The euro crisis is a direct consequence of the crash of 2008. When
Lehman Brothers failed, the entire financial system started to collapse
and had to be put on artificial life support. This took the form of
substituting the sovereign credit of governments for the bank and other
credit that had collapsed. At a memorable meeting of European finance
ministers in November 2008, they guaranteed that no other financial
institutions that are important to the workings of the financial system
would be allowed to fail, and their example was followed by the United
States.
Angela Merkel then declared that the guarantee should be exercised by
each European state individually, not by the European Union or the
eurozone acting as a whole. This sowed the seeds of the euro crisis
because it revealed and activated a hidden weakness in the construction
of the euro: the lack of a common treasury. The crisis itself erupted
more than a year later, in 2010.
There is some similarity between the euro crisis and the subprime
crisis that caused the crash of 2008. In each case a supposedly riskless
asset—collateralized debt obligations (CDOs), based largely on
mortgages, in 2008, and European government bonds now—lost some or all
of their value.
Unfortunately the euro crisis is more intractable. In 2008 the U.S.
financial authorities that were needed to respond to the crisis were in
place; at present in the eurozone one of these authorities, the common
treasury, has yet to be brought into existence. This requires a
political process involving a number of sovereign states. That is what
has made the problem so severe. The political will to create a common
European treasury was absent in the first place; and since the time when
the euro was created the political cohesion of the European Union has
greatly deteriorated. As a result there is no clearly visible solution
to the euro crisis. In its absence the authorities have been trying to
buy time.
In an ordinary financial crisis this tactic works: with the passage
of time the panic subsides and confidence returns. But in this case time
has been working against the authorities. Since the political will is
missing, the problems continue to grow larger while the politics are
also becoming more poisonous.
It takes a crisis to make the politically impossible possible. Under
the pressure of a financial crisis the authorities take whatever steps
are necessary to hold the system together, but they only do the minimum
and that is soon perceived by the financial markets as inadequate. That
is how one crisis leads to another. So Europe is condemned to a
seemingly unending series of crises. Measures that would have worked if
they had they been adopted earlier turn out to be inadequate by the time
they become politically possible. This is the key to understanding the
euro crisis.
Where are we now in this process? The outlines of the missing
ingredient, namely a common treasury, are beginning to emerge. They are
to be found in the European Financial Stability Facility (EFSF)—agreed
on by twenty-seven member states of the EU in May 2010—and its
successor, after 2013, the European Stability Mechanism (ESM). But the
EFSF is not adequately capitalized and its functions are not adequately
defined. It is supposed to provide a safety net for the eurozone as a
whole, but in practice it has been tailored to finance the rescue
packages for three small countries: Greece, Portugal, and Ireland; it is
not large enough to support bigger countries like Spain or Italy. Nor
was it originally meant to deal with the problems of the banking system,
although its scope has subsequently been extended to include banks as
well as sovereign states. Its biggest shortcoming is that it is purely a
fund-raising mechanism; the authority to spend the money is left with
the governments of the member countries. This renders the EFSF useless
in responding to a crisis; it has to await instructions from the member
countries.
The situation has been further aggravated by the recent decision of the German Constitutional Court.
While the court found that the EFSF is constitutional, it prohibited
any future guarantees benefiting additional states without the prior
approval of the budget committee of the Bundestag. This will greatly
constrain the discretionary powers of the German government in
confronting future crises.
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