(By Deutsche Welle) Limited private sector exposure and massive public sector intervention means little risk of financial contagion spreading from Greece. But there is one area of uncertainty: European politics, says DW’s Spencer Kimball.
Financial contagion is normally preceded by a surprise.
Take the 2008 Wall Street meltdown as an example. The US housing market had experienced a boom. Seeking to profit from the bonanza, private financial institutions the world over purchased securities issued by the mortgage lenders Fannie Mae and Freddie Mac.
Fannie and Freddie are government-sponsored enterprises. As a consequence, investors implicitly assumed that securities issued by the two mortgage lenders were backed by Uncle Sam. But their assumption was wrong, at least initially.
Fannie and Freddie’s securities did not have the same backing as US Treasury bills and when the boom went bust, financial institutions were exposed to more risk than they had anticipated. As the crisis spread through the US and global financial systems, the federal government was ultimately forced to intervene and bail out Fannie and Freddie.
“Financial institutions had wildly underestimated the riskiness of these assets, which made for really fast and furious contagion,” Carmen Reinhart, an economist who researches financial contagion at Harvard’s Kennedy School of Government, told DW.