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Are We Entering Another Phase of Financial Crisis?
NOV 29 2010, 8:36 AM ET3

By MEGAN MCARDLE - Megan McArdle is the business and economics editor
for The Atlantic. She has worked at three start-ups, a consulting
firm, an investment bank, a disaster recovery firm at Ground Zero, and
the Economist.


As Spain starts looking rocky, Tyler Cowen writes:

In a nutshell, we're watching the most pitched, highest-stakes, most
determined battle between politics and finance which has been staged.
I am expecting finance to win.
Arnold Kling follows up with four questions:

1. What is the true state of the large European banks? In particular,
if, they had to write down the principal on the debt of the PIGS by,
say, 15 percent, which banks would still be solvent?
2. What does the option for inflating away European debt look like?
How would the cost of that inflation be distributed? Can the inflation
take place within the context of the euro, or does it require that
some countries leave the euro?

3. Does a crisis create an opportunity for governments to make radical
changes to the welfare state, or is that still not possible?

4. Suppose that governments have to choose between preserving their
banks and preserving high levels of spending on public employees and
retirees. Which choice is better for the economy? For political
survival?

I don't know the answer to any of them, but of the four, I think the
last is the most interesting; Europe cannot let its banks fail, but it
also can't divert public pensions to line the pockets of bankers. Yet
it may well have to do one or the other. I am also expecting finance
to win. Forget whether Germany has the political will to bail out the
PIIGS: does either the EU, or the ECB, actually have the means to
bail out all five? If Spain topples, that is what it will come to.

This is starting to throw off more echoes of the Great Depression,
where you have a sequence of crises, each touched off by the ones that
came before, like dominos falling into some diabolic design. Europe
and America thought they'd seen the worst of things by the end of
1930, only to be knocked back down even harder by the contagion of the
Creditanstalt crisis. In the US, the crisis ultimately triggered a
string of bank failures worse than those sparked by the initial stock
market crash, and the worst two years of the Great Depression were
1932-3.

I don't want to lean too hard on this, as economic commentators (maybe
including me) have started seeing Creditanstalt everywhere--in Dubai,
in Greece, now in Ireland and maybe Spain. It's entirely possible
that we'll eventually muddle through without a second major event.
But it's worth remembering that these things take a long time to
unfold, and that we are often most vulnerable just when we think we
have time for a breather.

Related thoughts: whatever events unfold, a lot of pundits who insist
on treating whatever has happened in the last five minutes as if they
were the final events of the crisis, are going to look like idiots.
If Spain ends up in the same place as Ireland, the virulent arguments
over Irish austerity are going to look rather silly in retrospect; if
Europe's banking system is badly compromised, the model of economic
crisis that centers around American bank regulation and monetary
policy will be severely compromised; and so forth. Pundits and
regulators should both be playing the long gam