What are the causes of the European financial crisis in a nutshell?
The Eurozone Crisis is an extension of the GFC that occurred due to over-borrowing by Member States and banks. Additionally, the nature of Eurozone meant that abuse and over-borrowing by smaller and weaker economies was being shielded by the larger economies in the Eurozone (Eijffinger, 3). The supervision of the Eurozone was primarily left to the markets under the Lamfalussy framework, which is an EU-wide initiative based upon the co-ordination of national supervisors (Alford, 395). The problem is the Lamfalussy framework was too fragmented, which meant that supervision of national markets was insufficient (Eijffinger, 3).
This fragmentation results in a system where there is not a sufficient central monitor to ensure that the financial markets are not being destabilised. In addition, there has to be consideration of conflicting national interests that is present when developing a common market whilst retaining the sovereignty of member states (Eijffinger, 3). This means trying to balance the political interests present meant that the system, both in the financial markets and with the consolidation of the Eurozone, has failed to develop a framework with the necessary supervision and ethos to breed stability. Rather, over-borrowing illustrates a short-term approach was applied, which undermines long-term stability.
Who is responsible for the crisis, and why?
a. In the financial sector:
The financial sector failed because of supervisory failure within banking institutions, the industry in general and by the regulators (Brown & Dinc, 1380). Supervisory failure allowed banks and other financial institutions to go unchecked, which enabled a high level of risk that was akin to institutionalised gambling to occur (Brown & Dinc, 1380). This institutionalised gambling meant that unsustainable acts were allowed by the system, which resulted in financial meltdown. The failure to develop an ethos of long sustainability, rather than short-term gain, should be seen as the primary failing within the financial sector. If a different attitude to risk was taken then the financial meltdown may have been mitigated.
b. In the government sector
The problem in the Eurozone is that there is a quasi-sovereignty model (i.e. the markets are sovereign, but the currency is common). This model tried to balance: (i) a common currency; and (ii) national fiscal policy. The consequence of this is that regulators were weak and effective governance was missing, which allowed weak player to misuse the strength of the Euro, in order to over-borrow (Issing, 4). This means that a short-term attitude was also taken to national fiscal policy, which failed to implement a failsafe if there was a wider economic failure. Thus, when the global financial crisis occurred, over-extended states were unable to avert implosion of their economies.
What are your recommendations to fix it?
The best framework to fix the European crisis is through developing a support system to rebuild the imploding economies. It is necessary that this support system does not merely bail out member states (Issing, 4). Fiscal policy requirements will build an ethos to ensure that the imploding states can engage a framework of long-term stability in its financial markets and economy (Issing, 5). Thus, a system that will act as a tool to provide financial support, as well as an injection of funds to rebuild failing economies, is necessary. Sustainable fiscal policy has to be built into the system also.
- Alford, D “The Lamfalussy Process and EU Bank Regulation: Another Step on the Road of Pan-European Regulation?” Annual Review of Banking and Financial Law Vol 25, 2006: pp. 296. Print
- Brown, Craig O. and I. Serdar Dinç, “Too many to fail? Evidence of regulatory forbearance when the banking sector is weak”, Review of Financial Studies Vol 24, 2011: pp 1378. Print
- Eijffinger, SCW “What Role for the ECB on Financial Market Supervision” Briefing paper for the Monetary Dialogue of March 2009 by the Committee on Economic and Monetary Affairs of the Parliament with the President of the European Central Bank, 2009. Print
- Issing, O “Why a Common Eurozone Bond Isn’t Such a Good Idea” Centre for Financial Studies White Paper No III, July 2009. Print