Bankia's president, Jose Ignacio Goirigolzarri, arrives for a press conference at the bank's headquarters , in Madrid, Saturday, May 26, 2012. Spain's troubled bank, Bankia, has asked the Spanish government for 19 billion euro ($23.8 billion) in financial support just as a leading credit rating agency downgraded it to junk status. The request came as Standard & Poor's downgraded Bankia and four other Spanish banks to junk status because of uncertainty over restructuring and recapitalization plans.
The joke recounted by the boss of a large Italian bank is an old one, but it captures the moment. Two hikers are picnicking when a bear appears. When one laces up his boots to run, his friend scoffs that he can't outrun a bear. The shod hiker retorts that it is not the bear he needs to outrun, merely his fellow hiker. "We're sitting at the picnic with our boots still on," says the bank boss.
As policymakers and pundits try to work out the effects of a Greek exit, banks and investors have already been taking precautions. One course of action has been to pull money out of more fragile markets. Never mind the weakest economies like Greece, Ireland and Portugal; Spain and Italy have lost foreign bank deposits of about 45 billion euros ($56 billion) and 100 billion euros, respectively, from their peaks. Add in things like sales of government bonds by foreigners, and capital flight is probably equal to about 10 percent of GDP in those countries, say Citigroup analysts. Such outflows are hard to stop.
The European Central Bank (ECB) has filled this funding gap by providing liquidity to banks. But that has in turn reinforced the second precautionary tactic: matching assets and liabilities within countries as much as possible. It is a common refrain from bankers that the euro area no longer functions as a single financial market, although that has the paradoxical advantage of making a breakup less destructive. Banks have used ECB loans to borrow from the national central banks of the countries in which they have assets; that should mean that both sides of the balance sheet would get redenominated in the event of a euro exit.
Much of that ECB liquidity is meant to find its way into the real economy, of course. But the third precautionary technique, for both lenders and borrowers, is to hang fire while uncertainty is high. The Economist has compiled a credit-crunch index, comprising a number of measures on everything from bank lending to the cost of buying insurance against default. It shows that credit is crunchier now than it was at the height of the banking crisis in 2008.
This credit squeeze will have tightened since Greece's inconclusive election this month. That further dents growth prospects: estimates by Now-Casting, a forecasting firm, suggests that eurozone GDP will contract by 0.2 percent in the second quarter. That in turn risks worsening the debt dynamics of the zone's peripheral countries at just the wrong time.