The Euro Disaster: An Economic Union in Disunion

The Euro: gift or gaffe?

Prologue

When the subprime mortgage financial crisis compounded into a major recession that threatened to topple the American banking sector in 2008, Europe from across the pond found itself no less immune to the spillover as the financial implosion materialised into a trans-Atlantic crisis that whiplashed back into the core of an unprepared European monetary union. In fact, the consequences of the Great Recession in the U.S. arguably paled in comparison to the existential crisis that the Eurozone and the European Union was confronted with when what started as a Greek default spiralled into a region-wide sovereign debt crisis that threatened to disintegrate the monetary union and even the supranational political coalition that was designed to bind together a once warring continent. This essay aims to formulate an institutional and macroeconomic diagnosis of the origins and broader consequences of the Eurozone Crisis on the European Union through a comparative dissection of key trans-Atlantic, Southern European “PIIGS” (Portugal, Ireland, Italy, Greece, and Spain), and European Union actors. 

Was it Uncle Sam or PIIGS?

As Greek borrowing costs approached unserviceable levels along with Portugal, Italy, and Spain in 2010, a contagion of sovereign default appeared imminent across the Eurozone after the 2008 subprime mortgage crisis aftermath that originated in America reverberated across both sides of the Atlantic. Given the timeline of the events that transpired, it may have appeared all too convenient for debt-mired Eurozone member states and their leadership to point fingers towards Wall Street to mitigate culpability as were the cases with then-Greek Prime Minister George Papandreou “not ruling out taking legal action against U.S. investment banks for their role in creating the spiraling Greek debt crisis” (Associated Press, 2010); then-Chief Economist of European Central Bank Juergen Stark admonishing American creditors for harboring “vested interests” and “topping off [their] books” by fueling market pressure on Greece to restructure its debt and austerity measures (Associated Press, 2011); and European Commission President Jose Manuel Barroso insisting the Eurozone Crisis originated in North America due to the European financial sector contaminated by purported ‘unorthodox practices’ from Wall Street (Crowley, 2012).  

However, brushing aside the veneer of politicking and finger pointing, empirical evidence and macroeconomic data suggests a very different story. European banks from Germany to Spain and Ireland willingly purchased toxic Mortgage Backed Securities (MBS) worth billions of dollars that American financial institutions packaged out of subprime mortgages amid a housing boom and then-favorable macroeconomic conditions (Bayoumi, 2017). Above all, the Euro Crisis was more than a mere financial crisis–it was a widespread breakdown and malfunction of the institutions that held together the Eurozone and their member states at the domestic and regional levels within the massive supranational bureaucratic machinery known as the European Union. 

Trouble in Iberia

Well before the warning signs flashed on subprime mortgage defaults on Wall Street and Lehman Brothers collapsed in 2008, the trajectory of the Portuguese economy itself too was a warning sign of troubles brewing within the Eurozone. Portugal had experienced virtually no growth, distressing unemployment numbers, and lagging productivity at the turn of the millennium. Its wages and production input costs were relatively high compared to its EU counterparts and therefore its industries were chronically uncompetitive. When it adopted the Euro, it relinquished monetary policy independence over to the European Central Bank and could no longer devalue its currency to make its exports more competitive within the Eurozone, the Portuguese economy was siphoned away by its more competitive counterparts such as Germany and France (Reis, 2013). The Portuguese story was the first of many that would be retold around peripheral Europe and materialize into the foundation for the Euro Crisis.

When the 2008 subprime mortgage crisis erupted in America, the Spanish economy’s addiction to credit, overreliance on construction, lagging competitiveness and productivity, and a massive current account deficit of 8.6% primed it to bear the brunt of the economic shock as the financial crisis played out across the Atlantic (Royo 2020, p. 119-140). But the straw that broke the camel’s back was the deeply rooted culture of corruption and cronyism within Spanish financial and governmental institutions equally fostered by the socialist Spanish Social Worker’s Party (PSOE) and conservative Popular Party (PP) in post-Franco Spain. Scandal after scandal engulfed savings and commercial banks, the Spanish Stock Exchange and even the most venerable institutions such as the Bank of Spain; a deep and widespread permeation of corruption within Spain’s bureaucracies and financial sector completely eroded any and all of Spain’s credibility and trust with its own citizens and, more importantly, its creditors and investors. In return they gifted the Spaniards with sky high debt servicing costs and their very own sovereign default crisis. 

A Big Fat Greek Crisis

Of course, the role of Greece in the Euro Crisis can hardly be overstated–after all, this small Mediterranean economy situated below the Balkan peninsula was ground zero. Greece had struggled with persistent lagging productivity and competitiveness, overspending, and a high debt load exacerbated by paltry tax revenues due to a culture of tax evasion that permeated every corner of society–a problem so great it prompted then-IMF head Christine Lagarde to say she had “more sympathy for the children of Africa than tax evaders in Greece.” Given that the Greeks evaded taxes on a staggering amount of approximately €28 billion of unreported income in 2009 alone, perhaps Lagarde was justified in not mincing her words. To put this into perspective, it accounted for approximately 31% of the Greek economy's budget deficit in that fiscal year, one of the largest shadow economies in the Eurozone (Artavanis, Morse, & Tsoutsoura, 2016). 

Even Greece’s adoption of the Euro itself was laden with controversy and misrepresentation when it was revealed that it manipulated macroeconomic data to hide the true scale of its fiscal woes through creative accounting practices such as credit swaps and secret loans in order to meet Maastricht convergence criteria (Aragão & Linsi, 2020). From the moment Greece forced its way into the Eurozone, it was a ticking time bomb.  When then-Prime Minister George Papandreou’s administration revised “accounting errors” in deficit numbers to double the original estimates and spurred a downgrade of its sovereign debt to junk status, the panic spread throughout credit markets and culminated in skyrocketing borrowing costs for Portugal, Italy, Spain, and other economies investors deemed incapable of debt repayment, and from there the Euro Crisis was born.

Dolce far niente d’Italia

The Italian reproduction of the crisis that played out as Greece headed for default was consistent with the rest of its PIGS counterparts on the surface, with a slight twist. While Portugal, Italy, Greece, and Spain all belonged to an exclusive club within the Eurozone that boasted high public spending, ballooning deficits, lagging productivity, and anaemic competitiveness, what set Italy apart from its PIIGS peers was the fact that it was its government’s perceived political incompetence in dealing with a debt crisis that drove investors to squeeze the taps on the Italian borrowing. Lagging competitiveness and a growing budget deficit notwithstanding, the Italian economy was still the third largest in the Eurozone after Germany and France–this was not irrelevant, and it could be argued that the economic problems it faced did not warrant a sovereign default crisis in light of its size and large manufacturing industry compared to its Southern European peers (Romano, 2020).

In the end, however, it was a deficit of trust and confidence from the markets and international observers on the will and competence of the Berlusconi administration to deal with the economic shock that pushed Italy into a sovereign debt crisis and toppled Berlusconi from office. The incoming technocrat administration headed by Monti voluntarily enacted austerity measures not out of pressure from Germany or the ECB, but to assuage market concerns and project confidence. The markets simply did not trust the Italians with the sweetness of doing nothing in the face of a debt crisis, and so a change of guard was forcibly instituted from within and without.  

Emerald Isle, Recession Style

Even the once illustrious Celtic Tiger had its creditors demand a 14% 10-year yield upon catching the first whiff of default (Purdue & White, 2014) when it became apparent the Irish banking sector was exposed to high-risk loans by holding the very same toxic subprime mortgage securities packaged and sold by American financial institutions which triggered the 2008 Great Recession,  while its government expanded it debt-load to the size of five times Ireland’s GDP (Baudino, Murphy, & Svoronos, 2020). As a result, international investors and creditors locked Ireland out of credit markets through skyrocketing debt servicing costs; the Irish economy was a Celtic Tiger no more but instead a leprechaun left with an empty pot of gold forced into painful austerity.

A European Union in Disunion

Above all, the European monetary union’s sheer incompetence coordinating a fiscal response in the face of a crisis was both a symptom and direct reflection of the nascency and incongruence of the European Union itself as a political union. When introduced in 1999, the Euro managed to achieve the once unthinkable: it economically and politically united a Europe that nearly wiped itself out in a war five decades ago under a single and shared monetary union. The E.U. itself was forged through the sheer will to uphold the promise of Never again. And yet, the Eurozone Crisis still laid bare the Westphalian remnants of Europe by exposing the utter lack of supervisory structures capable of enforcing pan-E.U. fiscal prudence and banking regulations for a simple reason: sovereignty. Even national polities united under a single currency could not stomach a Brussels with oversight over their domestic budgets and financial sectors. Therefore, the Euro that E.U. member states adopted had to be built around an institutional framework incapable of broad fiscal and financial coordination. 

The seemingly-minor and inconsequential political quirks that shaped the emergence and structure of the EMU is particularly salient in the context of the Eurozone Crisis precisely for two reasons. First, the “fiscal disunion, monetary union” framework left the European Central Bank and EU Council in no position to directly apply fiscal intervention in response to the crisis. Secondly, the lack of pan-E.U. banking regulation meant the Union was left unprepared and under-equipped to enact extensive E.U. wide "carrots and stick” financial regulation in the same way the U.S. Securities and Exchange Commission is free to investigate and fine financial institutions across all 50 states. This was not trivial, particularly because the European bank-based model of corporate governance and financing is distinctly characterised by its high reliance on banks, as opposed to securitised equity and debt, for corporate financing (Pillay, 2013). In contrast, the Anglo-American model defined by its more diversified approach to corporate financing through public and private debt and equity markets proved far relatively more resilient in both the Great Recession and Eurozone Crisis thanks to a reduced dependence on banking institutions. Perhaps that is why the U.S. never faced an existential economic and political reckoning during the 2008 Great recession in the same way that the Eurozone Crisis did for the European Union, while the United Kingdom emerged from both the Euro Crisis and 2008 subprime mortgage crises relatively unscathed compared to its continental counterparts (Redl 2017, pp. 17-18).

Ultimately, the Euro Crisis emerged from an environment that permitted European banks to operate across the entire Eurozone while subject to lax pan-E.U. regulatory oversight and risk management. The European Central Bank found itself without much leverage to enforce fiscal supervision on Eurozone member state budgets exactly because the Eurozone represented a bureaucratic chimera with two heads: an extraordinarily centralised monetary union beside an equally decentralised and uncoordinated fiscal policies spread across all EMU member states–one head was bound to bite the other (Avgouleas & Arner, 2017). 

Conclusion

Ultimately, the Euro Crisis that followed the 2008 U.S. subprime mortgage crisis was at least as much a European gaff as it was an American invention; the Great Recession didn’t cause the Eurozone Crisis, but merely triggered it by peeling away the outer layers of an already rotting onion that appeared to fare well enough in a global economic boom. At its core, the Euro Crisis was a beast–or chimera–born from the Euro itself that grew by feeding on the institutional shortcomings of the European Union until it was primed to bite the hands of its owners; Uncle Sam merely opened its cage. Now that the dust has settled, the question that the European Union and its member states are left to answer is whether they will try to lock that cage tighter or get rid of the beast that dwells within.

Just for fun, here are 6 quotes that aptly describe the Eurozone Crisis:

1. "Spain is not Greece." (Elena Salgado, Spanish finance minister, Feb. 2010)

2.  "Portugal is not Greece." (The Economist, 22 April 2010)

3.  "Ireland is not in 'Greek Territory." (Irish Finance Minister Brian Lenihan)

4.  "Greece is not Ireland." (George Papaconstantinou, Greek Finance minister, 8 November 2010)

5.  "Spain is neither Ireland nor Portugal." (Elena Salgado, Spanish Finance minister, 16 November 2010)

6.  "Neither Spain nor Portugal is Ireland." (Angel Gurria, Secretary-general OECD, 18 November 2010)

Notes

Aragão, Roberto, and Lukas Linsi. “Many Shades of Wrong: What Governments Do When They Manipulate Statistics.” Review of International Political Economy 29, no. 1 (May 25, 2020): 88–113. https://doi.org/10.1080/09692290.2020.1769704. 

Artavanis, Nikolaos, Adair Morse, and Margarita Tsoutsoura. “Measuring Income Tax Evasion Using Bank Credit: Evidence from Greece *.” The Quarterly Journal of Economics 131, no. 2 (February 24, 2016): 739–98. https://doi.org/10.1093/qje/qjw009. 

Associated Press. “Chief Economist Blames U.S., UK for Fueling EU Debt Crisis.” CTV News, May 18, 2011. https://www.ctvnews.ca/chief-economist-blames-u-s-uk-for-fueling-eu-debt-crisis-1.645479?cache=oswkadlgqjzv%3FcontactForm%3Dtrue. 

Associated Press . “Greece Links U.S. Banks to Debt Crisis.” CBC, May 16, 2010. https://www.cbc.ca/news/world/greece-links-u-s-banks-to-debt-crisis-1.912672. 

Avgouleas, Emilios, and Douglas W. Arner. “The Eurozone Debt Crisis and the European Banking Union: A Cautionary Tale of Failure and Reform.” The International Lawyer 50, no. 1 (2013). https://doi.org/10.2139/ssrn.2347937. 

Baudino, Patrizia, Diarmuid Murphy, and Jean-Philippe Svoronos. The Banking Crisis in Ireland. Bank for International Settlements, 2020.

Bayoumi, Tamim A. Unfinished Business: The Unexplored Causes of the Financial Crisis and the Lessons Yet to Be Learned. Yale University Press, 2017.

Crowley, Kevin. “Barroso Blaming U.S. for Euro Crisis ‘Foolish,’ Investors Say.” Bloomberg, June 19, 2012. https://www.bloomberg.com/news/articles/2012-06-19/barroso-blaming-u-s-for-euro-crisis-foolish-investors-say?embedded-checkout=true. 

Pillay, Renginee G. “Anglo-American Model Versus Continental European Model.” In Encyclopedia of Corporate Social Responsibility, 100–105. Berlin, Heidelberg: Springer Berlin Heidelberg, 2013. http://dx.doi.org/10.1007/978-3-642-28036-8_479. 

Purdue, David, and Rossa White. “What Drove Irish Government Bond Yields During the Crisis?” National Treasury Management Agency of Ireland, September 2014.

Redl, Chris. “Working Paper No. 695.” In The Impact of Uncertainty Shocks in the United Kingdom, 17–18. Bank of England, 2017. https://www.bankofengland.co.uk/working-paper/2017/the-impact-of-uncertainty-shocks-in-the-united-kingdom. 

Reis, Ricardo. “The Portuguese Slump and Crash and the Euro Crisis.” Cambridge, MA: National Bureau of Economic Research, August 2013. http://dx.doi.org/10.3386/w19288.

Romano, Simone. “The 2011 Crisis in Italy: A Story of Deep-Rooted (and Still Unresolved) Economic and Political Weaknesses.” In Financial Crisis Management and Democracy, 173–84. Cham: Springer International Publishing, 2020. http://dx.doi.org/10.1007/978-3-030-54895-7_10. 

Royo, Sebastián. Why Banks Fail: The Political Roots of Banking Crises in Spain. Springer Nature, 2020.