Investors clamored last week to lend money to the German government for two years at no interest. Some investors accepted negative yields – meaning they gave Berlin a cut of their assets merely in exchange for their safekeeping.
If not yet indicative of an out-and-out panic, it is at least a sign of economic hopelessness. Skepticism regarding most other European governments and European banks has reached levels that are driving investors to seek refuge rather than opportunity. Their money is flowing out of banks, out of bonds issued by less financially stable governments, and out of corporate stocks, all for fear that tighter credit and government austerity will trigger a profit-crushing recession.
As European leaders bicker over how to respond, the bickering itself is adding to the problem by feeding concern that the situation will be allowed to get much worse before policymakers finally take forceful enough steps to allow healing to begin.
Today’s Euro-centric problems are reminiscent of those that prompted our own appearance at center stage of 2008’s global financial mess.
The worst moment in the crisis that year arguably occurred on September 29, when the House of Representatives shocked its own leadership by rejecting a $700 banking bailout plan. The vote came exactly two weeks after Lehman Brothers’ bankruptcy. Suddenly, even though most institutions were actually solvent, nobody trusted anybody. Stock markets plunged, and credit for everything from business expansions to mortgages all but dried up. Money flooded into U.S. Treasury obligations, which were perceived as a safe haven.
This was no mere crisis of confidence. There was a real problem at the root of the financial gridlock – namely the bursting of a U.S. housing bubble that exposed a mountain of unpayable mortgage debt. Someone was going to take a big loss; we just did not know then who the unluckiest parties would be. Trading in securitized mortgages and derivatives amplified the losses and transmitted them around the world.
Yet, as big as the problem was, the financial system itself was much bigger. As a whole, the leading banks here and abroad remained solvent, even though individual institutions risked failure. An isolated failure was a manageable risk in the broad scheme of things, even if it was not a risk that private actors were willing to accept after the Lehman collapse and the subsequent troubles at AIG, Merrill Lynch and a number of other firms.
Federal Reserve Chairman Ben Bernanke, then-Treasury Secretary Henry Paulson, and Timothy Geithner, who at the time headed the Federal Reserve Bank of New York and later became Paulson’s successor, organized the bailout plan. Their idea was to buy troubled mortgages and other so-called toxic assets from the banks, removing the threat to the institutions’ financial strength that such fast-depreciating assets represented.
President George W. Bush signed on, as did congressional leaders in both houses from both parties. But when the plan came before the House, rank-and-file members rebelled. Democrats, who controlled the chamber, voted 140-95 in favor, while Republicans opposed it by a two-to-one margin, at 65-133. The result was a stunning 228-205 defeat.
The markets reacted furiously, even as the vote was going on. Everything sold off except Treasuries, which reached levels not seen since the immediate aftermath of the 9/11 attacks, and the bonds of a few of the most secure foreign governments, notably Germany and the United Kingdom.
Despite their leaders’ entreaties, lawmakers opposed the bailout plan, partly because they believed it would saddle the government with losses that rightly belonged to the banks and partly because they feared voters would promptly turn them out of office for backing the bankers who the public largely blamed for creating the crisis in the first place.
But within a few days, the House reversed itself and passed the plan 263-171. Fifty-eight lawmakers changed their minds. In the end, everyone recognized what many refused to acknowledge then and have refused to acknowledge since: The bailout was not for the benefit of the bankers. It was for the benefit of the country. A functioning economy is impossible without functioning banks. Functioning banks are impossible without public confidence in their ability to do business. And the banks, for all their missteps, were in the aggregate fundamentally sound. The bailout, which was eventually modified to become the Troubled Asset Relief Program, has been a net moneymaker for the government on its bank operations.
Though there are some similarities, notably in the role that housing bubbles played in bringing on troubles in Spain and Ireland, Europe’s issues are still somewhat different from those we confronted four years ago. We worried then that private banks were overexposed to one another; today’s growing concern is that Europe’s banks are overexposed to the shaky finances of governments in places like Spain, Greece and Portugal. Unless you strengthen the governments, it is very hard to strengthen the banks. If you can’t strengthen the banks, you can’t strengthen the local economy. If you can’t strengthen the economy, you can’t strengthen the government.
Yet certain policy responses, like our 2008 bailout, are likely to be forced on even reluctant European politicians. A multinational system of bank regulation and deposit insurance, direct loans and other support from the European Central Bank to individual institutions, multinational oversight of national budget and tax plans, and eventually European multinational bonds are all likely to happen sooner or later.
Passage of the 2008 bailout bill was a key step in stabilizing the American financial crisis and restoring faith in our financial institutions. It happened only after the financial markets sounded a clear warning of the disaster to follow if the banks were left to flounder on their own. Europe is now having its own 2008 moment. Here’s hoping the ultimate response is equally constructive.