And if the ECB can abandon its mandates in times of economic crisis, what stops the member states from doing the same? The next legalism sure to be widely ignored will be the prohibitions on excessive deficit spending, which many would call the fundamental requirement of eurozone membership.
The Individual States’ Responses
EU treaty details aside, the issue now will be the ability of the individual states to act. The stronger a state’s economic fundamentals, the more likely the country in question will be able to raise money to tackle the situation effectively in some way, whether by raising taxes or issuing bonds. (Bonds of economies with good fundamentals in particular are an attractive location for parking one’s money while stock markets and real estate around the world undergo corrections.)
The three leading criteria to consider are the government’s share of the economy, the government budget deficit and the level of national indebtedness. Combining these three variables gives a good snapshot of whether a particular country will be able to raise capital during a credit crunch. Incidentally, European governments consume the highest percentage of their countries’ resources in the world, greatly reducing their ability to surge government spending.
Not surprisingly, the most seriously threatened European states are France, Italy, Greece and Hungary, each of which is running a serious budget deficit while also being burdened by high government debt. Three of these four (France, Italy and Greece) also have very active banks in emerging markets of the Balkans and Central Europe, home to the European states that are likely to suffer the most from the credit crisis. These four countries are closely followed by Romania, Poland, Slovakia, Bosnia, the Netherlands, Portugal and Lithuania.
Further bloating the deficits of many European countries will be the many bailouts and reserve funds being planned to deal with the liquidity crisis on an individual country basis. On Oct. 13, Germany announced a 70 billion euro ($95 billion) bank capitalization plan and up to 400 billion euros ($543 billion) for interbank loan guarantees. On the same day, France announced slightly smaller figures — a 40 billion euro ($54.3 billion) injection plan for banks and up to 300 billion euros ($407.25 billion) for interbank loan guarantees. The United Kingdom infused further liquidity into its banks by propping up Royal Bank of Scotland with 20 billion pounds ($34 billion) and Lloyds and HBOS, which are merging, with 17 billion pounds ($29.2 billion).
This followed an Oct. 5 announcement by the German government of a (second) bailout proposal for real estate giant Hypo to the tune of 50 billion euros ($67.9 billion). The Netherlands and France bailed out Fortis with 17 billion euros ($23.3 billion) and 14.5 billion euros ($19.8 billion) respectively. Struggling Iceland — where the country, not just the banking sector, is now technically insolvent — nationalized its entire banking sector. Nationalization is even sweeping the usually laissez-faire United Kingdom, which announced that it was seizing control of mortgage lender Bradford & Bingley on Sept. 29, followed by an even more dramatic move in which the government announced it would spend 50 billion pounds ($87.8 billion) on rescuing (and thus partially nationalizing) Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Nationwide Building Society, Roy al Bank of Scotland and Standard Chartered.
Unlike the British and German bank-specific bailouts, Spain set up a 30 billion euro (about $41 billion) aid package to buy good assets from banks to inject liquidity into the entire system. The Spanish approach seems to suggest that unlike in the United Kingdom and Germany, where only a few bad apples needed to be nationalized, the entire Spanish system might be threatened. This is certainly a possibility in a country where 70 percent of all bank savings portfolios are in real estate, and where real estate is dangerously overheated.
Also relevant to determining the exposure of a particular European state is its dependence on foreign exports, both in terms of goods and services. By this measure, Germany, the Czech Republic and Sweden will suffer as their industrial exports slacken due to a decline in worldwide demand. Extremely high trade imbalances will also become more difficult to sustain as credit to purchase European exports becomes more difficult for buyers to procure. Again, particularly at risk are countries in Central Europe with extremely high current account deficits (in terms of percentage of GDP). This will be especially true if demand in western EU countries dulls for Central European exports, further bloating the Central European countries’ current account deficits — which of course are no longer easy to finance.
Even assuming that each bailout plan functions perfectly, and that the U.S. economy pulls through relatively quickly, Europe is settling in for a protracted banking crisis. Ultimately, the American problem is limited to the United States’ financial and housing sectors. Should the United States’ problems spread to other sectors, the crisis at its core will still remain a credit crunch. In Europe, various regionalized and interconnected weaknesses are much broader and deeper, pointing to systemic problems in the banking sector itself. For the United States, developments the week of Oct. 5 might signal the beginning of the end of the crisis. But for Europe, this is merely the end of the beginning.
