The global economy is a mess, and Europe is in the most trouble. The European Union (EU) is enduring a very similar crisis to what the USA endured in 2008, but I think it’ll be worse for them than what 2008 was for us. Because it’s a primarily European problem, I don’t believe the US markets will suffer like we did in 2008, but the weakness of the EU will continue to hurt our economy and our markets. European markets, on the other hand, are the ones I think have more downside. Obviously, there are differences in the crises, but they’re not so different. The root causes of both crises are the governments and bad securities, there was/is/will be a lot of pain, and the recovery was/is/will be slow and jerky.
What caused the US’s crises? In the USA, an overzealous federal government under the Clinton administration wanted to increase the percentage of homeowners and combat the supposed problem of racial discrimination in lending like redlining. Basically, Clinton took Carter’s Community Reinvestment Act (CRA) and gave it some teeth and, along with the GOP-controlled Congress, repealed Glass-Stengall, which paved the way for this goal by breaking down the firewall between investment and commercial banking at financial firms (commercial banking is where people go to get loans and have bank accounts, but investment banking is merger and acquisition activity and complex securities and investments). Also, Fannie Mae and Freddie Mac were allowed to balloon exponentially under both Clinton and Bush Jr. Government regulators, most notably Alan Greenspan’s Federal Reserve, allowed dangerously high levels of leverage.
The government made it clear that the private sector should do its part to make mortgages more easily available. This necessitated a relaxation of underwriting standards that had been established decades ago and had proven effective in that time. Some financial companies resisted the government’s pressure to compromise their standards, but most didn’t and that’s where most of the bad securities came from. The government tried to get more people into houses and strong-armed the private sector to oblige. Both the government and financial sector lost sight of the fact that not everybody should own a house because owning a house is expensive (as I’m learning now that I’ve been a homeowner for just over a year) and not everybody has a stable enough financial base to do so. That’s a big lesson here – not everybody should own a house.
So, we have excess leverage and weak securities. That’s a recipe for disaster, and eventually, these securities started going bad as people who shouldn’t have been in those mortgages in the first place began to default and we had several large financial firms blow up due to being overlevered. Some firms had say 25:1 leverage ratios. This means that a firm borrowed 25x its actual assets in leverage. Think about this for a minute. With 25x leverage, you’d be wiped out entirely if you took a 4% loss on your leveraged portfolio.
Bear Sterns and Washington Mutual were sold to JP Morgan and Wachovia was sold to Wells Fargo. JP Morgan and Wells Fargo have mostly digested these acquisitions. Bank of America bought Countrywide and Merrill Lynch, but it’s still choking big time on Countrywide. AIG and Citi were basically taken over by the US government. Lehman Brothers was allowed to collapse (this was the real problem). There was significant pain here and we eventually needed dramatic action from the Federal Reserve and the Treasury.
Lehman was the big deal back in 2008. That collapse is what changed the situation from a series of relatively contained problems to a full-blown crisis. There were two reasons for this – because Lehman was such a mess with such far-reaching exposure and because our regulators mishandled it by allowing it to just blow up versus a more orderly unwind.
What about Europe? After all, while the US was having its meltdown in 2008, they were overseas snickering, “Stupid Americans and their overleveraged banks and worthless securities. We don’t have these problems over here because we are so much smarter than they are. Haha.” Obviously, it’s in some European accent. I hear it in a French one because of SocGen, which I’ll explain below.
Guess what. Not only do Europe’s banks have even greater leverage than ours, but they have even worse securities than ours. Switch out the American subprime securities with European sovereign securities and there you have it. Greece, Portugal, Italy, Ireland, and Spain are all countries on the brink of financial collapse because their governments have spent themselves into oblivion and their economies are grossly uncompetitive. Yes, I’m saying explicitly right here that the European nations’ sovereign debt is probably of even lower quality than our subprime debt was.
Several European institutions are in trouble here, such as Royal Bank of Scotland, National Bank of Greece, Banco Santander, Allied Irish Bank, Banco Bilbao, and Ireland Governor and Company Bank. The biggest one I’m worried about is Societe Generale (SocGen). SocGen is a totally different beast from any of those, very much like Lehman. Indeed, SocGen very well could be Europe’s Lehman. This article by Jim Cramer is an absolute must-read for anyone who wants to understand the US/EU crises and why Lehman/SocGen are so much bigger problems than regular banks.
We should learn two lessons from Europe. One, as I’ve maintained all along, socialism doesn’t work. Social democracies, as they are sometimes called, are how all these governments racked up so much debt and became such uncompetitive economies. Two, it’s not feasible to have monetary union without political union. Said another way, one-size-fits-all monetary policy doesn’t work and neither does a common currency. The monetary policy for Greece isn’t right for Germany right now, for example. Also, why should Germany have to bail out all of these troubled nations? The Euro needs to be dissolved because it’s a failed currency and the EU needs to break up because the grand experiment has failed.
Europe is going through today what we went through in 2008. All you have to do is change what exactly the governments did to cause the problem and change the toxic debt from subprime to sovereign debt. I just hope they learned what we did right and wrong in 2008, but judging by how they’ve handled things so far, I don’t think they have.
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