European Financial Crisis: Was ECB’s €500B-Rescue A Bear Stearns Moment?

The European financial crisis has seemingly abated after Greece managed an orderly default on €100 billion ($132 billion) worth of its debt and the European Central Bank injected banks with €530 billion in three-year loans.

But these breakthroughs, which occurred about two weeks ago, may not have marked the bottom of the European financial crisis. Instead, like the failure of Bear Stearns in early 2008, they may be signs of much worse trouble to come, said Neel Kashkari, head of global equities at Pimco’s Newport Beach, Calif., office, in a recent commentary.

From the lows of March 6, the S&P 500 and the STOXX Europe 600 have both rallied more than 5 percent, ostensibly reflecting the market’s optimism about Europe’s financial system.

But Kashkari, formerly a U.S. assistant treasury secretary, noted that in the two months following Bear Stearns' collapse and acquisition by JPMorgan Chase (NYSE:JPM), the S&P 500 surged 12 percent. Just four months later, Lehman Brothers filed for bankruptcy and the global financial system suffered a full-blown crisis.

Just as JPMorgan’s purchase did not resolve the U.S. subprime mortgage issue, Kashkari does not think Greece’s debt restructuring and the ECB’s massive loan injection have solved Europe’s sovereign debt problem.

Several noted experts believe that while Greece’s debt restructuring deal, officially called a credit event to avoid the dreaded term default, did somewhat reduce its payment burden, it didn’t go far enough.

Nouriel Roubini of Roubini Global Economics expects Greece to eventually require another restructuring deal and then exit the euro zone altogether.

A key reason is that Greece, pressured by harsh euro zone-imposed austerity measures, will struggle to grow economically, which makes it harder for the government to raise the necessary tax revenues to pay down its debt.

Greece’s exit could happen as soon as 2013 and other peripheral euro zone members like Ireland, Italy and Portugal could follow, Roubini said in a recent CNBC interview.

Catastrophe from Greece, moreover, can strike even before its government runs out of money.

Greece’s election, coming in early May, could “usher in a government that is more hostile” to the outsider-imposed austerity currently in place, noted Andrew Balls, head of European portfolio management at the huge Pimco bond dealer, in a March commentary.

If Greece fails to achieve the austerity targets set by its euro zone masters, it may not receive its previously negotiated financial aid to keep its government afloat.

Political risk could also come from the euro zone's core in the form of the French election in April, with candidates who may not cooperate well with Germany to negotiate rescue packages for indebted euro zone countries.

If catastrophe strikes, the ECB’s current three-year loans, or even more of the same, may not be enough to save the European financial system.

In Kashkari’s view, these loans may prevent European banking failures. However, banks may still be forced to choke off credit to the private sector and wipe out their shareholder value if they require more government assistance.

Furthermore, the loans do not directly fund governments, which leave indebted euro zone members extremely vulnerable should they lose borrowing access to the private market.

Kashkari admitted that although he sees these inadequacies in Europe’s response to its sovereign debt crises, he does not know with certainty whether nightmare scenarios like a disorderly Greek default will ultimately materialize.

Still, he believes it is worth contemplating these possibilities given the seriousness of their implications and the unpredictability of massive financial shocks, as evidenced by the events of 2008.