|Subprime Europe [NYT Op-Ed]|
By LIAQUAT AHAMED
Published: March 7, 2009
THE 1931 collapse of the Austrian bank Creditanstalt provoked financial panic across Europe and almost single-handedly turned a bad downturn into the Great Depression. Last week, when I read about the brewing European banking crisis, I suddenly began to dread that history might be repeating itself.
You might think that my worries are a bit late. After all, losses on subprime mortgages in the United States have already caused a Depression-like banking collapse. Well, believe it or not, Europe’s current crisis is scarier. For while losses on Eastern European debts may be only a small fraction of those on subprime mortgages, the continent’s problems are politically harder to solve, and their consequences may prove to be much worse.
Much as in our subprime mess, Eastern Europe’s problems began with easy credit. From 2004 to 2008 Eastern Europe had its own bubble, fueled by the ready availability of international credit. In recent years countries like Bulgaria and Latvia borrowed annually the equivalent of more than 20 percent of their gross domestic product from abroad. By 2008, 13 countries that were once part of the Soviet empire had accumulated a collective debt to foreign banks or in foreign currencies of more than $1 trillion. Some of the money went into investment, much of it into consumption or real estate.
When the music stopped last year and banks retrenched, the flow of new capital to Eastern Europe came to an abrupt halt, and then reversed direction. This credit crunch hit the region just as its main export markets in Western Europe were going into free fall. Moreover, with so much of the debt denominated in foreign currencies, everyone in Eastern Europe has been scrambling to get their hands on foreign exchange and local currencies have collapsed.
Most of the Eastern European debt is held by Western European banks. It also turned out that some of the biggest lenders to Eastern Europe were Austrian and Italian banks — for example, loans by Austrian banks to Eastern European countries are almost equivalent to 70 percent of Austria’s G.D.P. Now, Italy and Austria can’t afford to bail out even their own banks.
The debt crisis in Eastern Europe is much more than an economic problem. The wrenching decline in the standard of living caused by this crisis is provoking social unrest. American subprime borrowers who have had their houses foreclosed on are not — at least not yet — rioting in the streets. Workers in Eastern Europe are. The roots of democracy in the region are not deep and the specter of right-wing nationalism remains a threat.
So what is to be done? The potential approaches essentially mirror those that have been attempted in response to America’s subprime problem.
The first approach is to deal with the short-run liquidity problem. In the same way that the Federal Reserve expanded its own lending last year to compensate for the collapse in private lending, the International Monetary Fund is providing funds to Eastern Europe, and Hungary has proposed that the European Central Bank lend to borrowers who use non-euro assets as collateral. But given the state of the rest of the world, Eastern Europe will not be able to export its way out of its troubles in the immediate future.
The debts of many Eastern European countries and some banks will have to be written off. Ultimately, as in the case of the American subprime debts, taxpayers will have to foot the bill. But which taxpayers? The taxpayers of Austria and Italy certainly can’t. So the burden will have to fall on the rich countries of Europe, especially Germany and France.
There are two approaches to taxpayer-financed bailouts. The first is to go case by case. This is being proposed by the Germans. The problem here, as we discovered after the Bear Stearns rescue last March, is that the case-by-case approach does nothing to establish confidence in the system and prevent contagion.
The best choice would be a fund that provides bailout money and a protective umbrella to banks and countries, even those that don’t seem to need it now. Hungary has proposed the creation of such a fund with roughly $240 billion at its disposal. Though the proposal has already been rejected by stronger European economies, the American experience of last year in which the Treasury finally had to ask Congress for $700 billion for a similar fund suggests that this is where Europe will end up.
The response of the American government to the financial crisis has been criticized for being too slow and inadequate. But at least we have a federal budget, the national cohesion and the political machinery to get New Yorkers and Midwesterners to pay for the mistakes of homeowners in California and Florida, or to bail out a bank based in North Carolina. There is no such mechanism in Europe. It is going to require leadership of the highest order from officials in Germany and France to persuade their thrifty and prudent taxpayers to bail out foolhardy Austrian banks or Hungarian homeowners.
The Great Depression was largely caused by a failure of intellectual will. In other words, the men in charge simply did not understand how the economy worked. Now, it is the failure of political will that could lead to economic cataclysm. Nowhere is this danger more real than in Europe.