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 François 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.
"The smugness is no longer there," Barysch said.
Steinbrueck, who had been particularly acerbic in blaming Washington for allowing U.S. banks to spin out of control, was busy in Berlin trying to keep up with the troubles in his own banks. An initial $49 billion package for Hypo unraveled, as banks that had agreed to come to the rescue complained that its losses were far more than they had been led to believe. Steinbrueck had to round up billions more to prevent a collapse.
Sarkozy, who had called for revamping world financial rules as early as Sept. 25, also stepped out ahead with a call for coordinated action by E.U. countries to douse the flames heating up across the continent. As head of the country that holds the union's rotating presidency, he invited Berlusconi, Chancellor Angela Merkel of Germany and Prime Minister Gordon Brown of Britain to join him last Saturday for an emergency summit in Paris to adopt a common strategy.
Sarkozy's initiative reflected a long-standing propensity to seize leadership, a trait denounced by his opponents as rashness. But it also reflected a belief that because Europe's troubled banks operate across national borders, they would benefit from Europe-wide solutions to their weaknesses. Finally, it responded to the widely shared ideology of a united Europe, the idea that the E.U. is heading toward more integration and should thus confront the financial crisis as a group.
"The financial crisis strains the unity of the 27" E.U. countries, wrote Pierre Rousselin of the Paris newspaper Le Figaro as the leaders of Europe's four major economic powers gathered at the Elysee Palace. "But if Europe wants to exist, now is the time to prove it."
Despite decades of unity rhetoric, Europe has never come together to the point of a government with powers such as those enjoyed by Washington. As a result, Sarkozy's summit produced ringing pledges of coordination but no concrete Europe-wide steps. It was, commentators concluded, every country for itself, to defend its national interests.
Nicolas Véron, an analyst at the Belgian economic research center Bruegel, noted that those calling for specific and coercive E.U. action to dampen the crisis were exaggerating the group's level of integration and the power of its common institutions. Although the union has the European Central Bank to set interest rates in the 15 member nations that use the euro, he noted, it does not have an executive that can make transnational decisions in the way Treasury Secretary Henry M. Paulson Jr. can guide banks in all 50 U.S. states.
"Basically our institutions do what they're designed to do," he said, "but they don't do what they're not designed to do."
In particular, suggestions that the E.U. set up a $400 billion bailout fund based on proportionate national contributions gained automatic interest as a way to restore confidence in the troubled system and confirm European solidarity in the face of difficulty. According to press reports, it was floated by mid-level French officials during preparations for last Saturday's summit. But Steinbrueck swiftly and publicly ruled it out. From London, Brown made his opposition known more quietly. Sarkozy renounced it as unrealistic even before his guests arrived.
Back in Rome, Berlusconi kept pushing for the fund and visited Merkel to try and talk her into supporting it. But the idea that Europe's governments could find that much money in a time of financial crisis was fanciful to begin with, Véron said. And European integration has not advanced to the point where Germany, the union's largest economy, would find it politically palatable to hand over billions of dollars to rescue banks around the continent.
Contracting their ambitions, French officials succeeded Tuesday in getting E.U. finance ministers to agree on a common increase in private deposit guarantees, from about $27,000 to $68,000, to prevent runs on banks by account holders.
That decision had little more than symbolic value. Many countries, including France, had already announced higher guarantees.
"After all, the European Union is made up of 27 sovereign nations," Barysch said.
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