A precarious balance
We have heard much in recent years about institutions that were, or are, ‘too big to fail', particularly in 2008 when Bear Stearns collapsed, followed later that year by the entry of Fannie Mae and Freddie Mac into government conservatorship, the bailout of AIG and the collapse without rescue of Lehman Brothers.
Lax standards of loan underwriting, outright fraud and predatory lending were among the root causes of the US sub-prime lending debacle that mushroomed into outright crisis in 2008. Loans that had been packaged into CDOs contaminated the balance sheets of banks once the market for these instruments dried up completely. Among the factors fanning the flames of the crisis were the business models of ratings agencies, poor due diligence of investors, lax oversight by regulators and, of course, greed among the institutions that enriched themselves at the expense of their shareholders and the taxpayer.
In other words, a range of causes - both action and inaction - that contributed to the lending bubble. And bubbles can be terribly hard to spot. In the run-up, during the boom years of excessive leverage and risk, those who questioned the provision of affordable loans with low or no down payments were derided for denying the American dream to low-income families, while those who predicted systemic risks in the parcelling of risk throughout the financial system through CDOs were derided for not understanding the ways of modern finance.
Likewise, the roots of the current European debt crisis are many and complex. Greece's entry to the euro was mired in lies and falsification; more prosaically the malaise of Italy and many other countries lies in a systemic failure to restructure the economy by reform of taxation, pensions, business regulation, employment law and a whole list of other things. But is the long-term medicine to the problem of Europe's malaise - a combination of austerity with rigorous budgetary mechanisms followed by fiscal consolidation - too difficult to bear?
The EU's Lisbon Agenda, the plan launched in the aftermath of the euro's launch to make Europe's economy the most competitive in the world by 2010, looks like a grandiose folly and a miserable failure in hindsight. In contrast, Germany's own Agenda 2010 gave the country a decade of belt tightening but a fitter economy. Even so, the relaxation of the Maastricht budget rules was arguably the single most damaging cause of moral hazard, giving governments in southern Europe the green light to ignore the fundamental imbalances in their economies.
The world now seems very unstable, even if technocrats leading unity governments are the order of the day in Europe. This crisis is also highly dynamic, with a different focus on different days of the week, switching from Greece, to Ireland, to Portugal, back to Greece then to Italy.
The solutions of the G20 summit in Pittsburgh in the autumn of 2009 were supposed to provide the blueprint for a new generation of financial regulation and oversight that would prevent future crises. Yet the focus of much coverage post crisis has been on the very end of the value chain - the structured finance units of the investment banks that bought the pools of mortgages that became toxic and the disequilibrium in the remuneration of those people against the systemic risk that the financial system experienced. Likewise, despite the recent fixation on Italian and Greek politics, short-term political reforms are no quick fix for the euro-zone.
The aftermath of this crisis, assuming a relatively benign solution to the continent's problems, must see a determined push towards euro-zone fiscal integration. But it will take time for economies to reform and heal. In the meantime, the problem of ‘too big to fail' is still with us. It must be addressed through decisive reform of both corporate and political life.