The financial and economic crises have revealed the entrenched power of the banks in the European Union. In this EU in Crisis essay, Corporate Europe Observatory’s Kenneth Haar describes how a wave of financial regulation was set in motion by the crisis in 2008. By now most of this regulation has been passed, and there’s plenty of evidence to show that the banks are being let off the hook. Looking back, banking lobbyists can conclude that decision makers have practically fallen over themselves to serve the banking industry’s interests. The dream of a European Union that would curb the power of finance has become a joke, and instead we’ve seen a bankers’ Europe emerge that may make even Wall Street envious.
The problem is systemic. Banks have been allowed to grow so big that the collapse of just one poses a major problem to society. They’ve also been allowed to make huge risky bets, often using ordinary people’s money. There are remedies to this, reforms that could roll back their power. But the first necessary step might be simply to make politicians and Commissioners stop thinking of bankers as the oracles of the economy.
A captive Commission
Less than 15 years ago, banking was not really the EU’s business. Regulation was either framed internationally at the Basel negotiations or at the national level. But by the end of the nineties, there was an emerging consensus among governments on building a genuine single market for financial services. The aim was to remove barriers for banks and other financial institutions, not to strengthen regulation which might avoid systemic risks or reign in speculators. They did not want to contain the financialisation of the economy, but promote it. This model was developed in close cooperation with those who were considered the real experts, the big financial institutions themselves, not least the banks.
At the time, banking was not a seriously politicized issue, so only a few fought to denounce the problematic influence of banks on EU legislation. Whenever new initiatives were being developed, or old ones reviewed, the Commission routinely called in the big players to get their opinion. The Commission would then write proposals in line with their advice, and these would generally be adopted with only minor changes.
The financial crisis set new agenda
But with the financial crisis in 2008, the party seemed to be over. There was brutal criticism of irresponsible banks and of the lax rules on banking from all sides. Governments and EU Commissioners alike came out with remarkably aggressive statements on the irresponsibility of banks and on the need to review legislation.
“I think the current crisis has shown that we need a comprehensive rethinking of our regulatory and supervision rules for financial markets” said the President of the Commission José Manuel Barroso.
His colleague in the Commission, the top man of Single Market regulation Charlie McCreevy, flatly admitted to listening too much to financial corporations:
“What we do not need is to become captive of those with the biggest lobby budgets or the most persuasive lobbyists: We need to remember that it was many of those same lobbyists who in the past managed to convince legislators to insert clauses and provisions that contributed so much to the lax standards and mass excesses that have created the systemic risks. The taxpayer is now forced to pick up the bill.”
Quite amazing words from the very man who had let the financial lobby dominate his own work with financial regulation. There seemed to be little doubt that radical reforms were in the pipeline.
Costly safety nets
The crisis revealed both extreme excesses by the banks and a flawed system of supervision and regulation. It left their public reputation in tatters. But new effective regulation was not the first priority. Top of the list was saving the banks.
One spectacular rescue operation after another has weighed heavily on member states’ budgets. As when the Irish government assumed the debts of Anglo Irish Bank, allegedly pushed by Goldman Sachs International chairman, former EU Commissioner and former Irish Minister Peter Sutherland. A move that could ultimately have left the Irish tax payers with a 47 billion euro bill – more than a third of the country’s GDP.
Or when the Franco-Belgian bank Dexia collapsed twice, first in 2008, when it was only saved by a loan guarantee of 150 billion euro. Then again in October 2011, when the Belgian government guaranteed a loan of 54 billion euro, (14 per cent of the country’s GDP) plus an immediate pay-out of 4 billion euro for the take-over of Dexia-Belgium. With Belgian MEP and former minister Jean Luc Dehaene on the board, Dexia had easy access to the political elite of the country.
Enormous amounts of public money have been put at risk to save the banks. Combined, the 27 member states of the EU have (by October 2011) set aside 4.5 trillion euro for support, guarantees and loan packages to banks, or almost double the annual GDP of Germany.
The generous side of the ECB
The euro crisis has revealed the potential to raise huge sums of money when the health of the balance sheets of banks is at stake. In fact, the European Union is putting the banks at the forefront of its attempt to stave off the crisis and kickstart the economy. In December 2011, the new President of the European Central Bank, former Goldman Sachs director Mario Draghi, launched a bold initiativeto ignite bank lending to the private sector and calm the rise or even reduce the interest rate on sovereign bonds. The ECB spent 489 billion euro in this first batch of the Long Term Refinancing Operation (LTRO) – cheap loans and no strings attached - a move widely welcomed by the banks.
“Seeing this amount of liquidity from the ECB is encouraging. To whatever degree investors are nervous about stepping back into markets and funding banks, the ECB will be there and provide liquidity to make sure things keep ticking over,”
a strategist at the US investment bank JP Morgan said in December 2011.
The bargain loan sale was to continue, and in February 2012 another 530 billion was put up for grabs, this time to the benefit of certain consumer loans – and bringing the total to 1 trillion euro. Car manufacturers Mercedes Benz, Daimler and Volkswagen were among the beneficiaries, thanks to their financial arms set up to provide customers with loans to buy a car. But there is little real evidence to prove the LTRO has met its objectives. While President Draghi claimed the initiative to be ”an unquestionable success”, his own ECB reported in February that loans to the real economy actually fell in February.
The jury may still be out on the final verdict, but either way the LTRO begs a couple of questions. If the ECB can provide so much money, why spend it boosting the banks’ coffers in the hope that the banks will lend more cheaply to governments? Why not lend directly to governments? And if the real economy needs a boost, why not support public investments, for instance by investing in green energy greening the economy? The answer is that according to EU treaty, the ECB has to be independent of governments and is barred by law to provide direct loans. As a result the ECB backs the banks as the life and blood of the economy.
And there’s another absurdity at play: the money spent on the LTRO is double the amount of money put into the new rescue fund over the next three years, the European Stability Mechanism (ESM), to offer loans to the governments of states in severe crisis. While the LTRO attracted little political controversy, finding half the amount of money for government lending has been very difficult and has taken several EU summits to get settled.
Even so, it’s likely we will see an LTRO 2 in the not so distant future. because a lot of banks are ”chronically dependent” on the funds from the ECB according to Alberto Gallo, a strategist of Royal Bank of Scotland.
The economic generosity to banks is mirrored by political generosity, and one incident is a stark symbol of this.
Shortly before the start of a Eurozone summit in July 2011, a black car pulled up in front of the Council building in Brussels, and out stepped a man in a suit, shaking hands and smiling – like any leader of state or government. Despite appearances, he was not a statesman, but Joseph Ackermann, the chief executive of Deutsche Bank and chair of the international banking lobby group, the Insitute of International Finance (IIF), joining the negotiations with governments on the Greek debt.
Before these talks, it looked as if banks would have to pay part of the bill for their investment adventures. During 2011 it had become clear that it was impossible for Greece to service the burden of debt accumulated, which included loans to private banks. A so-called ‘hair cut’ to trim the debt was needed. A solution had to be found with the banks – and so Ackermann was invited to join the summit.
It could be argued that the banks brought this on themselves, and that when their investments turned sour, they should simply have been left to bear the losses. But when years of easy prosperity ended, it was seen as a problem governments would have to solve. The big banks were seen as counterparties with whom Eurozone governments would have to negotiate. Following the negotiations led by Ackermann, a deal was finally reached with officials of the Greek and Euro Area, and ‘eventually with the Euro Area states or governments and EU institutions’, as an IIF document set out.
Evidence suggests Ackermann is a skilled negotiator. On the face of it, the banks had to swallow a 50 per cent cut, but the value of Greek bonds had plummeted to 35 per cent of their nominal value. With the deal, governments had in fact come to the aid of banks. Less a ‘hair cut’ for banks, more a full-body shave for Greece.
And there was an extra bonus for the banks, with a clause in the treaty underpinning loans to crisis ridden Eurozone economies – the ESM Treaty - that will prohibit governments from future attempts to make the banks write off debt owed to them by governments.
The usual suspects
Against this background, it would be a surprise if the European Union had in fact enforced strong regulation – disobeying advice from bankers to refrain from real action.
Indeed, the first thing, the Commission and the Council did in 2008 was to set up a high-level advisory group to propose an overall approach to financial reform. Of the seven in the group, 4 had strong ties with big banks, a fifth was the regulator blamed for ineffective supervision of British banks, a sixth was known for extreme liberalist views. In other words, the EU had asked the very kind of people who were responsible for the crisis, how to respond to it. Their report would be seen as a benchmark in the future proposals.
Despite the impatient rhetoric at the start of the crisis, the pace of reform was soon to slow. And the banking lobby did its best to stave off ambitious measures. To do this, they used scaremongering, and the IIF were masters of the craft. Ackermann stated that there was a “very real risk” that “regulatory reforms come into force that could undermine global recovery and job creation”. And the IIF carefully timed the release of a report on the dangers of regulation for the summer of 2010. That’s when the international negotiations on banking regulation (the Basel Accords) reached a climax. By then the political mood had changed completely. The desire for reform had been dampened by fear of slower growth and instability in the banking sector. That allowed financial lobbyists to temper politicians’ ambitions.
Little hope for credible steps
According to a new part of the the Basel III agreement, if Lehman Brothers had been scrutinised shortly before its collapse, it would have been considered a sound enterprise! At that time, Lehman Brothers’ leverage (how much money banks lend compared to the value of their assets) was 31 to 1. Under the agreement the limit is at 33 to 1. In other words: according to this set of rules, Lehman Brothers was a sound company when it went bankrupt.
The new Basel Accord (dubbed Basel III) is not legislation in itself, but rather a set of guidelines. Theoretically the rules it sets out can be improved when implemented nationally or in the EU. But there is no sign of a stronger approach in the EU. For instance, the advisors at the Commission are no different from those nurtured by Commissioner McCreevy before he left in early 2010. In one phase of the discussion, the key advisory group to advice the Commission on banking regulation, the Group of Experts on Banking, was heavily dominated by "experts" from banks affiliated to the IIF lobbying group, which worked so hard to water down any international regulations. Of the 42, 23 were members of the IIF, and most of the rest were from other financial corporations.
And the governments? The German and French governments recently came out against Basel III, claiming it would have a ‘negative effect’ on growth and would have to be watered down when implemented in legislation.
Stop listening to banks
The privileged role of banks in the debate on banking regulation reform is no real surprise. That the financial corporations have been given a prominent role has been true of all the reforms of the financial markets since the EU’s first comprehensive strategy on financial markets in 1999. Some small things have changed since the crisis of 2008, but the changes to legislation on derivatives, on accounting, on tax havens, and on hedge funds, have failed to meet the challenge posed so dramatically by the crisis. And when the Commission takes the unprecedented step of proposing a tax on financial transactions (FTT), the eventual details reveal it is a long way from the original design. And there is little hope of even this watered down version becoming a reality, due to opposition from some member states.
What this comes down to is the dominance of the financial sector in the debate on financial regulation, and banking regulation is no exception to the rule. In a comment on banks’ influence on the handling of Greek debt, two financial experts, Simon Johnson and Darem Acemoglu, recently wrote: “The lesson for Europe – and for the US – is clear: it is time to stop listening to what banks say, and start focusing on what they do. We must re-evaluate the distorted political economy of the financial sector, before the excessive power of the few imposes even larger costs on everyone else.”
It ought to be shocking to see the dependence of decision makers in the Commission and in member states on banks and bankers. When they want advice on banking regulation, they ask bankers. When the banks are in trouble, they socialise their debt. When the economy is in trouble, they hand out money to banks. The bankers are grateful, but society at large shouldn’t be.
Breaking the strong links between banks and the political system seems to be a prerequisite for the deeper reforms needed. As long as the words of bankers and the narrow interests of banks carry more weight than the words of those who pick up the bill, we’re in deep trouble.
- ALTER-EU; “A captive Commission – the role of the financial industry in shaping EU regulation”, November 2009.
- Corporate Europe Observatory; “Finance lobbyists in experts clothing”, April 2009.
- Corporate Europe Observatory; “Lobby to take presidency of ECB again”, October 2011.
- Corporate Europe Observatory; “More needed to break financial industry’s stronghold”, December 2011.
- Corporate Europe Observatory; “What are bankers doing inside EU summits?”, January 2012.
- Kenneth Haar (Corporate Europe Observatory); “Lehman Brothers forever”, Infobrief EU & International, Sonderausgabe 3a, Arbeiterkammer (Austria), September 2011.
- Kenneth Haar (Corporate Europe Observatory); “What the squid did next”, New Internationalist, issue 450, March 2012.
- Simon Johnson & Daron Acemoglu; “Captured Europe”, Project Syndicate, March 2012.