Not excessive government spending but excessive bank lending lies at the root of the eurozone crisis. Here’s why the bankers, not the people, should pay.
We’ve been listening to the same tired old story for almost three years now: if governments don’t cut back on their reckless spending, the euro crisis will escalate and the world will face catastrophe. Collapsing banks, spiraling unemployment, rioting workers — all are said to be the direct result of irresponsible fiscal policies in the lead-up to the worst crisis since the 1930s. And if government is to blame for these ills, austerity is certainly its only cure.
“But hold on,” some hundreds of thousands of protesters have been asking over the past year, “if governments were spending excessive amounts of money, then where did all this money come from? And if we are running out of cash so rapidly that we need to sacrifice social security, education, healthcare and hard-earned pensions in order to keep our heads above the water, then why is there somehow always money left for the bankers when they run into trouble?”
Instead of receiving answers, the protesters posing those questions mostly received blows. The reason why indignant citizens from Athens to Barcelona have been beaten up so relentlessly by the state, is that their questions go to the very core of the insurmountable paradox that is both endemic and essential to democratic capitalism. Some economists have called it the doom loop: the mutual dependence of the state and the financial sector on one another.
How does it work? Very simple: private banks prop up states by lending them money at attractive interest rates. But when these states fail because the banks lent them too much money at too low an interest rate (which the state now can’t repay), the failing state is forced to prop up the private banks which are now failing as a result of its own failure. Obviously, this only compounds the problem, as state bailouts of failing banks add to the state’s own debt problems.
The result of bank bailouts is thus that they temporarily keep failing banks afloat while simultaneously making these banks more reluctant to keep lending to the increasingly indebted state. This in turn makes it more difficult for the state to keep propping up the banks upon whose lending it depends for its own survival. In a vicious cycle of sorts, banks and states thus spin down together like two entangled paragliders caught in a mutual embrace of death.
This is exactly what is happening in Europe today. This evening, I appeared on Russia Today for a short interview on the formal requests for EU bailouts made by the Cypriot and Spanish governments earlier today (check back for the full interview tomorrow). One of the straightforward questions I was asked was, “if the crisis has been going on for so long, then why are Spain and Cyprus only now forced to request a formal EU bailout? What’s with the timing?”
The answer, again, is simple: we have reached a tipping point. We have finally reached the stage at which it has become impossible to deny that we are facing not just a sovereign debt crisis, but a full-blown banking crisis; that at the root of our troubles lies not excessive state spending, but excessive bank lending. Whether they lent to governments (Greece, Portugal) or to homeowners (Spain, Ireland), everywhere they went, they simply lent too much. This reckless bank lending has now come full circle with even more reckless bank bailouts.
As a result, superficial lies about excessive public expenditure will sound increasingly hollow. As long as the euro crisis remained more or less confined to Greece, it was very easy for neoliberal apparatchiks to argue that it was ultimately Greek profligacy, corruption and laziness that were to blame for derailing the grand euro project. None of that can credibly be argued now that Spain, whose public debt of 63.4 percent of GDP in 2010 was significantly lower than Germany’s 81.2 percent, has requested an EU bailout.
Spain’s problems have nothing to do whatsoever with excessive public expenditure. Rather, Spain’s problems are the result of a gargantuan housing bubble which saw the construction of millions of homes and the destruction of its once beautiful seashore and countryside. Assuming the housing boom to last forever, Spanish banks doled out billions of euros in mortgages to families who would never be able to repay them under normal circumstances.
And thus, when the financial crisis that started on Wall Street in 2008 brought housing construction in Spain to a standstill, sending the economy into recession and causing unemployment to skyrocket, hundreds of thousands of Spaniards suddenly found themselves unable to service their mortgages. Over half a million families were forcefully evicted from their homes in four years of crisis. The banking system also began to tremble as a result of this wave of defaults.
In the end, of course, it was the banks — not the homeowners — who got bailed out by the government. Even while Caritas announced that nearly a quarter of Spaniards now live in poverty and an additional 11 million are on the brink, the Rajoy government pumped 23.5 billion euros into the rescue of Bankia (more than double the amount currently being cut from education and healthcare combined). Never mind the fact that Bankia itself is a conglomerate of failed regional savings banks and that its chief executive, Matías Amat, was recently let off on early retirement with a 6.2 million euro bonus.
While Spain managed to avoid the type of neo-colonial EU “rescue package” that was imposed on Greece, Portugal and Ireland, the 100 billion euro bailout for its banks is a confirmation that the much-feared doom loop is now in full swing. The EU money may temporarily prop up the country’s failing banks, but because it will add another 15 percent to Spain’s debt-to-GDP ratio, the long-term creditworthiness of the state will only be further undermined, while the people are once again being made to foot the bill for the excessive lending of the banks.
Investors seem to realize this better than EU policymakers. No wonder, then, that Spanish borrowing costs spiked to a historic high of over 7 percent in the wake of its EU bank bailout — precisely the level at which Greece, Portugal and Ireland previously required their EU bailouts. By turning to the EU to prop up its banks, the Spanish government, rather than averting an “orthodox” bailout, may actually have made such a full sovereign bailout only more necessary.
Amid these horror stories, it makes sense that the Cypriot bailout received relatively little media attention. But even though it only counts 1 million inhabitants, Cyprus’ predicament is typical of the doom loop. Cypriot banks lent over 29 billion euros to Greece (160 percent of GDP!), 7 billion of which to the government, whose bonds have long since been relegated to junk status. Like an entangled paraglider, the failing Greek state dragged Cypriot banks down with it.
Until today, Cypriot banks could still use Cypriot government bonds as collateral for cheap loans from the European Central Bank, thereby averting immediate collapse. But the ECB will only accept sovereign bonds as collateral if at least one of the three big credit rating agencies rates these bonds as investment grade. Now that Fitch has become the last of the three to downgrade Cyprus’ credit rating to junk status, Cypriot banks can no longer turn to the ECB.
The government would thus have to step in to prop up the banks to the tune of at least 4 billion euros. But since the government is effectively locked out of foreign capital markets, it simply couldn’t raise the money for the bailouts, and hence was forced to turn to the EU to prevent a collapse of the banks upon which it depends for its own survival. Yet the EU will impose draconian austerity measures in return for this “aid” (which ultimately has to be paid back with the money of Cypriot taxpayers), only further compounding the doom loop.
What the Spanish and Cypriot bailouts tell us, therefore, are three things: first of all, the euro crisis originated not with excessive government spending but with excessive bank lending, and therefore was always a banking crisis to begin with; secondly, the doom loop of state and bank insolvency is now in full motion, threatening to push the entire financial system over the precipice; and thirdly, as long as this doom loop continues, the people will be made to foot the bill for the financial disasters of democratic capitalism.
Three good reasons, in other words, to argue that — as long as the state fails to make bankers pay for their own risk-taking — our political and economic system is not really that democratic after all. And three good reasons, therefore, to renew our popular resistance to the modern European bankocracy. In the end, we are the only ones who can stop the doom loop: not by saving the banks, but by seizing and socializing them. After all, the only ones who really deserve a bailout today are the millions of Spaniards, Greeks and other Europeans who are currently being made to pay with their livelihoods for a mess they didn’t create.