Part 1: Europe Blames America While U.K Warned of Bankruptcy
by Chris Tew, February 4, 2009
Niall Ferguson, respected economic historian, warns of other European countries facing an Iceland style bankruptcy. 'Switzerland is first in line… and Britain is not far behind,' he says.
While many politicians in Europe like to shift the blame for the credit crisis to the U.S. Niall points out that excessive lending and leveraging was much more endemic in countries such as Germany and the U.K.
Yet the U.K Prime Minister, Gordon Brown, like many European politicians continues to argue that the world is being brought down by a U.S. caused recession. Before we get Niall's version of current events let's look at what Gordon has to say:
Gordon Brown's View on the Global Credit Crisis - Blame America
BBC Politics Show 23rd November 2008 Gordon Brown interview with Jon Soper
"I mean what's happened is we've had a banking crisis which started in America; makes me incredibly angry about what happened, the irresponsibility of risk taking and the irresponsibility of not disclosing things...
...This is an international crisis that has not been generated in Britain".
Niall Ferguson Calls Collapse of U.K Financial System
Here Niall mentions the excessive leveraging taking place in the banking system. Leveraging essentially means how much money the bank actually has, compared to how much it is borrowing. It has become standard practice (and legal) for banks to lend out a lot more money than they actually have and excessive leveraging has been identified by many as a fundamental cause to the worldwide financial collapse.
While financial tools such as credit default swaps are largely blamed for creating a bubble instead of leverage, credit default swaps were essentially a clever way for the bank to create more leverage. In other words banks were doing whatever they could to sell more loans, with no care for how much real money they had to back those loans. This situation was much worse in Europe than in the U.S.
Pointing the finger at the U.S. banking system
is not a justifiable stance for a European politician.
The lower a bank is leveraged the lower the risk but the lower the potential reward, the higher it is leveraged the higher the risk, but higher the potential rewards. Every bank getting bailed out took too much risk and hence needed a bailout to avoid bankruptcy.
Niall states that leveraging has averaged 12:1 in the U.S., whereas in Europe it was much higher with German banks having an average leverage ratio of 52:1. That's essentially $52 of debt based money for every $1 of real assets/money.
So pointing the finger at the U.S. banking system is not a justifiable stance for a European politician. The chart below shows how excessive the leveraging was among many European banks:
|Bank||Leverage Ratio June 2008||Leverage Ratio
|Hypo Real Estate Holding||83||65.9|
(Source: CEPS, Sept 2008)
The Global Downturn Excuse
When questioned about the recession Gordon Brown repeatedly refers to the fact this is a global problem. In the news video above Gordon Brown describes the situation as a 'Global banking crisis' and calls for 'international cooperation'. It could very well be argued that this repeated message from Gordon Brown is a way to shift the focus of blame. How can you blame the local government for things happening all over the world?
More recently Gordon has pushed this message even harder stating:
"This is a global banking crisis and you've got to deal with it for what it is, a global banking crisis"
However, as previously stated, with many respected economists and the IMF arguing that Britain is among the worst placed economies of western nations, the global blame shift diminishes.
Gordon Brown also points out that countries across the world are adopting a stimulus and bailout strategy.
"Britain, like many other countries in Europe, is prepared to make its contribution for a temporary and affordable fiscal stimulus. It is now clear that the need for an urgent fiscal stimulus, within a medium term framework of fiscal sustainability, is overwhelmingly accepted across the world. "
This infers that because everybody else is doing it then it must be right. However, this argument is completely flawed and here's why:
- It's Gordon's Idea:
Gordon Brown is pushing the stimulus agenda across the world urging other countries to take up this strategy. He is not simply adopting this strategy, he is encouraging other countries to use it.
- Britain Might Not Be Able to Afford it:
While other countries are bailing out banks and pushing a stimulus package it doesn't mean that Britain can afford it. As David Cameron has warned, the U.K may need a bailout from the IMF, while others discuss how the IMF will need a bailout.
- World Leader's Decisions Worked in Unison to Cause a World Recession
Just because many countries are adopting the bailout and stimulus approach it does not mean it is right. The same people making decisions over the past decade allowed a financial bubble to be created by allowing banks to leverage excessively and encourage debt based consumption. This detrimental approach, which caused the recession, was largely done in unison across many nations so it is clear that leaders world-wide can make bad decisions in unison, or make decisions which damage the average citizen in the long-run.
The stance 'everybody's doing it so it must be right' has already proven to be a dangerous strategy. Just as the decisions of world leaders helped cause the recession, world leaders can make it worse.
U.K Heading for Bankruptcy?
While leveraging in Germany is very high the country arguably has a much more resilient economy than the U.K with a trade surplus resulting in more money coming into Germany than going out of it. Compare this to the U.K which has an excessive trade deficit with approximately £100 billion leaking out of Britain in 2007 alone.
That means in 2007 the U.K had to borrow approximately £100 billion from abroad to make up for the loss. That was before the U.K government first nationalized Northern Rock, announced a £500 billion bailout plan in October, and then a further bailout scheme in January 2009.
While difficult to calculate, the total bailout package, including all cash injections, loan guarantees and removal of toxic debts, comes roughly to a scary £900bn. Worse is that this may not be the end with further expensive bailouts are to come.
As the IMF has speculated, the U.K is going to be the hardest hit western nation by the recession. Some fundamental reasons for Britain's expected poor performance are:
- A large trade deficit
- Record levels of government debt
- Average bank leverage levels higher than U.S. banks (see above)
- Huge level of personal debt among citizens
- Significant drops in tax revenue
- A collapsing currency
With this arguably dire economic situation the question remains...