Leaders from the 15 eurozone countries along with British Prime Minister Gordon Brown met Oct. 12 to try to solve the worldwide liquidity crisis. In a show of unity, the leaders agreed on measures such as guaranteeing interbank loans for up to five years and buying stakes in banks. But this show of unity was missing a Europe-wide solution. Proposed measures were simply guidelines for member states to follow in the development and implementation of their own independent solutions.
Main European economies quickly started putting the agreed-upon measures into action Oct. 13 by offering concrete proposals for infusing liquidity directly into banks. This would be done either by injecting capital straight into the banks (as the United Kingdom did with eight banks on Oct. 8) or by setting up interbank loan guarantees. Together, Germany, France and the United Kingdom announced more than 163 billion euros ($222 billion) of new bank liquidity and 700 billion euros (nearly $1 trillion) in interbank loan guarantees.
The U.S. subprime mortgage mess impacted Europe almost immediately after it erupted in August 2007, causing write-downs and credit losses among some of the largest European banks. The Europe-wide cost of the subprime to date has been $323.3 billion in asset write-downs. Most analysts — though not Stratfor — mistook Europe’s initial resilience in the face of the U.S. subprime crisis for an overall economic robustness that would stave off a wider economic crisis.
Europe can only wish the U.S. subprime crisis were the extent of its problems, however.
The Importance of Banking to the European Economy
The underlying reason for Europe’s vulnerability is rooted not in the U.S. subprime — that is only the proximate trigger — but instead in the importance of banks to the entire European economy. In the United States, the crisis might be contained within the financial and housing sectors alone, but in Europe, the close connections between banks and industry almost assure a broad and deep spread of the contagion. Unlike the United States, where the government has spent more than a century battling to break the links among government, industry and banks, this battle is only rarely joined in Europe. If anything, such links — one could even say collusion — between banks and businesses were encouraged from the very beginning of modern European capitalism.
Since the 19th century, European financing and investing has been coordinated between banks and industry, and encouraged by the government, because industrialization was a modernizing project led by the state that did not spring up spontaneously as it did in the United States. Bank executives often sat on the boards of the most important industries, and industrial executives also sat on the boards of the most important banks, making sure that capital was readily available for steady growth. This allowed long-term investment into capital-intense industries (such as automobiles and industrial machinery) without the fear of quick investor flight should a single quarterly report come back negative.
The most famous example of this type of cozy link are the ties between Siemens AG and Deutsche Bank, a relationship which has existed for more than 100 years. An overlapping and intermingling of interests results from this type of arrangement, insulating the system from many minor shocks like strikes or changes in government, but making the system less flexible in the face of major shocks like serious recessions or credit crises. Therefore, in times of a global shortage of capital, European corporations are left with few financing alternatives they are comfortable with. (In contrast, while banks are an important source of financing in the United States, corporations there depend much more on the stock market for investment. This forces American firms to compete ruthlessly for capital and constantly seek greater and greater efficiencies.)
The Next Wave of Problems
Wholly unrelated to exposure to American subprime, Europe’s banking vulnerabilities can be broken down into three categories: the broad credit crunch, European subprime and the Balkan/Baltic overexposure.
The first issue, the global credit crunch, exacerbates all inefficiencies and underlying economic deficiencies that in capital-rich situations would either be smoothed over or brought to a much softer landing. Think of submerged rocks; many are far enough below the surface that vessels can simply sail over them. But when the tide drops, the rocks can become deadly obstacles.
Various European countries had such inefficiencies long before the U.S. subprime problem initiated the global credit crunch. Many of these were caused by the post-9/11 global credit expansion in combination with the adoption of the euro. After the Sept. 11 attacks, many feared the end was nigh. To tackle these sentiments, all monetary authorities — the European Central Bank (ECB) included — flooded money into the system. The U.S. Federal Reserve System dropped interest rates to 1 percent, and the ECB dropped them to 2 percent.
The euro’s adoption granted this low interest rate environment, which normally only a state of Germany’s strength and heft could sustain, to all of the eurozone. This easy credit environment echoed by affiliation to most of the smaller and poorer (and newer) EU members as well. Cheap credit led to a consumer spending boom — which was stronger in the traditionally credit-poor smaller, poorer, newer economies — leading not only to a real estate expansion, but also to an overall economic boom that, even without the subprime issue and the global credit crunch, was going to burst.
Underneath the global credit crunch looms the second problem: the European subprime crisis.
