Why Doesn’t Europe Have Financial Crises ?
Kevin Drum asks
I like to think of myself as a serious econ-blogger, but don’t claim the title when I am writing about banks. We clearly have brilliant what’s wrong with the banks bloggers here.
I live in Europe and I have a sense about why this doesn’t happen here.
First we have to distinguish the UK and Continental Europe as the UK is much more like the USA. I will talk about Continental Europe (the easy part).
My thoughts, for what they are worth, after the jump.
Anyway serious bloggers on banking here are warmly invited to try to answer Drum’s question.
First the banks that are failing in the USA are investment banks not depository institutions. They are less tightly regulated, that is, allowed to take more risks. This is partly a relic of the Glass-Stegal act, which made it illegal for depository institutions to own stock. It is possible to set up and investment bank anywhere (no laws against it) but few pop up naturally without the protection of such a law — bank deposits are an attractive form of debt as people accept very low returns on them and they are publicly insured (note UK exception above). In particular in Continental Europe banks suck huge amounts of money out of checking and savings accounts for fees for everything and pay very low interest (my expertise is in being irritated by my bank). The commercial banking sector in Europe is much less competitive than in the US or UK. Now with European unification this might change and then there might be bankruptcies, but up until now, Continental European banks have cash cows which can keep them solvent when they make huge errors playing the market (as they do). The gap between the deposit rate (paid by banks) and the mortgage interest rate is tiny in the USA compared to most countries, so banks don’t have huge average flows of cash to keep them solvent.
Second, the sort of private bailout (Bailin in Roubini’s terms) that failed this weekend would have worked on the Continent. If the minister of the treasury or the president of the central bank asks big banks to take some losses for the good of the financial system they will. This is because good relations with the state are very valuable. What they get in return is not glaringly obvious every day, but it is worth it. For example, nothing is done about the lack of competition.
Third, aside from that, giving public money to companies at risk of bankruptcy and maximizing moral hazard is a long Continental European tradition. EU rules make it much more difficult now, but for decades, companies in Europe didn’t dramatically fail, because the treasuries bailed them out without humiliating them by making it clear what was going on.
Fourth, fierce competition among commercial banks and non-bank mortgage companies and such has implied that they loan to individuals who are not very credit worthy. This means that ordinary Americans are incredibly indebted (see Mooser’s comment stolen by me and linked by Rdan below). This is a root cause of the problem.
Fifth, US banks have designed incentive systems which make it rational for bankers to do things that will occasionally cause a crisis. Bankers and traders are rewarded for performance. This, in practice, means they are rewarded for taking risks as if the bet wins, they share the winnings, but if they lose big the worst thing that can be done to them is to fire them. In particular a collapse of the system can’t be blamed on any one person, so almost no one pays. That is it is OK to lose when everyone is losing, because not everyone can be fired.
A ‘sound’ banker, alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.
—Keynes
Of course, if you ask Keynes, he would say it is obviously because Americans are just stupid and inferior. He was wrong about that, but had a point about bankers.