European Perspectives on the Global Financial Crisis: Introduction*

The global financial crisis, which began in 2007 with the collapse of the US sub-prime mortgage market and which has yet to run its course, is on a scale that has not been seen since the Great Depression. Worldwide losses from the crisis, measured in terms of write-downs on assets originating in the USA, Europe and Japan, could be as high as $4.1 trillion (IMF, 2009, p. 30). This financial turmoil has had a devastating effect on the world economy, with global gross domestic product (GDP) contracting in 2009 for the first time since World War II and trade likely to experience its steepest fall since this time (World Bank, 2009, p. 1). Europe has not escaped the effects of the global financial crisis. The European Central Bank (ECB) expects write-downs of $649 billion on securities and loans by euro area banks alone over the period 2007–10 (ECB, 2009a, p. 103). European Union (EU) GDP fell by an estimated 4 per cent in 2009, the bloc's first recession since the early 1990s and its worst performance on record (Commission, 2009a). This downturn has had a dramatic effect on the labour market, with the number of people unemployed in the EU-27 rising by 5.4 million between March 2008 and May 2009 (Eurostat, 2009). Terrible though this turn of events may be, the global financial crisis represents an extraordinary opportunity for students of European political economy. Firstly it provides a unique natural experiment for understanding the functioning of economic and monetary union (EMU) in a world of intense but incomplete financial integration at the regional and global level. Secondly, it offers a case study into the EU's ability to provide policy co-ordination at home and leadership abroad in the absence of more centralized modes of decision-making. Thirdly, it allows us to observe the response of both the euro area and Europe's distinct models of capitalism to a colossal common shock. This special issue of the JCMS tackles these and other issues from a variety of disciplinary backgrounds. It brings together economists, political scientists and political economists with the aim of putting the European dimension of the global financial crisis in its historical and intellectual context. The overarching themes are developed in the second part of the introduction following a brief, factual overview of the financial crisis from a European perspective. The flashpoint for the global financial crisis was the collapse of the US sub-prime mortgage market in early 2007 as homeowners who had been granted loans in spite of their poor credit ratings struggled to make repayments in the face of higher interest rates and falling property prices (see Federal Reserve of St Louis, 2009, for a detailed timeline of the crisis). Following the collapse of a major US sub-prime mortgage provider, New Century Financial Corporation, in April 2007, problems quickly spread to the US banking sector and the international financial system at large. At the beginning of August 2007, the German government was forced to bail out IKB Deutsche Industriebank, one of several European banks to incur large sub-prime-related losses. Within a matter of days, BNP Paribas, one of France's leading financial institutions, took the decision to suspend three of its investment funds, citing a ‘complete evaporation of liquidity in certain market segments of the US securitization market’ (BNP Paribas, 2007). The ECB responded to this move within a matter of hours, providing nearly €100 billion in short-term financing to banks so as to ensure orderly conditions in the euro area markets. This move was the first of several emergency liquidity measures by the ECB and monetary authorities worldwide. This initial phase of the global financial crisis in Europe claimed a high-profile victim in the form of Northern Rock. This UK mortgage provider, which had relied heavily on wholesale money markets as a source of finance, faced serious liquidity problems and was forced to apply to the Bank of England for emergency financial support on 13 September 2007 (Treasury Committee, 2008). This move triggered the first run on a UK bank since 1866, leading to the eventual nationalization of Northern Rock in February 2008. Tensions in the US financial sector continued to mount over the course of 2008. In March, the US Federal Reserve brokered a deal that allowed US investment bank J.P. Morgan to acquire its troubled rival, Bear Stearns. No such solution could be found for Lehman Brothers, leading to the collapse of the investment giant in September 2008. The destabilizing effects of this event, which were magnified when the Federal Reserve was forced to bail out American International Group (AIG), the USA's largest insurance company, quickly became apparent in the EU as one Member State after another was forced to rescue banks so as to maintain confidence in the financial system. In Germany, for example, the government rescued Hypo Real Estate, a Munich-based commercial-property lender, which was destabilized by liquidity problems at its Dublin-based subsidiary, Depfa Bank. In the UK, the government nationalized the mortgage division of Bradford and Bingley and was forced to bail out Royal Bank of Scotland, Lloyds TSB and HBOS. The intensification of financial integration in the EU, which had led to a number of cross-border bank mergers over the last decade, complicated the task of rescuing European banks. The experience of Fortis provides a cautionary tale in this respect. This Benelux-based bank encountered difficulties in autumn 2008 not only due to widespread liquidity shortages but also because it was highly leveraged following its takeover of Dutch bank, ABN AMRO, in 2007, as part of a consortium with the UK's Royal Bank of Scotland and Spain's Banco Santander. After protracted discussions, authorities in Belgium, Luxembourg and the Netherlands failed to agree on a workable rescue plan and Fortis, which had won the Global Finance Award for the best bank in Belgium and Luxembourg a matter of months earlier, was broken up (see Quaglia et al., 2009). Events in Iceland at this time were more dramatic still. The country's banking model, which relied to a significant extent on assets and liabilities denominated in foreign currencies, left it highly exposed to the global financial crisis and with limited policy options (Buiter and Sibert, 2008). The government took charge of the country's three largest banks, Glitnir, Landsbanki and Kaupthing, in October 2008. The fiscal implications of this measure only added to concerns over Iceland's economy, however, prompting the government to turn to the International Monetary Fund (IMF) for a $2.1 billion loan (IMF, 2008a). Within the EU, Hungary was the first Member State to seek external financial assistance. Its economy was rocked in October 2008 by sharp rises in interest rates and a sudden fall in the value of the forint as concerns spread over the exposure of central and eastern European countries to the global financial crisis (Darvas, 2008). Several factors seem to have added to Hungary's vulnerability, including high debt levels, a burgeoning current-account deficit and significant exposure of domestic borrowers to foreign loans (Darvas and Szapáry, 2008). The ECB, mindful, perhaps, that euro area banks had lent heavily to Hungarian borrowers (Economist, 2008), provided emergency support to the country's monetary authority, the Magyar Nemzeti Bank (ECB, 2008). In October 2008, the IMF, the EU and the World Bank put in place a more comprehensive rescue package to the tune of €20 billion (IMF, 2008b). Initial efforts to find a co-ordinated EU solution to this banking crisis foundered as Member States moved unilaterally to reassure savers. In September 2008, Ireland announced a 100 per cent guarantee for all banks' liabilities, including retail, commercial and inter-bank deposits that was initially restricted to the six largest Irish-owned banks. This put UK banks, which were protected by a less generous system of deposit insurance, at a competitive disadvantage and raised concerns that there would be substantial flows of savings to Irish banks (Millar, 2008). Fearful of such beggar-thy-neighbour policies, several EU Member States, including Austria, Denmark, Greece and Slovenia, moved quickly to guarantee bank deposits. Germany's decision to do likewise was especially controversial, coming as it did hours after Angela Merkel attended an extraordinary meeting of EU members of the Group of 8 (G8), which called on Member States to ‘ensure that potential cross-border effects of national decisions are taken into consideration’ (European G8 Members, 2008). EU Member States eventually regrouped, however, and, in October 2008, the heads of state and government of the euro area invited the UK prime minister Gordon Brown to an emergency summit, where agreement was reached on a bank rescue plan (Eurogroup, 2008). Under this plan, which was later endorsed by the full European Council, EU Member States pledged €2 trillion to recapitalize and, if necessary, take shares in European banks (European Council, 2008). The plan also provided government guarantees for medium-term debt issuance in the EU and raised the minimum standards for deposit insurance guarantee schemes. This spirit of co-operation carried over into Member States' preparations for the G20 summit in London in April 2009. The heads of state and government agreed on a ‘line to take’ on international financial issues at the Spring European Council in Brussels in March 2009 (see European Council, 2009a, Annex I) and EU members of the G20, France, Germany, Italy and the United Kingdom joined by representatives of the Council Presidency and the ECB worked closely together to co-ordinate their positions. European leaders – including French President Sarkozy, who had threatened to quit the summit if reform efforts fell short (Hall et al., 2009) – were also broadly supportive of the summit's outcome, which included an agreement to strengthen and provide additional resources to international financial institutions, such as the IMF and World Bank and to combat protectionism and maintain openness in international trade (G20, 2009). They also supported plans to step up financial services regulation, for example by extending supervisory oversight to systemically important hedge funds and credit rating agencies (CRAs), revising the Basel II accord and clamping down on tax havens and non-compliant offshore jurisdictions. The EU's efforts to ensure a co-ordinated solution to the effects of the global financial crisis on the real economy have been less successful. The European Recovery Plan, adopted at the European Council in December 2008, committed the EU and its Member States to an immediate budgetary stimulus equivalent to 1.5 per cent of EU GDP. Although the European Recovery Plan broke new ground in some respects (it is the first joint attempt by EU fiscal authorities to stimulate aggregate demand) it fell short in others (the proposed fiscal stimulus is small when compared to the efforts of other countries, such as the United States, and it makes little attempt to share the burden of fiscal adjustment among Member States ex ante). The ECB has been more decisive than EU finance ministers in responding to the global financial crisis. The Bank cut its base rate by 325 basis points between October 2008 and May 2009, taking it to an historic low of 1.0 per cent. Conventional monetary policies have been accompanied by unconventional measures. The latter have included allowing banks to use a wider range of assets as collateral when borrowing from the Eurosystem and a switch from variable to fixed-rate tenders for the Bank's main refinancing operations, thus providing banks with unlimited liquidity at very low interest rates (ECB, 2009b). In May 2009, the ECB also agreed to purchase €60 billion worth of covered bonds, debt securities backed by mortgages or public-sector loans, in an attempt to ease credit conditions in the euro area (ECB, 2009). The global financial crisis has prompted a rethink of financial regulation in the EU and other jurisdictions. In April 2009, the EU passed a regulation on CRAs (Commission, 2008). The USA also revised its legislation on CRAs (Securities and Exchange Commission, 2009) and the International Organization of Securities Commissions (IOSCO) revised the voluntary code of conduct for CRAs (IOSCO, 2008). In April 2009, the European Commission proposed a directive on Alternative Fund of hedge funds and (Commission, 2009b). The USA is also the of revising its legislation on hedge funds and the has a on hedge funds oversight in 2009 (IOSCO, 2009). The Basel on has been on the of the Basel II the of which has been by the in the EU, which is also in the of in to the taking place in the In both these the policy has on the of for the and new for liquidity the of in the and to that is assets for which there is not a market, have also taken place in the EU as as at the International over the of financial regulation in Europe have in with over the of financial At the EU the which was in March 2009, proposed the of a European Council and a European of Financial with a to the of national into EU Although it is less than the plans to supervisory to the Federal Reserve (see of the the is significant the European Council would be by the Council of the ECB, thus the dimension of EU financial market policy as as the Bank's area of The global financial crisis to at the time of 2009) and is likely to a over EU for some to The European Council in Brussels in 2009 endorsed for EU financial but the of reform to be agreed and (European Council, 2009b). It to be seen the crisis or the of European Iceland's in 2009 to the EU that the economic crisis may new political over the and of the recession in the EU and the ability of central and eastern European Member States to the for the euro area are among the factors that in the The of the global financial crisis are and (see et al., Financial Financial Group of 2009). The to this special issue of the there is agreement that the economic and financial in 2007 and 2008 from a of domestic and international policy the of the crisis in the of national to in cross-border policy co-ordination following the collapse of the system in the early all the of in international and over the last the United States to and savings measures were to and other major burgeoning current-account deficit in the United States was by from and to assets denominated in US The ground was for when on a credit and a widespread of that were among the of the global financial crisis. 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This of support for the may be but it is of In this the financial crisis has that the ECB has limited options for the of the euro a period of over the economic have European countries responded to the global financial In their to this special and the of the crisis on the models of and of the is that German banks, which have been seen as more and than their French have losses. This is the to the that the German banking sector has a more dramatic of in as commercial and regional banks have to by such as such the of German banks to the global financial crisis as for example, by the exposure of to the US sub-prime market commercial The German response to the financial crisis may down the of but it is to the of the country's and the of in its variety of and economic and financial in the United Kingdom has been by the crisis. 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The G20 in London in short of providing for policy co-ordination and thus failed to one of the of the global financial crisis. the decision to the Financial to a Financial the to to at the international but this new resources and a The Irish of that its and were put there to the for This special issue of the JCMS that the European dimension of the global financial crisis is and in several Europe's exposure to the crisis understanding of the of banks and financial in European models of capitalism and the between monetary and financial integration within the The EU's response to these events Europe to be both a global and a victim of global and on from the of of their European to be if do and if do The of the crisis on EU provides an opportunity to the and of and to the extent to which economic and financial be a and a European these and the global financial crisis in the among students of European political economy.