Why Greece won’t trigger a global crisis

(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.

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Partisan politics holds US economy captive

Just as European nations have begun to implement a series of crisis-fighting mechanisms to save their common currency, the United States now faces a so-called fiscal cliff at the end of the year, a series of austerity measures that could throw the world’s largest economy into a double-dip recession.

In October, the International Monetary Fund (IMF) warned during its meeting in Tokyo that the slow pace of reform in Europe and the United States was causing global economic uncertainty. And increasingly, emerging economies such as China are no longer able to pick up the slack, as they also witness slower growth.

“Whether you turn to Europe, to the United States of America, to other places as well, there is a level of uncertainty which is hampering decision makers from investing and from creating jobs,” IMF chief Christine Lagarde said in Tokyo. “We need action to lift the veil of uncertainty.”

In Europe, the European Central Bank (ECB) has agreed to an unlimited bond-purchase program aimed at pushing down interest rates in crisis-stricken states, while the 17-member eurozone has set up its permanent bailout fund. But across the Atlantic in Washington, a deeply divided Congress is still struggling to resolve America’s ballooning budget deficit.

Currently, the world’s largest economy faces a series of massive taxes increases and cuts in spending to the tune of $607 billion (470 billion euros), or four percent of the country’s gross domestic product (GDP). Both Lagarde and the Congressional Budget Office (CBO) have predicted that in lieu of some sort of political compromise that cushions the worst of the austerity, America will dip back into recession.

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