The world financial crisis will either leave European financial integration in tatters or quicken the development of European fiscal capacity. European integration is a historical process that routinely stumbles upon crises that threaten to destroy it, only to find that the crisis has served to deepen it.
Avinash D Persaud career spans finance, academia and public-policy in London and New Yorkis chairman of Intelligence Capital Limited
This article was first published in Voxeu.org (6 October 2008)
Also by Avinash Persaud in openDemocracy:
Avinash D Persaud, "The dollar standard: (only the) beginning of the end" (5 December 2007)But how long will this process take? An interesting and perhaps sad lesson of the mini-summit of European leaders in Paris on 4 October 2008 is that Europe's predicament has been made worse by allowing financial integration to run ahead of fiscal integration - and in turn of Europe's governance capacity.
The logic at the time was that financial integration would reinforce the single market and facilitate economic integration. The consequence is that Europe now has financial institutions that are large relative to individual member- states. European financial institutions funded the acquisition of cross-border assets through the money markets (since regulators make it expensive to acquire deposits). Now the money markets have frozen and these institutions are too large for taxpayers in their home country to rescue.
The Atlantic gap
The problem for Europe's national leaders is that they, or rather the states they govern, don't have the tax-base for a version of the United States bailout plan (originally proposed by the treasury secretary, Hank Paulson, subject to delay and intense political argument, before being passed by both houses of Congress and signed into law by the president on 3 October 2008).
The absence of an equivalent tax-base meant that at the Paris summit, individual European states could not agree to a US-style bailout. The contrast is revealing: the liabilities of Bank of America (the largest US bank by balance- sheet) are approximately half of the annual tax-revenues of the United States. That is a big ratio, but it is far exceeded by the ratio of liabilities to home tax- revenues of Deutsche Bank (one-and-a-half times) and of Barclays (two times).
Also in openDemocracy on the global financial crisis of 2007-08:
Saskia Sassen, "Globalisation, the state and the democratic deficit" (18 July 2007)
Tony Curzon Price, "The end of gentlemanly capitalism" (13 August 2007)
Robert Wade, "The financial crisis: burst bubble, frayed model" (1 October 2007)
Ann Pettifor, "Debtonation: how globalisation dies" (15 August 2007)
Ann Pettifor "America's financial meltdown: lessons and prospects" (15 September 2008)
Willem Buiter, "The end of American capitalism (as we knew it)" (17 September 2008)
Ann Pettifor, "The week that changed everything" (22 September 2008)
Fred Halliday, "The revenge of ideas: Karl Polanyi and Susan Strange" (24 September 2008)
Godfrey Hodgson, "The week that democracy won" (29 September 2008)
The currency markets have followed the scent of this fiscal issue ever since the US began considering the "Paulson plan" - after which the euro lost 5% in a little over a week against the US dollar. But the problem may not be as bad as the currency markets think. Big government can make big mistakes. The US approach, far from being enviable, may prove to be expensive folly. It is far from clear that the modified version of the plan which has now become law will trigger private investment into banks; and if there is none, US treasury purchases of troubled assets above market prices is an expensive way to inject new capital into the banks. I suspect that Europe will eventually stumble towards solutions to the credit-crunch that are better for being constrained by Europe's national budgets, but can nevertheless operate effectively at the European level.
The European response
An idea that emerged from the Paris discussions is for European governments to offer an injection of equity capital into institutions that seek assistance. But as a condition of doing so, they should negotiate a partial debt-for-equity swap of the bank's creditors.
The problem that banks have today is (now that things have moved on from the liquidity problems since 2007) of getting sufficient capital to operate with - and injecting capital is far less expensive than buying assets. The US is taking advantage of its tax-base more than it should. Instead, using the promise of an equity injection as a lever to negotiate a restructuring of bank debt would also help European taxpayers share this lower burden of bank rescues with bondholders (who were, after all, paid to take the risk of bank failures).
Many thorny issues arise when governments start taking equity stakes in local banks. This is one of the reasons why the US authorities decided to be indirect and buy bank assets instead. But Europe has the potential to do this at one step removed from national governments, in a way that may not have been possible in the US.
European governments can increase the capital subscription of the Luxembourg-based European Investment Bank (EIB) to fund capital injections into banks. The 4 October meeting already sanctioned an increase in the EIB's lending capacity by €30 billion to help small businesses hit by the credit-crunch. While the process could not be depoliticised, the EIB or a new "cousin" can act more independently of national governments and more consistently across them.
The solvent of crisis
The most interesting lesson of this phase of the crisis is that there is a greater limit to the globalisation of finance than was previously thought (see Grahame Thompson, "Deglobalising the crisis", 3 October 2008). But the constraint is in a different direction than previously imagined - the taxpayers' guarantee.
This will cause a reappraisal of a few global banking brands. It also casts a new light on the viability of offshore financial centres. In Europe's case, it either leaves financial-integration plans in tatters, or it quickens the development of a European fiscal capacity. For good or for ill, I would bet on the latter. Again, European integration is a story of potentially destabilising crises that in fact prove regenerative. (The arrival of the euro probably required the near-collapse of the European monetary system in 1992-95, for example). The current convulsions may see the pattern repeated.