Ratcheting Up The Crisis In Europe

Elections in Greece can’t cause as much trouble as bank runs in Barcelona or Turin

By WALTER RUSSELL MEAD

“Crisis in the eurozone” stories are getting boring and this is one two year old soap opera the world would just as soon see disappear. Nevertheless it grinds on; yesterday the German finance minister said it could go on for another two years.  Unfortunately, he’s right.

But while the news from Europe is complicated and inconclusive (they are always threatening to jump off the bridge but so far, no one has), this is still a story one has to watch. And after months and years when the crisis was mostly in the hands of elites — heads of government, central bankers and the like — in the last couple of weeks the public has been getting involved, and that makes the crisis more dangerous and harder to solve.

The Greek and French elections were the public’s first real chance to get a word in on how Europe is handling the crisis, and the word from the public is one of those expletives that we don’t allow here. The public not only doesn’t approve of the way Europe is handling its problems; it wants to hang, draw and quarter the people responsible. The Greeks and the French both voted for candidates who wanted to rip up the fragile agreements already negotiated; as more European countries hold elections we must expect that more European politicians will come to power with mandates to change Europe’s direction. Many like the new French President François Hollande will try to manage this artfully, but the Greeks are unlikely to be the only bull in Europe’s china shop by the time this is done.

The other way that public sentiment threatens to blow Europe sky high is swifter, less predictable and far more dramatic. As Greek savers and investors read the writing on the wall, they are pulling their money out of Greek banks. They know that if Greece pulls out of the euro, the government will do something funny to the banks; they aren’t sure what (nobody really is), but there is a strong suspicion that any money left in Greek bank vaults will be converted from euros to drachmas at the stroke of a pen (more likely, by the tap of a keyboard), and those drachmas will soon be worth much, much less than a euro.

Better to have your money in Swiss or German bank than in a Greek one, every sentient vertebrate in Greece has to understand; as a result, hundreds of billions of euros have been moving out of the Greek banking system. At one point last week, television networks were sending camera crews out onto the streets to look for panicky customers standing in line at ATMs or at bank counters; but then they realized that these days you can do it all on the net. We have entered the age of the invisible bank run and are waiting for the first virtual panic.

An invisible bank run is a hard thing to watch; not only is it less telegenic than the old-fashioned kind, one relies on numbers from official government agencies for statistics. How much money left the banking system today? How many banks need emergency liquidity to meet the tide of withdrawals? In the old days, reporters could and did watch lines form outside the banks and watch the armored trucks arrive with cash. These days it is happening anonymously and you only know what they tell you.

They are very unlikely to tell you the truth. Officials lie like rats in times of financial panic; they do it out of a sense of duty. They will insist that a given country will never leave the euro until the moment that it does; they will say that a deposit freeze is unthinkable until they announce that they’ve done it; they will tell you a bank is rock solid until the moment they padlock its doors. This is all for your own good, of course. They don’t want you to panic — and they want to make sure that your money is trapped when they take it away or turn it from gold into straw.

Bank runs, even virtual ones, are the method by which public fear can blow up the eurozone. A bank run, as hundreds of thousands of depositors decide to pull their money out of a bank or a banking system at the same time, is the financial equivalent of a dam break. Banks, even very well run ones, never have all the money that their customers have deposited in their vaults. They lend that money out to other people, and because they charge borrowers a higher rate on their loans than they pay savers on their deposits, they make money.

At least they make money as long as enough of the borrowers can pay back their loans.

When borrowers can’t repay their loans, the bank sooner or later has to “write down” the value of those loans. In bad economic times, when borrowers are going bankrupt and the collateral on their loans loses value, banks can make huge losses. This is how Ireland lost its shirt; the banking system collapsed as the Irish real estate bubble burst, making building contractors and home owners bankrupt all over Ireland, and making the real estate that served as collateral for their loans almost worthless at the same time. The government — to prevent a panic and bank runs — guaranteed the deposits held by Irish banks, and ended up assuming such a massive debt that the Republic of Ireland needed a bailout from Europe.

Since then, European bailouts have been the safety net for all the countries in the eurozone. When investors worry that countries like Spain, Portugal and Italy will have a Greek style financial meltdown and the interest rates on their bonds rise to reflect that risk, the ECB steps in to buy their bonds and the panic goes away — for a while. More, when individual banks are having trouble, the ECB has made huge amounts of money at extremely low interest rates available to them. Spanish banks, for example, can borrow cheap money from the ECB in order to buy Spanish government bonds at high interest rates. They pay one percent interest to the ECB and collect four percent interest from the Spanish government, and use the profit of three percent to offset their losses on their loans to private companies and consumers who are going belly up in Spain’s savage recession.

The success of this little merry-go-round is why Europe calmed down last December. The ECB in effect prints money which it gives to busted banks. The busted banks lend the money to insolvent governments at artificially low rates (but at rates that still allow the banks to make a profit). It was a neat little trick that kept the crisis quiet without forcing the Germans to admit openly that the ECB was in effect using German resources to bail out the rest of the zone.

Bank runs, even virtual bank runs, would blow this fragile arrangements to bits. As the prospect of Greece leaving the euro becomes more likely, savers in Portugal, Spain and Italy have to start wondering if their countries, too, will have to jump ship. Sophisticated investors have been moving their money out of those countries for some time; things may soon reach a pass in which ordinary, unsophisticated investors start to do the same thing. Again, why have your money in some gut-shot Spanish bank when you can transfer it to a German, Austrian or Dutch bank with a mouse click? And if you are worried about the whole eurozone, or that devious financial trolls will find a way to convert all deposits held by Spanish citizens in European banks to pesos when and if the change comes, put the money in Switzerland, the UK or even the US.

If a few thousands or a few tens of thousands do this in Portugal, Italy and Spain, no problem. But if hundreds of thousands or millions of people shift their money out of their home banking systems, then you have a new and very grave bank crisis that blows the December fix out of the water. Either the ECB would start creating trillions of euros to bail out the Club Med banks (and Club Med under some circumstances could stretch as far north as France), or banking systems start exploding like firecrackers across the southern tier. At the same time you would have a new panic on the bond markets; nobody is going to want to own Spanish or Italian debt under those circumstances.

This is one of those cases when what is good for one is bad for all. A good financial investor would probably be suggesting to anybody in Spain or even Italy that it is a good idea to separate the fate of your savings from the fate of your country’s currency or its banking system. The trivial costs of moving money into a safer banking system are well worth the protection you gain.

But if everyone gets and acts on this sound and prudent advice, the whole banking system and perhaps the whole eurozone comes down.

Europe’s stability now rests on the sloth and stupidity of European savers. As long as millions of retail investors think their money is OK, it will be sort of OK for a while. But while governments can and will lie, and while soothing official pronouncements can be printed up almost as fast as the ECB produces euros out of thin air, sooner or later people may start to put two and two together.

Voters are not nearly as scary as depositors right now from the standpoint of Europe. Elections in Greece can’t cause as much trouble as bank runs in Barcelona or Turin.

This isn’t an abstract or imaginary worry; on Thursday rumors of a bank run in Spain led to a fall of thirty percent in the value of Spanish bank shares; the government denied any run was taking place, and, this time, people believed the denials. The panic stopped and the next day the bank shares recovered most of the loss.

Bank panics are contagious; everyone who read last week’s stories about the banking problems in Greece and the rumored problems in Spain is suddenly aware that the safety of their money is something that they need to think about. Invisible runs can spread and spread fast; this is the specter at the feast of the G-8 leaders as they meet at Camp David.