denominated money markets with liquidity. However, the ECB, always walking a tightrope between the high and low growth countries, is limited to what it can do on rates nor does it have much influence outside of rates (Gillian Tett, one of the FT's best writers, wrote a piece on this on Friday. It is worth a read). It is my contention that the current problem in credit has been made worse by the heavy involvement of European institutions that have little experience in these credit issues.

If you speak with Europeans involved in the fixed income markets, (as an aside, and for the purposes of this post, the UK is not considered part of Europe) they present themselves as very knowledgeable and sophisticated. In fact, many derivative and structured products originate or find homes in Europe. Their cash bond markets are dominated by governments, Pfandbrief, and covered bonds, all triple-A or highly rated, with the latter two being secured loans with various credit supports . The European experience with credit risk is tiny, compared with the US and elsewhere. Their high yield market is relatively small and new, with little comparables on how it will perform in a crisis situation.

Herein lies the problem. Maybe part of the reason is that there isn't a culture of credit risk in Europe, brought on by generations of a welfare state mentality. Part of the problem certainly lies with rating agencies, doling out AAA ratings on products that don't meet the accepted criteria of AAA, and the over reliance on those ratings. Secured loans in the US, with its various tiers of support, is not the same as secured loans in Europe, like Pfandbrief.

Soon enough, the market here will work through these troubles, value items appropriately, punish those that were foolish, and move on. Hopefully, the same will happen in Europe, unless governments step in to bail out the banks, which is tantamount to rewarding bad behavior.