The Crisis Spreads to Eastern Europe

The contagion from the financial crisis has spread to Eastern Europe. Growth in the region is off, credit has dried up, and falling currencyexchange rates risk setting off a repeat performance of the Asiancontagion. The Latvian government already a victim of the fallout, and the European banking system is exposed through lavish loans made during the boom years.

The IMF has stepped into the gap, but it is clearly and increasingly underfunded, leading to packages that are insufficient to stem the bleeding. A weekend summit of E.U. leaders called for recapitalizing the Fund, with the goal of doubling its current emergency fund to $500 billion. Thing is, of its current deployable assets, $100 billion is in the form of a recently sealed Japanese loan. That led Edward Hugh at AFOE (essential reading these days for the European component to the crisis) to worry about the very real risk of defaults:

If the IMF borrow $100 billion from Japan, and the loans are defaultedon, then who covers the debt, or do we just turn the IMF into another”bad bank”? I don’t think people are being at all responsible here.

Meanwhile, the question arises, where will the new round of IMF capital come from? As Simon Roughneen and Diana Ionescu point out in today’s WPR Briefing, the sovereign wealth funds that up until very recently caused such fear and alarm might be this year’s “white knights.” Trouble is, some of the SWFs have got their own capitalization issues.

And the ones that don’t, like China’s, are busy buying up equity at firesale prices, or making loans to cash-strapped resource exporters for increased access. Many of the SWFs were also already burned by taking premature stakes in the financial sector last year, so they’re reluctant to make the same mistake now.

Probably the best idea (via this Charlie Rose interview with Marc Andreessen) I’ve heard regarding the financial crisis, taking into account my non-economist ears, suggested that whether or not we bail out or nationalize insolvent banks, or create new “bad banks” to divest them of the risky assets clotting up the credit system, we should use at least part of the bailout capital at our disposal to create new good banks.

That might ultimately be the route the SWFs take, as outlined by Daniel McDowell in his WPR Briefing, Towards a Post-Bretton Woods Global Financial Architecture. But even if they ultimately do bail out the IMF, it is likely to come at the cost of a realignment of the global balance of power.