Financialization, not debt, is the cause of Europe’s crisis

There are many across Europe, policymakers especially, who point the finger at debt-ridden governments in Greece, Ireland, Portugal and Spain, saying that the reason we are in such a mess is that these governments have spent beyond their means. We commented last week on an op-ed in the Financial Times by the Dutch prime minister and finance minister making just this point. “The main cause of the current problems”, they wrote sternly, “is that some countries played fast and loose with the very rules designed to guarantee budgetary discipline”. Austerity measures are thus the solution to the Eurozone crisis, to be enforced with the stick of a threatened exit from the Eurozone for those governments unable or unwilling to push through the painful measures.

As argued before, the Eurozone crisis cannot be understood as simply a debt crisis. Wendy Carlin, Professor of Economics at University College, London, gives us a very useful account of the crisis that puts the accent not on debt as such but on the role of the banks in the pre-crisis European and global economy and on government responses to the fragility of their banking sectors. “The unwillingness of policy-makers to recognize the on-going role of the banks in the crisis and the benefits of a pan-European solution worsens both the economics and the politics of the situation”, she argues.

Prior to 2008, there were great differences between countries in what is now the fragile periphery of the Eurozone: Ireland did not have high levels of government debt before the crisis, Greece and Italy did. The connection between the 2007-8 financial crisis that was sparked off in the sub-prime mortgage market in the US and today’s Eurozone sovereign debt crisis is through Europe’s banks. They were shaken by the first part of the crisis, with governments intervening – most visibly in Ireland and the UK – in order to stabilize their balance sheets. Carlin notes that one of the first banks to fail in 2007 was a German bank. In France, policymakers at the time – notably current IMF director, Christine Lagarde, who was French finance minister when the crisis first broke out – complimented their banks for what seemed to be limited exposure to US sub-prime mortgages. Today, we see that French banks are no different from their peers, only that the risk they took on was more heavily concentrated in Southern Eurozone economies – Spain, Italy and Greece. What is driving the Eurozone crisis at the moment is the fear of contagion: a Greek default alone would not topple big Northern European banks, but if Italy and Spain defaulted, the French government would be called upon to intervene in order to recapitalize its banking system. French government debt would soar and it would move from creditor to debtor in one swift move.

Enthused by the Brown-Darling school of macroeconomics, John Lancaster in the London Review of Books wonders why Eurozone governments are dithering about helping their own banks. Why, he writes, did the Europeans not listen to Gordon Brown and extend the European Financial Stability Facility to the tune of around 2 trillion Euros? That, he thinks, should probably have been enough to reassure the markets. When in doubt, it seems, the answer is to throw public money at the problem. Here we reach the limits of the analysis. The Eurozone crisis is not a debt crisis. The current sovereign debt concerns are symptoms of the problem, namely the fragility of the European banking system. And that fragility is the result of a transformation in the role of financial instititutions, what we can call financialization. To start understanding Europe’s current predicament, we need to go beyond the kneejerk belief that government bail-outs can make the problem go away and look more closely at the actual causes of the current crisis.