ther increased due to the ability to raise loans with collateral in residential real estate, implying that high house prices have become a means of achieving high levels of consumption.
Finally, as a further political reason behind the decision of policy-makers to intervene during the financial crisis, one might point to the short-term benefits which can be derived from such an intervention. By intervening in financial markets, governments can gain short-term political advantages by displaying a capacity to act, while the costs in terms of higher government debt and a less efficient economic system only show up in the longer term.
scheme provoked a sharp reaction from the British government, which strongly criticised the intervention for distorting competition to the disadvantage of British banks operating in the Irish Republic. The Danish government also criti- cised the Irish intervention, which harmed the activities of Danske Bank in the Irish Republic. The Irish finance minister, Brian Lenihan, openly admitted that the Irish government had given priority to its national interests, saying: ‘I accept it is a tendency towards economic nationalism but we’re on our own here in Ireland and the government had to act in the best interests of the Irish people’.6
After the introduction of the Irish guarantee scheme, a veritable race opened up between European governments to implement guarantee schemes for bank deposits and other bank liabilities. International considerations seemed largely to have been abandoned as governments apparently turned to pure economic nationalism. Only two days after the Irish guarantee scheme, the Greek govern- ment issued a guarantee on deposits in Greek banks, while the governments of France and Italy assured investors that deposits in their respective national banking systems were safe. On 5 October 2008, the German government an- nounced its willingness to guarantee all personal savings deposits which were held in domestic accounts. At a meeting of EU finance ministers on 7 October 2008, there was criticism of countries which had unilaterally established na- tional schemes to guarantee bank deposits. Several countries branded the inter- ventions as a lack of solidarity and stressed how the national guarantee schemes had distorted competition because bank customers were given an incentive to move their savings to banks in countries which offered better protection. The Swedish finance minister, Anders Borg, said: ‘If all countries resolve the prob- lems separately, one country’s solution will be another country’s problem’.7 The national guarantee schemes were introduced in obvious breach of the rules for state aid laid down by the EU. Subsequent investigations confirm that national intervention schemes did in fact make it harder for financial companies from other jurisdictions to attract funding.8
The unilateral pursuit of national interests is also evident when we look at the national schemes for the injection of capital into banks. On 29 September 2008,
6 Financial Times, 2 October 2008.
7 Jyllands-Posten, 2 October 2008.
8 See Panetta et al. (2009).
the Dutch, Belgian and Luxembourg governments undertook concerted action to inject new capital into Fortis Group, one of the largest financial companies in Europe. However, on 3 October 2008, the Dutch Government chose unilat- erally to nationalise the Dutch parts of Fortis. The Dutch decision was taken without consultation with the other two governments. In many cases, govern- ments imposed as a condition for the injection of capital that banks must main- tain lending to domestic enterprises and households. The British government, for example, made it a condition that banks that received public capital injec- tions, should maintain lending to domestic households and small businesses at the 2007 level. In an article published in the Financial Times on 26 November 2008, the Ukrainian Prime Minister Yulia Tymoshenko criticised the condi- tions posed by West European countries that taxpayer funds were not to be used abroad. The Ukrainian Prime Minister stressed that this policy had led to the withdrawal of capital from emerging economies, and especially from Eastern Europe. At the World Economic Forum in Davos in February 2009, the British Prime Minister, Gordon Brown, raised the risk of ‘financial mercantilism’.
In some cases, national governments deliberately adopted a confrontational style that caused conflict with other countries. Cross-border conflicts arose in two areas especially.
First, after the collapse of Lehman Brothers, members of several European governments – including the French and German governments – strongly crit- icised the American administration for how it handled the crisis, especially its decision to let Lehman Brothers file for bankruptcy. European governments further announced the end of the Anglo-Saxon capitalist system and the role played by the United States as a financial superpower.9 In a speech to the Bun- destag in October 2008, German finance minister Peer Steinbrück declared that the crisis was due to an irresponsible U.S. government that had failed to meet German demands for a tighter regulation of financial markets.10
As a second area of cross-border conflict, governments acted as the defend- ers of national residents who had transacted with collapsed banks in foreign countries. The most notable example is the dispute which arose over the col- lapse of the Icelandic banking system. Prior to the collapse of the Icelandic
9 For a discussion, see Wyplosz (2009).
10 Financial Times, September 26 2008.
bank Landsbanki, many British and Dutch customers had transferred savings to deposits with Landsbanki’s internet-based arm Icesave through the inter- net. After the closure of Landsbanki, the British and Dutch customers were refunded by their respective governments, which in turn demanded compensa- tion from the Icelandic government. In Britain, anti-terror legislation was used to freeze Landsbanki’s assets.
Rather than seeking conflict, however, the main impulse of national govern- ments was to strengthen international coordination. This was apparent already at an early stage. Thus, immediately after the collapse of Lehman Brothers, the French President, Nicolas Sarkozy, proposed the creation of an EU-wide fund to support distressed banks. This initiative, while being supported by Italy, was rejected categorically by the German government. As France and Italy are the two countries which seem to have encountered the fewest problems with their banking sectors during the crisis, the French and Italian support for a rescue fund at the EU level seems not to have been motivated by narrow na- tional self-interest. The French President also made proposals for international action to change the rules for financial companies, including a change in ac- counting principles. After the Bush administration had presented a proposal for an American rescue plan in September 2008, the U.S. treasury secretary Hank Paulson called on other countries to implement similar plans. On many occasions, the British Prime Minister Gordon Brown stressed that the crisis required a global response. Gordon Brown tried to persuade both the U.S. ad- ministration and the governments in the euro zone to follow the example of the British rescue plan, based on the recapitalization of distressed banks.11
A concrete example of concerted action came in September 2008, when the French President took the initiative for a combined French, Belgian and Lux- embourg action to recapitalise the financial group Dexia, which played a major role as a lender especially to public authorities. Another example of interna- tional action occurred on 29 September 2008, when the Belgian, Dutch and Luxembourg governments acted together to inject capital into Fortis Group.
As mentioned above, this cooperation was disrupted when the Dutch govern- ment unilaterally decided to nationalise the Dutch parts of the Fortis group a few days later.
11 A description of the British initiatives is given in Financial Times, October 14 2009.
The most important case of coordination was that which was undertaken by the central banks which cooperated closely during the crisis. On 8 October 2008, the major central banks – including the Federal Reserve System and the European Central Bank – undertook a coordinated cut in interest rates. This was the first time central banks had acted together in setting interest rates. In the months following the collapse of Lehman Brothers, the Federal Reserve System made U.S. dollars available to other central banks to overcome a serious shortage of dollars outside the United States.
After the initial confusion had subsided, national governments resolutely came down in support of international coordination. On 10 October 2008, at a meeting in Washington D.C., the G7 finance ministers adopted a declaration which stated, inter alia, that national governments will ‘take decisive action and use all available tools to support systemically important financial institutions and prevent their failure’. This statement was seen as endorsing the principle that national governments, if necessary, must support systemically important financial institutions and prevent a collapse similar to that of Lehman Broth- ers. The Bush administration subsequently took the initiative to call a summit among leaders in a newly formed G20 group, which, in addition to the G8 countries, included other old industrial countries (Australia, the Netherlands, and Spain) and some of the most important emerging economies (Argentina, Brazil, China, India, Indonesia, Mexico, Saudi Arabia, South Africa and South Korea).12
As explained above, since October 2008, comprehensive international col- laboration has taken place to tighten financial regulation. This collaboration has occurred within the international forums which have been put in place in setting international rules for financial institutions, in particular the Basel Committee on Banking Supervision. As a result of the crisis, the role of the Financial Stability Forum was expanded and the membership was broadened to include all the countries that participate in the G20 meetings. At the same time, the Financial Stability Forum was re-named the Financial Stability Board.
The most important change to emerge from this work is a tightening of capital requirements, which will affect banks from different national jurisdictions very differently. It is remarkable that it is possible to push through such changes
12 Besides these countries, the EU country which holds the presidency is represented.
with profound effects on the competitiveness of national financial institutions without major opposition from individual countries.
As a condition for lending from the IMF, it has been stipulated that recipi- ent countries should act to prevent the collapse of domestic financial compa- nies. In the case of Latvia, pressure has further been exerted to prevent the government from introducing new arrangements for debt restructuring which would alleviate the burden for debtors. This would have had the consequence of causing losses for the banks that had granted the loans, in the case of Latvia predominantly foreign-owned banks. In the case of Iceland, pressure has been exerted to make the country refund the expenditure incurred by the British and Dutch governments in connection with refunding their citizens’ deposits with Icesave.
After the adoption of the national rescue packages, the European Commis- sion worked to modify the original provisions to make them more compat- ible with the EU framework, for example, by requiring the restructuring of financial firms that have received state aid. This has led to the break-up of large financial groups such as the Dutch group ING and the British financial groups Royal Bank of Scotland and Lloyds Banking Group. The European Commis- sion has also called for the modification of the guarantee scheme adopted by the Irish government so as to allow foreign subsidiaries operating in Ireland to be covered by the scheme too. It was later agreed to establish a European Sys- tem of Financial Supervisors (see above).
Probably the most important extension of European cooperation took place in the spring of 2010 when the euro-zone governments decided to guar- antee debt obligations incurred by each other (see above). It is probably too early to assess the behaviour of policy-makers in the bail-out of Greece in Feb- ruary-May 2010. Outwardly, as a reason for the support of Greece, the euro- zone leaders stressed their commitment to safeguarding the financial stability of the euro zone. Policy leaders also stated that a failure to intervene in support of Greece could lead to the break-up of the euro zone. The solidarity among euro-zone countries was also stressed as a motive for intervention. The French government wanted to avoid Greece having to turn to the IMF for support in order to avoid non-European interference in the affairs of a euro-zone country.
One may remain sceptical about some of the reasons stated officially for the support of Greece. It is, for example, difficult to see how financial turmoil can
bring about the collapse of the euro. The euro is a common currency and, un- like a fixed exchange rate arrangement, capital flows cannot force a government to withdraw from the currency area. The euro zone can only break up if govern- ments take an explicit political decision about one or several countries leaving.
In the absence of such political decisions, the euro zone is stable.
In their support of Greece, policy leaders may also have acted from pure- ly national motives. A large proportion of the government bonds issued by Greece, Portugal and Spain is held by French and German banks. If Greece had decided to declare a suspension of its debt obligations, only a smaller pro- portion of these government bonds would have been covered, and it is likely that French and German banks would have needed further government sup- port. For political reasons, French and German policy-makers may have seen it as more convenient to support their domestic financial institutions in aiding Greece rather than providing new support through domestic channels.