Sunday, November 20, 2011

Former UK deputy prime minister says euro going under catastrophic for UK

According to a Guardian article, former UK deputy prime minister, Lord Heseltine, observed that the euro going under would be catastrophic for the UK as it would damage both the banks and the government's financing.

Regular readers know that there is no reason to link the government's financial condition to the banks'.  The banks can continue to operate with negative book equity for years.

As shown by the US Savings & Loan crisis, so long as the government does not shut down a financial institution, it can continue to operate while being insolvent (the market value of its assets is less than the book value of its liabilities).

Furthermore, the S&L crisis showed that because of deposit insurance, depositors will not stage a run, but will continue to do business with the insolvent institutions.

Finally and most importantly, the S&L crisis showed that the insolvent institutions will continue to make loans.  In fact, there is an incentive for management to gamble on redemption and book high risk, high return loans.  Disclosure of each bank's current asset, liability and off-balance sheet exposure is needed to prevent gambling on redemption.  Market participants will look for banks that are gambling and increase the cost of and reduce the amount of their exposure to these banks.

Britain will join the euro, Conservative peer Lord Heseltine has claimed. The former deputy prime minister, a long-time supporter of the single currency, said the public had "no idea" of the potential impact its collapse would have on the UK....
"I think the chances are the euro will survive because the determination, particularly of the French and the Germans, is to maintain the coherence that they have created in Europe
"Now they have got a hell of a problem, let's be frank about it, but my guess is that they will find a way through. I hope they will because the downside for the British economy of the euro going under is catastrophic. 
"People have no idea of the scale of money British banks are owed by European banks. If the European banks start going it will be our banks that are on the line, our government on the line."
Doesn't it make sense that all market participants should know the scale of money British banks are owed by European banks?

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