Dublin (and Vienna) Calling

Posted by Simon Johnson on 22 February 2009

If you think credit default swap (CDS) spreads are informative with regard to developing pressure points and issues that policymakers should focus on (or will likely spend hectic weekends dealing with), you should look at the latest CDS spreads for European banks.  The Irish story we have already flagged.  I’m also concerned that developments in East-Central Europe are starting to affect the prospects for West European banks, most notably in Austria.

My point is not that collapse is imminent.  Rather, I would suggest that now is the time for preemptive policy action - presumably at the European Union level - to head off these problems.  As we have been arguing since last October, there needs to be an integrated European-wide approach to these problems, including agreement on who receives what kind of financial support and under what circumstances.  The roles of the European Central Bank and the IMF (if any) in this context are in particular need of further explicit elaboration.

It is simply astonishing that, after all we have seen, senior European policymakers remain in substantial denial about the depth of global problems, the way in which these have direct impact on Europe, and value of thinking ahead.

Even if you are convinced that the CDS market represents pure speculative pressure, i.e., unrelated to “fundamentals”, spreads at this level are still a call for action.  In fact, in that case there is no excuse for not putting in place transparent and well-communicated fiscal policies with massive external financial support.  That should scare any speculators away.

Of course, if you believe that the CDS market is completely uninformative, there is nothing to worry about.  And there was, in retrospect, nothing to worry about when the same market pointed to growing dangers for UK mortgage lenders in fall 2007, US banks in 2007-2008, Iceland in fall 2008, and emerging markets right before the IMF started handing out big loans.


Simon Johnson, 
MIT and Peterson Institute for International Economics

Editor's note:  This column first appeared on the Baseline Scenario Forum, 20 February 2009