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Credit Insights

Together We Stand, Divided We Fall?

Each succeeding bailout entangles the global financial system even further.

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It appears to us that the global financial system continues to become ever more intertwined with every bailout. As the ECB and IMF continue to provide financing for sovereign nations, these packages essentially bail out the local banks, which have bought the sovereign debt used to fund the nation's deficits. By bailing out the local banks, the financing effectively bails out the international banks that had bought the debt of the locals. In addition, the ECB has been purchasing the bonds of the periphery European nations to support borrowing costs in those countries. So, if there were an event that could not be immediately contained, it appears to us that once the dominoes begin to fall, the ramifications would be global as opposed to being contained regionally, as we had seen in past sovereign defaults.

As such, each succeeding bailout entangles the global financial system even further. The global banks are exposed to the local banks, which are exposed to the sovereign nation, which relies on the local banks to finance their deficit. The ECB is exposed to all of the above, as it has provided direct financing to the banks through its liquidity facilities, and is exposed to the sovereign nations as a result of buying bonds in the open market. As the largest participant in the IMF, the U.S. government is exposed as well. We believe this is why we have been experiencing the mentality of "risk-on" / "risk-off" days in the markets, with every new headline that comes across the screen.

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David Sekera does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.