It Is That Simple: Europe’s Problem is the Banks.

16 May

By now it’s pretty clear something has gone wrong in the European economy, which is dipping again, even as the US appears to be gathering steam.

G2 GDP

The obvious culprit is the Big Bad Beast of Austerity – tax hikes and spending cuts that mean that public and private sectors are trying to save simultaneously. However, that doesn’t really appear to fit the facts.

adjustment

Source: IMF Fiscal monitor
The chart in the left shows the adjustment of the primary balances across the two economies, adjusted for the fact that recessions tend to make deficits bigger. The chart on the right is to show that I’m not just using adjusted data because it supports my argument. Over 3 years, the total excess EU adjustment is 0.8% of zone GDP. Over four years – assuming that hikes and cuts passed but not enacted affect how people behave – the difference is even smaller. These seem awfully small gaps to have caused such a pronounced gap between the two economies.

So how to explain it? Here’s a candidate.
banking
These two series are a long way from directly comparable but they’re close enough that the divergence is interesting. US firms are borrowing again, European ones aren’t. This looks like a clear-cut job for monetary policy.
———————————–
Here ends the simple bit. If you’re the sort of person who says ‘neoliberal’ a lot you may wish to stop reading here. There may be nuance.

The numbers for the Eurozone are an average. Clearly Greece’s depression is linked to massive fiscal cuts (even if I’m the sort of person who distinguishes between austerity and not having any money). But on the other hand, on average Eurozone citizens haven’t faced much tighter fiscal policy than the Americans. (Brits on the other hand, clearly have).
It’s an awful lot easier to say “the ECB should do something” than suggest exactly what it should do. In terms of cutting rates, it’s all but impossible to argue that they’ve done much less than the Fed. US banks are much smaller (relative to GDP) and the US has deeper and healthier non-bank capital markets to help when the banks are in trouble (see I warned you there was neoliberal apologia here). The US has a unified banking system – the fragmentation within Europe (German banks flooded in liquidity, peripheral ones treading carefully) is extremely difficult to address when sovereigns can’t recapitalise banks to the point where they’re happy to lend again. Fixing the banks is a job beyond pure monetary policy. Still, even bearing this in mind, it’s hard to argue that the ECB has done everything it can. Advantage Bernanke and the horse-waterboarders.

20 Responses to “It Is That Simple: Europe’s Problem is the Banks.”

  1. Andreas Provo May 16, 2013 at 2:52 pm #

    Your post could serve as an excuse for the fiscal austerity the Europeans are engaged in. ‘See, it’s not the austerity, it’s the banks, it’s that simple.’ But it’s not. The whole problem is that European policy makers ought to have known that even if the consolidation they implemented was smaller than the US’s, its consequences would be far more severe because of the blatantly obvious liquidity constraints the continent was facing. The Europese academic streets are paved with research on the contraction-exacerbating effects of a fiscal consolidation in a liquidity constrained environment. So please, do criticise the ECB, but don’t let the EU governments off the hook.

  2. Sander Wagner May 16, 2013 at 3:18 pm #

    Let me start out by yelling “neoliberal!”

    Now that I got that off my chest: I think your main point, that a really big part of the European Problem is due to the banking sector not lending, is spot on and the lack of alternative non-bank capital markets is a big issue here. I also think that one of the drivers behind the entire within-eurozone “divergence” we are seeing is that, as soon as things got nasty banks retreated from cross-border lending to a big extent.
    So countries with worse economic conditions were left with only their own banks with worse balance sheets providing cautious (or no) credit. Which means that the entire cycle of less growth -> less credit -> less growth got much worse in some places than in others (and much worse than it would have gotten with a more integrated banking sector) et voilà “divergence”

    What I slightly disagree with is the way you pose the problem as an “is it austerity or is it the banks” problem?

    In this case i think of the economy rather like a machine in which growth and credit market conditions feed on each other and sand slowing down stuff can be thrown into different parts of that machine. In Europe there is a lot more sand thrown unto the credit channels than in the US which is definitely a force behind the divergent recoveries, as you point out.

    I would not conclude from that however that both countries are not actually throwing way too much sand on the growth aspect of that machine by imposing relatively more austerity than they used to do in previous crises.

    With only 2 observations (US and European recovery now) you dont really have enough degrees of freedom to ask how much of a problem is austerity in each country and how much of a problem is lending in each country, seperately. You can only look at where the big difference between those two countries comes from (lending).

    If you include previous crises in your sample of observations (see here http://www.voxeu.org/article/why-global-recovery-different) I think there is a good point to be made that both the US and Europe are hurting their recoveries with relatively austere reactions to them (on the fiscal side at least). Only that the problem in Europe gets that much worse because we also have tons of sand in our credit channels.

  3. quantiger May 16, 2013 at 10:15 pm #

    There is more to a loan than interest rate! Loans are given based on proposals, collateral and bank officer decisions. You need to look at that process. In Spain, Greece, Portugal, collateral is a joke; proposals for profitability in those nations were the joke that started the Euro crisis; and corruption in the southern nations has not been touched with a ten-foot pole yet. Those bank officers and the politicians/administrators in the southern nations made loan decisions (and accepted loans) based on completely ridiculous criteria – nepotism and bribes.

    If you broke that EU graph down between the Eurozone southern basket cases and the northern stronger nations, I think you would see a rather different picture.

    I can’t imagine how any bank officer could grant loans in Spain, Portugal or Greece today. (Italy still has not had its day of reckoning – it will.) On what basis could that be done when those nations still haven’t written down the utterly bogus loans they still have on the books? What is going on today in the southern basket-cases is that officials are busy cooking the books to cover their own thefts and engaging in more theft and bribery so the few can waltz off into the sunset leaving the people to rot.

    • Vasilios Flou May 17, 2013 at 4:08 pm #

      “What is going on today in the southern basket-cases is that officials are busy cooking the books to cover their own thefts and engaging in more theft and bribery so the few can waltz off into the sunset leaving the people to rot.”

      i can’t agree more with the above statement

    • somebody May 19, 2013 at 2:37 am #

      Yes, but the difference between the Northern European (and American) banks and those of Southern Europe is more a matter of style, and perhaps degree, of corruption, rather than a difference of kind. Remember, even though the Fed has worked diligently to absorb the worst, most fraudulent collateral from the banks, the banks remaining “assets” are still marked to fantasy rather than market. I daresay that if American banks were forced to open their black boxes everyone would gasp in horror and realize that the fraudulent accounting at Enron and Lehman were mere portents of bigger things to come.

      The fact that the United States is a coherent, functioning political entity has given American banks advantages over their European counterparts. But the fundamental (and deeply corrupting) structure of the alliance between politicians, bankers, and corporate interests remains comparable. And yes this structure is a result of (to use the word derisively as God intended) the idiotic (but cocksure) neoliberal fantasies of how a globalized economic system should work.

      Remember, the EU was embraced by European elites because major corporate interests argued it would help “Europe” remain “competitive” in a global economy. It was intentionally designed to prevent pesky little democratic interferences with the “free market,” so that regulations could be reduced or manipulated to aid incumbent forces, and the middle and working classes could be forced to accept their declining power and the end of their “unrealistic” sense of “entitlement.” Austerity, deregulation, and “structural reforms” that shifted power away from labor and the democratic nation state to “the market” were always part of the underlying strategy. So the embrace of austerity against all empirical evidence of its negative impact on the majority of economic actors should be seen as a (failing) long-term political strategy, not mere denialism. Even worse, of course, was the belief that following American leads and removing restrictions on banks would make Eurobanks “competitive.” In many cases Eurobanks took on even more leverage than their American idols. And now the only thing holding the neoliberal financial world order together is a concerted effort to pretend the banks are solvent. And austerity.

      So the Americans are succeeding a bit better at making their bankers whole than the Europeans. But even a “nuanced” view of the divergences of thought and practice on either side of the Atlantic should not blind us to the systemic failures that have been brought on us by the international attempt to free capital from the rule of law and democracy.

      Neoliberal, neoliberal, neoliberal!

  4. crocodilechuck May 16, 2013 at 10:19 pm #

    You need to establish how european companies finance themselves. For instance, are they like GE, and issue paper direct to the bond and money markets? (disintermediation) If so, the state of bank lending in europe is not material.

    • Frances Coppola May 17, 2013 at 8:52 am #

      European companies rely much more on bank lending than US ones do. Indeed Pawel comments in the post about the role of US capital markets in enabling companies to bypass banks in their quest for finance. European capital markets simply are not that developed. Bank lending is therefore crucial.

  5. Frances Coppola May 17, 2013 at 9:00 am #

    I’m generally in agreement that the Eurozone crisis is to a large extent a banking crisis. But it is being made much worse by political game-playing, entrenched attitudes and some unbelievably stupid policy-making. Plus the construction of the Euro itself, of course: the fact is that in a currency union monetary policy is inevitably unhelpful to small divergent economies, so money remains far too tight in much of the Eurozone despite what someone (a German, natch) described to me the other day as the ECB’s “recklessness”.

    • crocodilechuck May 17, 2013 at 10:32 am #

      Agreed.

  6. IcelandicEcon May 21, 2013 at 9:55 am #

    Can we rule out the possibility that there are no willing borrowers? Sure, the European banks are not creating credit in comparison to the US ones (judging from the third graph) but can we be so sure that is because a) the banks are weak or b) because, like quantiger states, “collateral is a joke”? Maybe there are no borrowers that are willing to increase their debts. (Of course, this is Koo’s argument of a Balance Sheet Recession)

    Can we verify this somehow, e.g. look at the ratio of loan requests that are turned down or the willingness of EU companies to invest or EU households to take out a mortgage etc.?

    The interesting twist is that if this is the case – there is a shortage of willing borrowers – then we can at least partially blame that on austerity as people do not foresee being able to find income to pay back the principal of a possible loan, plus interest. Austerity then “spreads out” onto the lack of investment which is driven by companies’ and people’s willingness to borrow bank-credit. Public expenditures would “crowd in” and not “crowd out.”

    • pawelmorski May 21, 2013 at 10:11 am #

      The ECB Lending survey evidence is mixed http://www.ecb.int/stats/money/surveys/lend/html/index.en.html

      But the point on austerity is what my whole post was about: why would euro austerity be more crushing than US austerity, which in the end is comparable in scale.

      • Andreas Provo May 21, 2013 at 11:37 am #

        Well, that’s what my comment is about: it is exactly what economic theory predicts: when bank lending channel is impaired, it will hamper consumption smoothing by agents that find their disposable income has fallen. With the banking channel so much more important in Europe and so much more in the doldrums, austerity will bite harder.

      • englisheccentric May 25, 2013 at 1:15 pm #

        I can think of reasons why a unit of average austerity might be worse in Europe than the US.

        The European experience is for lots of austerity in certain struggling countries, whereas in the US it is spread more evenly.

        The European countries which have had the most austerity are in a mess:uncompetitive, fixed exchange rates, deep recession, zombie banks and mass capital flight.Their economies are completely screwed.

        The counterpart to this, which makes up the other side of the average, is Germany, a nation of the debt averse.

        So, it’s more than just the banks IMHO.

  7. Theo Clifford May 30, 2013 at 12:51 pm #

    The three strands of the Euro crisis – the banking crisis, the fiscal crisis and the competitiveness crisis – are basically all down to terrible monetary policy on the part of the ECB. So yes, it’s clear that the ECB should do something fairly drastic.

    Is there a good reason not to raise the Eurozone’s inflation target to 4-5%?

    Is there a snowball’s chance in hell of it happening?

Trackbacks/Pingbacks

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    […] stata sufficiente, alla fine di questo post, ma ad appena un giorno di distanza Pawel Morski ne ha pubblicato un altro dal titolo significativo: “Forse sono le banche?” ed il suo blog ospita questo grafico […]

  6. Europe’s problem is monetary, but that’s not all | Macro Exposure - May 30, 2013

    […] rightly, I think — that the difference in recovery between the US and Europe is monetary (see Pawelmorski for more). But then there’s […]

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