This is a Cato special podcast. I'm Caleb Brown. As American contagion

spreads to European banks, government officials within the EU are signaling that

the Paulson bailout will not effectively deal with the

financial crisis at hand.

Gary Driscoll, Cato Institute Senior Fellow and former Vice President of the

Dallas Federal Reserve offers his thoughts.

Contagion occurs when problems at one financial institution

lead individuals to believe without reason perhaps

that there are similar problems with other financial institutions so one bank fails it leads

them to run withdraw deposits from another bank that is opposed to a situation in

which all financial institutions actually have the same problem.

Difficult to distinguish in practice, but it is important to understand.

What makes the EU particularly susceptible to this to contagion?

Well, the U has a very large banks that operate across borders,

but they had not had really a system for resolving these

cross-border banks for who is responsible. In the case of the Fortis

failure the Dutch decided to take responsibility because Fortis was a big

presence in their country but there was also a big presence in Belgium for

instance. So it's an ad hoc response.

Also, the Central Bank is not set up to do bailouts

to do lender of last resort function. Obviously it's capable of doing it, but is

reluctant to do so because it's been adhering to its anti-inflation targeting.

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