Wednesday, July 27, 2011

Sovereign Default and Banking Collapse

In a recent stress test of selected European banks, the European Banking Authority made it known that it did not test what would happen if a country defaulted on its debt. Not Greece, not Portugal, not Italy and not the United States.

That means, at the least, that the official outcomes of the stress tests are useless. More seriously, it means that the EBA's official position on the possibility of default (that politicians are talking about amongst themselves very prominently) is that they don't want to talk about it. That is tantamount to reckless endangerment of the European financial system.

Given the obvious possibility of default, and the necessity of factoring it into stability scenarios, the only real question is: who is responsible for ordering the bank regulators to back off from the truth? Possibly, it is the bank regulators themselves who are shielding banks from the light of day. That would be bad enough. But it isn't likely that they could do such a thing without heads of government allowing or insisting that they do so.

Europe and its people deserve better. The EBA without realistic stress testing is, as my grandfather would have said, as useful as tits on a bull.

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