Sarkozy put pressure on us,” reports a nonplussed banker to a colleague in a recent French-newspaper cartoon, referring to the French president’s campaign against financial-industry bonuses. “And then what?” his colleague asks. “And then nothing,” is the reply. After a year’s worth of summits, lectures from the French and the Germans, vigorous intellectual debate from the British, and thousands of pages of commission reports, the French cartoon may sum it up best. The way national governments regulate their financial sectors hasn’t changed significantly anywhere, nor is it likely to. The reason: while everybody sees the problem with an unsustainable government-subsidized financial industry, coddled by a policy that protects firms that have become too big or complex to fail, no elected officials want their unsustainable, government-subsidized financial industry going somewhere else.
National leaders are, in effect, competing over which country can offer its financial sector the most generous economic subsidy. This losing game ultimately hurts the financial sector—which needs market discipline to reward success and punish failure—and economic competitiveness as well.
The financial crisis that started with American subprime mortgages spread to the global financial system in the spring and summer of 2007, when British, French, and German banks that had bought mortgage-related securities showed signs of distress. By late autumn 2008, after the U.S.-based Lehman Brothers investment bank’s disordered September 15 collapse, the crisis had led Western Europe’s major nations to stand explicitly behind their banks, offering them government money and various guarantees, just as America had done. On the Europe-wide level, the European Central Bank, which governs monetary policy in the 27 nations that use the euro, and the Bank of England rivaled America’s Federal Reserve in the extraordinary measures they took to keep money and credit flowing.
The French and the Germans determined that the crisis had sprung from the recklessness of “Anglo-Saxon” banking. The English speakers’ fancy debt products, the reasoning went, had inflated a global asset bubble that, when it burst, damaged France’s and Germany’s banks and, as global trade plummeted, their export-dependent economies as well. By late 2008 and early 2009, the French and German governments were reluctantly spending tens of billions of euros in stimulus funds to insulate their populations from a disaster that had swept across their borders.
British prime minister Gordon Brown initially charged that the crisis “came from America.” But America and Britain had together created and dominated the lucrative world of intricately structured debt securities and derivatives that were at the core of the meltdown. New York financiers had structured complex mortgage-backed securities so that financial institutions could invest in them without putting aside significant capital reserves to absorb potential losses, thus pushing profits higher. London bankers had designed the elaborate “structured investment vehicles” that let the firms hold the securities off their books, further cutting the perceived need for capital. Credit default swaps, the inadequately regulated financial instruments that seemingly allowed financial institutions to transfer the risk of debt securities to trading partners for a nominal fee, were an Anglo-American invention. The American bankers who devised the $500 billion in swaps for the insurance giant AIG—eventually resulting in the U.S. government’s $182 billion bailout of the firm after the guaranteed securities began to go sour—worked out of London.
Britain and America also each saw spectacular commercial-bank failures as the initial housing crisis deepened. While America had subprime mortgages, Britain had “buy-to-let” schemes in which regular people could buy houses on credit, renting them out until they could flip the houses for a hefty profit. Each nation saw a major bank fall because of its overexuberant investments in domestic housing: IndyMac in California and Northern Rock in northeast England. Months later, each country had to take a significant ownership stake in a marquee bank: in the U.S., Citigroup, and in Britain, the Royal Bank of Scotland. And each saw a commercial bank, until then weathering the crisis well, forced to accept government guarantees because of a hasty purchase of a trophy asset: Bank of America with Merrill Lynch and Lloyd’s with the HBOS financial group.
As the crisis worsened, France and Germany seized the moral high ground to pressure America and Britain into major overhauls of financial regulation. “The U.S. will lose its status as the superpower of the world finance system,” said Germany’s finance minister, Peer Steinbruck, in October 2008. Sarkozy promised that la crise would bring an end to financial “laissez-faire,” adding that “a certain idea of globalization is dying with the end of a financial capitalism that had imposed its logic on the whole economy.” The French president pushed for a global summit, winning rough commitments for big changes from London and Washington before President Obama took office. Britain seemed ready to take its lumps. Lord Adair Turner, chairman of London’s Financial Services Authority (FSA; similar to America’s Securities and Exchange Commission), began openly to question whether the financial industry had grown too big and arcane for Britain’s own good. America, too, appeared chastened.
Part of the regulatory solution, European leaders said, would be a new spirit of Europe-wide cooperation on financial rules, with a unified Europe pressing America into regulatory cooperation, too. The crisis had, in fact, exposed a significant weakness in Europe’s own system of nation-by-nation regulation. As was the case with America, Europe had no consistent, orderly way for a big, interconnected financial firm to fail without inflicting damage on the broader economy. The too-big-to-fail problem was actually even worse in Europe. Under the European Union’s “passporting” system, a financial institution could set up shop anywhere within Europe yet still operate under its home country’s regulations. That’s how an Icelandic bank, Landesbanki, could offer Britons online saving accounts under Icelandic rules. But when Landesbanki failed in October 2008, Britain—fearing that panicked citizens would rush to remove their savings not just from Landesbanki but from British banks, too—had to step in and save depositors, despite having had zero say in regulating the massively over-leveraged foreign-based firm.
