Can liberal democracy survive another financial crisis? – European Council on Foreign Relations

In recent weeks, media around the world have celebrated the tenth anniversary of a landmark event in the global financial crisis: the bankruptcy and collapse of Lehman Brothers, once one of the largest investment banks in the United States. . Much of the coverage depicted the developments leading up to the crisis, the villains of the play, and the political heroism that pulled the global economy from the brink, preventing a repeat of the Great Depression. Yet the uncomfortable truth is that neither the structure of the financial system nor the political discourse around it has changed enough to prevent another such collapse. In many cases, the lessons of 2007-2008 have been forgotten – or else written into a distant, albeit macabre, history that has little to do with the present.

This complacency can be seen in President Donald Trump’s retreat from stricter US banking regulations introduced after 2008. In May of this year, Congress pass the first package of measures aimed at significantly watering down aspects of the Dodd-Frank Act of 2010. In addition, Trump has appointed several officials in favor of relatively lax regulations to head major financial supervisory agencies. Because the Dodd-Frank Act gives these agencies great latitude in the application of financial rules, the appointments de facto weaken regulation.

Likewise, few major governments have really taken to heart the threat of banks that are too big to fail. The crisis has shown that it may be impossible to shut down large, heavily indebted banks without hurting the economy as a whole – a fact that is forcing political leaders to bail them out. This lesson seems to have been forgotten in many parts of Europe. For example, there is growing political support for a merger between Deutsche Bank and Commerzbank, even though the combination of their balance sheets – of around $ 1.5 trillion and $ 500 billion respectively – would create an institution of around 60%. of German GDP. The BNP Paribas balance sheet, France’s largest bank, grew from around $ 1.6 trillion in 2007 to around $ 2,000 billion in 2017.

Governments have also failed to meet the challenges of financial complexity. One of the most striking features of the 2007-2008 crisis was that it revealed how few people understood the Byzantine interconnections between global financial institutions. After Lehman’s insolvency and the ensuing stock market crash, there was widespread fear that the collapse of a major financial player would bring down the entire system – even if one could not perceive the exact links by which this would occur. Part of the concern stemmed from the large over-the-counter (OTC) derivatives market, non-standard contracts between institutions that defaults or movements in exchange or interest rates could trigger, and for which there is no had no central register. In 2007, as the crisis began to unfold, there were $ 507 trillion in derivatives in circulation around the world (by comparison, the projected global GDP for 2018 is just under $ 90 trillion). In 2018, according to the latest data from the Bank for International Settlements, $ 531 trillion in OTC is in circulation.

Another problem is that the European banking union remains incomplete. European politicians have placed too little emphasis on solving the well-known problems with the system that helped create and prolong the eurozone crisis. There is still no common deposit insurance scheme, while the common crisis bank recapitalization fund remains ridiculously small.

It’s hard to find a country that experienced a severe banking crisis in 2007-2009 but did not experience an increase in the share of populist votes

So while the global banking system may not experience another crisis anytime soon, it is far from so certain that another global financial collapse can be ruled out in, say, the next decade. It would be worrying enough if we were just talking about potential economic damage: the 2007-08 collapse cost hundreds of billions in direct spending to save banks and trillions more in lost production since.

Yet although most people don’t realize it, the financial crisis likely played a significant role in eroding liberal Western democracy. The economists Manuel Funke, Moritz Schularick and Christoph Trebesch have show that in advanced economies, over a long period beginning in 1870, the share of votes of right-wing parties increased on average by 30 percent (no percentage points) as a result of financial crises. This effect is specific to financial crises and does not apply to recessions or macroeconomic shocks that originate outside the financial system.

It is plausible that a financial crisis and the ensuing bank bailouts create the widespread perception that a corrupt elite is exploiting ordinary citizens. Because the transfer of taxpayer money to indebted banks limits the government’s budget, fiscal austerity often follows a crisis. Austerity increases unemployment, as well as competition for increasingly scarce public goods such as health care, education and infrastructure. In some countries, such competition can exacerbate hostility between native and foreign-born citizens.

The opinions of many European voters reflect this interpretation of events. For example, in the run-up to the Brexit referendum, some UK citizens expressed concern that migrant workers from Central and Eastern Europe had equal access to public schools and a national health service under pressure budget cuts. Similar concerns prevail in parts of Berlin where there is strong support for the right-wing Alternative für Deutschland. A common complaint is: “The government has told us for years that there is no money to fix the school building. But for the banks and the refugees suddenly there is money.

While the empirical work of the three economists invites criticism on several fronts, their larger point appears to be true. While parts of Trump’s uprising and the Brexit vote can be seen as populist, it’s hard to find a country that experienced a severe banking crisis in 2007-2009 but did not experience an increase in the share of populist votes. This phenomenon extends beyond right-wing parties: left-wing populists like Podemos have filled the void in Spain, while the Italian political system has come under pressure from both sides.

Of course, the populist push isn’t just about the global financial crisis. But the events of 2007-2008 appear to have made a substantial contribution to the lingering political instability in Western democracies.

All of this raises a troubling question: Given that populists already have a significant presence in most Western states, where would another financial crisis propel them? Ten years after Lehman’s insolvency, it is high time for politicians to treat finance as more than a technical economic issue; limiting the excesses of the financial sector could prove essential to the survival of liberal democracies.

The European Council on Foreign Relations does not take collective positions. ECFR publications represent the opinions of its individual authors only.


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