Financial Crisis Tests Limits of Unity Within the E.U.

By Edward Cody
Washington Post Foreign Service
Friday, October 10, 2008

PARIS, Oct. 9 -- Three weeks ago, as the Bush administration struggled to salvage collapsing U.S. investment banks, European leaders calmly reassured their people. Banks on this side of the Atlantic are more wisely regulated, they said, and unlikely to succumb to the chaos on Wall Street.

That was then.

The continent has in the intervening 20 days awakened to discover that its financial system is so interwoven with that of the United States and the rest of the world -- and so vulnerable to shaky assets -- that the virus in New York swiftly spread through the European banking network. In so doing, it revealed that Europe's leaders face challenges just as difficult as those bedeviling Washington and exposed the limits of the European Union's much-heralded economic integration.

But European leaders, with a tradition of state intervention lacking in the United States, responded forcefully outside the E.U. umbrella once they realized the depth of the crisis, bailing out banks, pumping hundreds of billions of dollars into the financial system and declaring publicly that no big financial institution would fail on their watch. Many people here feel they moved more swiftly than their counterparts in Washington. Jean-Claude Trichet, president of the European Central Bank, for example, said Europe had nothing to be ashamed of in its response to the crisis.

As they are increasingly pushed against the wall, some European leaders have begun to say out loud what many seem to have been thinking all along: that the original fault lies with the Bush administration and a hands-off, free-market dogma that led it to stand aside when the venerable Lehman Brothers investment house started to crumble.

"From my point of view, that was a true mistake," French Finance Minister Christine Lagarde said in a radio interview. "You knock over a domino," she added, "and the rest runs the risk of falling, as well." According to reports in Paris, President Nicolas Sarkozy has told associates he feels the same way but has refrained from saying so in public as he seeks to enlist President Bush for a summit to rewrite the rules of world finance.

If Lagarde or Sarkozy recognized at the time that the Lehman Brothers demise was the beginning of catastrophe, they did not sound the alarm. Neither did anyone else among leaders of the 27-nation E.U. "Well, they are human, too," said Katinka Barysch, deputy director of the Center for European Reform in London. "Nobody foresaw this."

One of the first European rescues targeted the giant Fortis group, in a joint operation by the governments of Belgium, the Netherlands and Luxembourg over the weekend of Sept. 27-28. Hardly was that fire put out when Paris and Brussels had to negotiate a bailout of Dexia, a Franco-Belgian bank specializing in lending to local governments, and Germany was forced to salvage its floundering Hypo Real Estate Group. Even Spain, whose banks were thought to be the firmest of all, announced Tuesday that government funds would be used to help liquidity.

The Dexia collapse illustrated two key aspects of Europe's financial turmoil.

First, it got in trouble through a New York subsidiary, Financial Security Assurance, a bond insurance firm that got stung in the U.S. subprime meltdown. Sarkozy was reported to be astounded to learn that what he knew as a wood-paneled institution for local financing in Europe was also a high-risk trader on Wall Street.

Second, Sarkozy and Belgian Prime Minister Yves Leterme made it clear in the bailout talks that their governments would not allow banks under their purview to fail, putting public money on the table at the outset. Similar pledges came from Finance Minister Peer Steinbrueck in Germany and Prime Minister Silvio Berlusconi in Italy. There would, they said in effect, be no Lehman Brothers cases in Europe.

By then, the facile claims that European banks were too well regulated to have any real trouble were long gone. French Prime Minister Fran├žois Fillon warned that the continent had stood on "the edge of an abyss" until its leaders stepped up to guarantee against the spread of bank failures.

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