The news of recent weeks brings back those memories for me. On 21 October, the Member States and the European Parliament reached a provisional agreement to make securitisation – the packaging and resale of loans – more attractive again. At the same time, the banking sector is lobbying for lower capital buffers. Also, yield spreads in Europe have widened again. Only now it is France that is under the microscope: in early October, the spread between French and German ten-year bond yields stood at the highest since 2011. On top of that, the blue tsunami last week, the win of the Democrats in the mid-terms, led to a considerable market correction of AI-related stocks, showing how fragile markets are.
The half-life of a crisis
Flashbacks are part of coming to terms with trauma. Anyone who has been through a terrible experience knows that even a faint echo is often enough to trigger them. I do not wish to exaggerate my trauma. An economist who is alarmed by the direction of policy, whilst both bank capital buffers and interest rate differentials remain well below crisis levels, perhaps deserves nothing more than a pitying glance. And yet. Traumas serve a purpose: ideally, they keep you well clear of the danger zone.
The American economist John Kenneth Galbraith wrote as far back as 1990 that financial memory stretches back no more than twenty years. Long enough to forget a crisis, short enough to allow a new generation to believe in its own genius. I call it the half-life of a crisis. Almost twenty years after all hell broke loose and we swore it must never happen again, and Queen Elizabeth II even wondered why nobody had seen this coming, the game is starting all over.
Unlike the austerity policies following the euro crisis, which directly affected many citizens, the memory of the banking crisis seems to have gradually faded from the collective memory. And as in physics, the half-life varies by substance. The austerity that followed the euro crisis hit many citizens directly. The banking crisis seems to have quietly faded from collective memory. We seem to have forgotten that we all bailed out the banks. That we were furious about bankers’ bonuses, and that we only narrowly escaped an economic collapse.
After the crisis, stricter regulation was meant to make the banking system safer. Now that very same regulation is blamed for Europe falling behind. Less risk has come to mean less competitiveness. A serious mistake. So we are once again reaching for the old remedy, fewer rules for banks, in the name of competitiveness.
European banks want the same leeway as their American competitors. In the US, the regulations have already been relaxed. And Europe must invest in competitiveness and resilience. Quite right. Except that fewer rules and lower buffers do not help with that. Above all, they make the next disaster worse.
France under the microscope
And what about France? For decades, Paris has been unable to bring its budget deficit under control. Debt now stands at almost 120 per cent of GDP, a post-war record. Interest payments are rising ever further, whilst growth in France remains low. The risk: a potential debt explosion. Unlike in 2010, the European Central Bank now does have an emergency brake: the Transmission Protection Instrument (TPI). And because European banks still hold large amounts of government bonds issued by their own governments, if France falters, it could also drag Belgium and Italy down with it.
Paying twice
I do not know if or when things will go wrong. What I do know is that the risks are rising significantly and that we are sowing the seeds of new problems if we intend to resolve the next crisis in the same way as the previous one.
In 2008, ‘resolving’ mainly meant bailing out the banks. During those years, governments injected a total of over 640 billion euros into their banks and provided guarantees amounting to nearly 1.2 trillion euros. The risks posed by banks suddenly became a public problem. The homeowner whose mortgage was underwater received nothing. The banker lost, at most, his bonus.
Large-scale cuts to public services followed, and the burden fell on those at the bottom of society. This had political consequences. According to economist Thiemo Fetzer, Brexit would probably not have happened without British austerity. Other research shows that a one per cent reduction in public spending yields around three percentage points of additional votes for extreme parties.
During the coronavirus pandemic, it became clear that things could be done differently. Governments protected jobs and incomes directly. Why shouldn’t we, in the event of the next banking crisis, protect savers and the payments system, and this time let the shareholders bear the losses?
Of course, France needs to tackle its public finances. But how quickly this is done and who pays for it are political choices. Anyone who looks only at a deficit figure and prescribes harsh cuts for France without a proper plan is playing into the hands of both the far left and the far right. There is much more at stake than a budget deficit; this is about democracy.
So those flashbacks are actually quite useful. Nobody can predict the next crash. What we can do is decide now how we will respond, before panic decides for us. That means plans to protect savers and the payments system while shareholders take the losses, for instance with a digital euro and a public savings option, so that ordinary people no longer depend on whether their bank survives. And it means agreeing in advance that fiscal repair will be gradual and fairly shared, instead of being imposed overnight on those who can least afford it. Last time, those at the bottom paid twice: first with their incomes and their jobs, and then with their trust in politics. We cannot ask them to pay a third time.