The true cost of the 2008 crisis
As authorities only just prevented a 2023 repeat of the 2008 crisis, it is worth reminding ourselves of the cost of the 2008 financial crisis to European citizens:
- EUR 2 trillion of State Aid was allocated to the financial sector, that is around EUR 3,800 for every single EU citizen – man, woman and child.
- In only three years (2007-2010) public debt across the EU-28 rose by more than 20%, from 57% to 79% of GDP, due to the financial crisis.
- The following Euro crisis impaired real GDP growth for a decade, with no or even negative economic growth for some Member States.
- Meanwhile, unemployment jumped with youth unemployment remaining stubbornly high for even longer. Real disposable incomes, too, were depressed for years.
- The rescue of the financial sector has exhausted EU countries’ fiscal capacity, limiting the subsequent government support to the real economy.
- Following 2008/09, the international community’s fiscal and monetary arsenal for dealing with another global financial crisis has been depleted.
In the face of such enormous cost, global policymakers promised to strictly regulate the financial system to remove the Damocles sword of financial crises, in order to end moral hazard and remove the need to inject public money when financial institutions fail.
And yet…
Few lessons from 2008 were learned
In March 2023, the domino collapse of American and Swiss banks forced financial authorities to once again pour public money into the financial system. It was the only way to avoid a full-scale new global financial crisis.
Finance Watch and many experts have been raising the alarm for years: We have not drawn lessons from 2008, just as a decade of monetary easing across most major developed economies has left the world with unprecedented levels of public and private-sector debt.
None of the structural vulnerabilities that led to the financial crisis of 2008 has been tackled in a decisive way in the midst of a massive deregulatory backlash: already feeble international compromises (for example, Basel III) have been watered down and supervisory authorities de-fanged.
The third line of defence became the first
The injection of public money, whether via central bank or public budget intervention, is the last measure in three lines of defence to contain bank runs and systemic crises.
The first two lines of defence – prudential regulation and resolution frameworks – that were put in place to protect society from banking crises failed. In 2023, once again, the third line of defence effectively became the first.
Market participants don’t trust the first two lines of defence because they are not solid enough, meaning moral hazard remains the dominant principle in banking. This implicit public subsidy will incentivise risky behaviour by private actors leaving the risk of catalysing into uncontrollable financial crises at tremendous costs for society. Privatise the market profits, socialise the losses: everything but a financial system that serves society.
Reforms to “fireproof” the house
Public authorities throwing money at failing institutions are the third line of defence against financial instability. They can be compared to much needed fire-fighters, but it’s crucial to avoid fires in the first place. We urgently need to fireproof the house for good. Let’s extend the fire metaphor:
- Prudential Rules:
The first line of defence, the so-called prudential rules for financial institutions, are the fireproofing of the house and the safety rules for handling fire hazards. Just as barbecues are not allowed inside houses, financial institutions’ risky activities are subject to certain rules to prevent failures and contagion of the whole economy. The acceptable level of risk they can take is decided by lawmakers, including via setting minimum capital requirements.In Europe, though, the final implementation of the internationally-agreed banking rules (The Basel III frameworkThe Basel Framework is the full set of standards of the Basel Committee on Banking Supervision (BCBS), which is the primary global standard setter for the prudential regulation of banks. To learn more about the prudential rules in banking - the Basel Framework - and its implementation in the EU, read our guide: “Basel 3 in 5 questions”. For a recent assessment of how the Basel framework has effectively been implemented in the EU, read our recent blogpost: "Basel III finalisation comes undone: A proposal that lets down citizens and backtracks on global agreements") has been watered downRead our policy brief for a deep dive into the banking package 2021: “Cracks in the pillars – Financial stability loses out in the EU’s Basel III endgame” so badly that Europe’s own supervisors have warned that European banks may not even be compliant with the “Basel framework”. Even though banks’ capital requirements have increased from ridiculous lows before 2008, they remain insufficient to ensure market confidence and guard firms against another major market event.Ensuring system-wide stability means Europe must implement the existing international prudential standards and further reinforce them as new risks have emerged since the Basel III standards were adopted.
- Resolution framework:
The second line of defence, the resolution framework, is containment doors, or mandatory distance between buildings. Should one house be on fire, we must ensure the fire doesn’t propagate to the whole city.Banks’ post crisis ”resolution frameworks” are special insolvency regimes that would help failing banks to be wound up in an orderly way and without destabilising the financial system. These new rules are now under massive pressure from the financial lobby and Europe is just about to destroy the hard-won protections that were put in place after the crisis.The legislative proposal on the table of the EU co-legislators suggests the de-facto killing of the 8% rule. This could allow investors of a failing bank to tap into taxpayers’ money even before the shareholders lose their stake! We can’t let that happen. Meanwhile, a lot of the elements for the European resolution regime to really work are still to be deployed.
- Structural reform:
Prudential rules and bank resolution regimes are not enough on their own to remove the threat that large (too-big-to-fail) banks pose to financial stability. Given the size and complexity of megabanks, there will always be structural and practical complications and impediments that make resolution appear difficult and risky.Supervisors and politicians will continue to be tempted to resort to bail-out as a politically more expedient option. This is why we still need to reform universal banks and separate essential lending and payment functions from high-risk trading and investment activities. After years of political struggle, Europe’s bank separation law (that would have gone a long way towards solving the “too-big-to-fail” problem), was regrettably abandoned in 2018.With no political momentum to revive this essential legislative proposal, megabanks continue to dominate the banking landscape. Yet, structural reform is the only way to fundamentally address moral hazard in the financial system and really protect the interests of retail clients and taxpayers from the reckless risk-taking of banks. In the fire metaphor, this would equate to storing the highly inflammable objects far from the houses of ordinary citizens.
- Shadow banks:
Non-bank financial institutions – so-called shadow banks – have played an increasingly important role in financing the economy and managing the savings of households and corporates. Many of the shadow banking entities are highly leveraged, which makes them susceptible to market price movements and acts as an amplifier for liquidity and market risks in the system. Despite the systemic risk they represent, shadow banks have not been subjected to robust prudential rules, which would ensure their resiliency.Banks’ interconnection with non-bank financial institutions was at the heart of the subprime crisis. Today, banks are even more reliant on the shadow banking sector for their short-term financing while also acting as liquidity and credit providers to shadow banks. With the recent EU initiatives to revive securitisations as an opportunity for the banks to offload undesirable risks from their balance sheet into capital markets, these risks are then picked up by return-hungry shadow banks. Yet, the risks remain in the financial system as the 2008 crisis have abundantly illustrated. For example, the EU now allows for complex synthetic securitisations to be recognised as simple and transparent and made securitisations of non-performing loans easier.A much stricter regulation of the shadow banking sector and its interconnection with the banking sector is urgent. In the fire metaphor, this would be like enforcing robust safety rules for the industrial use of flammables and combustibles.
- Financial supervision:
Finally, the European supervisory authorities that implement and enforce the rules need stronger supervisory powers, improved governance and sufficient funding to effectively deliver on their mandates. We have seen positive developments with the European System of Financial Supervision, but stronger intra-EU cooperation, convergence of practices and mandates of national supervisors are also indispensable to equip the guardians of financial stability with the tools they need. Otherwise, it would equate to leaving the firefighters without enough equipment.In terms of the authorities’ independence from the financial industry, the memory of the revolving doors scandals has not faded away. The problem of regulatory captureThe porosity between public and private entities tends to transmit the values promoted by the financial industry to senior public management. Read more in our article "how to loosen the stranglehold of finance" needs a very strong public response if Europe doesn’t want to keep looking like it allows pyromaniacs to define the fireproofing rules for all the city…
Smell the Smoke
The recent SVB / Credit Suisse-induced crisis happened not so long after the collapse of several shadow banking entities that triggered significant banks’ losses. These are warning shots. We need to act before it’s too late: Trust in our fragile financial system can quickly disappear and the results could be calamitous. Regulatory efforts that have been repeatedly stalled and rolled-back need to be revived and completed as a matter of priority.
Meanwhile, new systemic risks loom on the horizon of the banking industry. Climate change poses a major threat to financial stability, and will disrupt the banking system if no precautionary measures are taken now. The increasing digitalisation in financial services also means growing cybersecurity, information and communication technology risks and increasingly, AI-induced risk.
Policymakers have to act now to protect society from being forced to foot the bill of a next financial crisis and ensure there are #NoMoreCrisis. The next EU election is the occasion to bring policymakers back to the drawing board!
Pablo Grandjean and Julia Symon – Finance Watch
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