by Ken Feltman
You can always count on Americans to do the right thing – after they’ve tried everything else.
– Winston Churchill
Two months ago, a few days after my article suggesting that the financial capital of the world was now Washington, I received a pleasant note from an executive of a large New York bank explaining why New York was still the world’s financial center. He stressed that the great decisions regarding investing, finance and banking would continue to be made in New York.
Within five weeks his bank was one of two of the largest three banks in the United States that was dragging down markets worldwide amidst rumors that those banks would be nationalized. The decision whether to nationalize was not being made in New York but in two adjacent buildings on Pennsylvania Avenue in Washington – the Treasury Building and the White House. Many in the financial industry still fail to comprehend the change. For example:
Earlier, at the other end of Pennsylvania Avenue, senators and congressmen were grilling the heads of financial institutions from New York and elsewhere. The bankers and financiers seemed resentful and poorly prepared. They displayed the public relations sense of a smashed pumpkin: messy, smeared all over everything and hard to clean up. One of them, from North Carolina, remarked as he brushed past me outside a hearing room that the senators who had just pilloried him were “trying to get into my pocket.”
Trying? No, he doesn’t get it. He took public money, he paid big bonuses. Surely he should have expected Uncle Sam to stick a paw in his pocket. And that humiliating hearing? It was not about pockets: Congress was in his face, not just his pocket. All corporate chieftains with supersized compensation packages need to get used to that abrasive, publicity-grabbing style of management in the world’s new financial capital.
As clumsy and obtuse as the bankers were, and as mean-spirited and pedantic as the senators and congressmen have been, they were behaving better than their European counterparts. European fecklessness seemed destined to come back to haunt us all. Then, Germany reconsidered.
Since the fall of the Berlin Wall, Eastern European countries have spent and borrowed and spent again to develop export economies as a way to catapult their citizens into Western European income levels and lifestyles. They gobbled up investment and credit from Western banks and corporations looking for lower-cost production and new markets. Eastern Europe wanted equality right now. They seemed ready to get equality, but not the kind they hoped for. Rather, Eastern European debt threatened to drag down some Western Europeans to the living standard of the Eastern Europeans.
How quickly times changed. Western Europe sank into recession and demand for Eastern European exports dried up. Throughout Eastern Europe, plants closed, unemployment spiked upward and stock prices tanked. To make matters worse, exchange rates for Eastern European currencies plunged: The cost of paying back all those loans denominated in Euro and other Western currencies become prohibitively expensive. Defaults rose among both businesses and individuals – and a few countries slipped into jeopardy of defaulting on their sovereign debt. But Europe could not agree on an overall plan to assist the Eastern Europeans. German Chancellor Angela Merkel was adamant: Germany would not bail out troubled neighbors.
Germany’s attitudes are understandable. Germans have a deep remembrance of the ruinous inflation of the Weimar Republic that contributed to the rise of the Nazi Party. They are savers and their financial system is the healthiest in Europe – and arguably the healthiest in the world. Germans remember the years of deprivation. They welcomed back East Germany and know how hard it is to prop up and assimilate failed economies. No one knows more than the Germans about what Europe – and perhaps the world – might be facing.
Eventually, declining German exports caused a fresh look. German analysts and economists soon found some troubling facts. Banks from larger countries – France, Germany – could expect cash injections from their governments, as has happened in the U.S. But in smaller countries with larger banking sectors – Austria, Italy, Ireland, Belgium, Sweden, the Netherlands – troubled loans can quickly become a sizable percentage of GDP. Any smaller country that attempted to rescue its banking sector could suck money out of other segments of the country’s economy. Iceland shows how a government rescue can flatten a whole economy.
Without assistance, some banks would fail. The Germans realized that assistance of the magnitude needed would not be available within the smaller countries. It could come only from beyond any smaller country’s borders. Politicians in Berlin, London and Paris resisted that idea.
Highly leveraged banks
In fact, the problem is compounded because, today, Europe is too interrelated for any regional or one-country solution to work. Western European banks have about $1.6 trillion in outstanding loans in Eastern Europe, and European banks tend to be even more highly leveraged than American banks. A financial default by an Eastern European country could ricochet through the Western European banking system, threatening individual countries with default.
Suddenly, the notions promoted by German officials – that this crisis was American-made, that Germany was on sounder financial footing and that the profligate Eastern Europeans had made bad choices – seemed unresponsive to the real crisis, which was much larger than the problem of BMWs piling up in German ports and rail stations. The problem was not just in the United States and former communist countries. The problem was in a smaller country nearby and if the problem was in that smaller country, it was in Germany and Britain and France, too.
The German analysts and economists came to believe something else: Europe is the key to world recovery. If Europe falters, so does the U.S., and Japan and everyone else. And Germany, of course, is Europe’s economic linchpin.
The economists urged stabilizing the smaller Western European nations. But stabilizing those nations required that Eastern Europe receive assistance. The German government opposed assisting the struggling countries of Eastern Europe. The German politicians were not alone. Politicians in France and Britain vowed to keep their money home. Britain denied Icelanders access to Icelandic funds deposited in British banks. Public officials in almost every Western European country stated that they would not ask their taxpayers to bail out other countries or foreign banks. France bailed out Peugeot and Renault, but only after extracting a promise from management to keep jobs in France while cutting jobs in other countries, especially in the East
Turning a back on the smaller countries?
Increasingly desperate, Eastern Europe finance ministers recommended that the European Union set up a TARP-type program to help countries and financial institutions in danger of default. They pointed out what the German economists believed to be true: A few national defaults could bring down even the Euro.
The larger nations balked. Their politicians echoed the protectionist rhetoric for which Washington is so infamous. They tried to shift responsibility. They said that the problem belonged to the European Union because the EU – or at least the Eurozone – is supposed to protect against the collapse of smaller economies by pooling resources. They knew that would not happen: The EU is still more of a fair weather friend and, in foul weather, a fiction.
But jettisoning the Eastern Europeans is a step beyond rhetoric into recklessness.
The Germans are not reckless. German politicians had been listening. Germany took the lead. First, German officials suggested domestically that financial protectionism based on isolation could end up shredding the EU. If that happened, Europeans might require a quarter century to recover and unite their governments enough to attempt another coordinated monetary policy. Meantime, the market for German exports would recover slowly. Some economists doubted that it would ever recover.
Germany acted. First came the announcement of Germany’s new willingness to intervene to prevent other countries in the Eurozone from sinking into fiscal default. Then Merkel did an about-face. She announced that Germany would help organize a rescue package for Eastern Europe through the International Monetary Fund. “We are ready,” she said.
Washington breathed a sigh of relief. People at the U.S. Treasury Department and elsewhere have worried about how Western European banks were repatriating capital – taking money out of banks in even other Western European countries, including money in their own subsidiaries abroad – and stashing it back home. They worried because the economists in Washington seem to be coalescing around the idea that nothing the U.S. has done so far has really worked, but nothing really worked in the Great Depression, either. So the U.S. seems to be determined to keep trying something, anything. Maybe Churchill was right and the U.S. will finally find the right thing.
But there is little doubt in Washington that Germany has made the right decision. And there is no doubt that only Germany could make that decision. So a decision made in Berlin and involving the International Monetary Fund, based in Washington, may mark the beginning of the recovery. If New York does not understand that, Berlin does. Washington does, too, as do political leaders in capitals across the world.
The politicians know that if Europe falters, whatever Washington or New York try will not matter. One Washington-based economist told me recently that when the first Western European country follows the East into national default, the rest of Europe and the U.S. will not be far behind. But the German decision buys time and means that maybe, possibly, probably Europe will stabilize and the world will be spared a catastrophic crash. Riga will not be this century’s equivalent of Sarajevo in 1914.
Such dramatic words may be too much to stomach. But the situation illustrates something that New York should keep in mind. In Medieval times, kings traveled and their government – even their treasury – traveled with them. One English king had much of his treasury washed away during a river-crossing, creating a national calamity. This week, the financial capital of the world moved to Berlin for a time. Calamity was avoided.
The financial capital is where the decisions are made – and the decisions are more likely to be made in political capitals by political leaders. We have seen by their behavior that financial people know very little about politics. Unless they are quick learners, the financial leaders of the world will become less and less important.
People like Chancellor Merkel will become more and more important.