As Europe’s financial markets spin down into the vortex created by the US credit crisis, we can only be sure of one thing: every new day will contain new surprises. Only a few months ago, the real economy looked solid, with the Euro providing an impressive shield from financial disruption (imagine last year without the ECB!). Now Europe is in negative play, shorted by the markets – possibly betting on a collapse of the EMU. The long shadow of the US crisis will determine almost inexorably the course of Europe’s over the next few weeks. Despite the Euro, Europe is perceived as a vulnerable mosaic of nation-states without any central voice, more likely to play individual strategies without thinking about aggregate outcomes. Yet the fundamentals in Europe appear more solid than in the US. What can Europe do to change this?
Reliquify and recapitalize creatively. The payments and credit systems are essential for the working of the real economy and cannot be left to a “workout” with healthy banks picking over the bones of the failures. The ECB must provide leadership by guaranteeing unsecured intra-European interbank lending and making for orderly markets, which it is already doing. But Europe may have to do more. Banks need recapitalization but may not get takers soon. If they don’t, the only solution will be – as we already seen in Iceland and in the UK – full-blown nationalizations of the banking system and the credit and payments system that goes with it. The US government has already nationalized one of the largest insurers in the world, half of the mortgage industry, and has taken stakes in banks unthinkable a few years ago. The partial or total nationalization of the banking sector should be temporary and for purely pragmatic reasons – and the EU and its members should develop careful contingency plans. The ECB is a natural agent for this type of action – assuming the national governments will allow it.
Don’t punish the financial sector. As tempting as it may be, don’t listen to the rhetoric of economic fundamentalists who rejected the Congressional bailout and similar interventions and want to put investors’ feet to the fire – their talk is eerily reminiscent of those who wanted to punish the moneymen and stock speculators following the Great Crash of 1929. Because of the web of derivative securities and insurance they have created, banks have – purposefully or not – made themselves “too big to punish.” We punish them, we punish ourselves. It will probably take decades to work out the international collateral damage of the Lehman bankruptcy. Europe can learn from this costly mistake.
Discuss openly the meaning of a European support fund. The go-it-alone strategy of Ireland, Germany, and Denmark could hasten the collapse of the EMU unless quantitative minimal and maximal standards for depositor protection are set. Certainly redistribution is involved but letting the system go down will have much more serious consequences. Each country in Europe is too big to fail. I am convinced the German rejection of a common front has the same roots that forced the Maastricht criteria – the fear of sudden redistribution across EU member states. It was also driven by the fact that Germany is more highly banked than many other countries, with households holding more wealth in bank accounts. Let’s not be coy – the crisis is much worse in some countries than others. Put these issues on the table and talk about maximal losses – in complete discretion, of course.
Personally I was sure a crisis like this would visit Europe, but in another decade’s time – following some national government default, not a credit crisis from abroad infecting the EU members in an asymmetric fashion. If Europe can’t handle this mess, which is not even of its own making – heaven help us when the home-grown variety comes along.