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A United States of Europe

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There’s a good chance that you’re fairly acquainted with the situation in Greece right now. If not, here’s a short summary: Last Tuesday, Greece defaulted on a €1.6bn IMF loan. Today, the Greek citizens voted “NO” during a national referendum (public vote) on whether or not to accept a new debt restructuring deal from the EU, pushing the latest German and French offer off of the negotiating table.

The rejection of the latest austerity plan spells trouble for Greece. EU politicians, who are being held accountable for the repayment of the largely German, French, and Italian government-owned Greek debt, have a momentous decision to make: do they (1) offer another deal that is more favorable to Greece, showing signs of weakness that might be exploited by other debtor countries within the EU, or (2) simply walk away from table and watch Greece withdraw from the Eurozone, implement a new currency, and attempt to turn its terrible economic situation around without access to most (if not all) of the world’s largest credit markets?

Neither of these options are great for either party. How did Greece get to this point? What is the solution? How can we prevent this from happening again?

I want to examine a comment made by Yanis Varoufakis, Finance Minister of Greece and central figure in the debt debacle, that addresses these questions on a very high level.

There is no doubt that if we had a Federal Republic - if we had a United States of Europe - we would not be here, discussing the Greek crisis, the Eurozone crisis, banking unions, or anything of the sort. I think most Europeans would agree with this, and most Europeans would want to live in a United States of Europe.¹

Now I want to tell you why this is wrong.

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EU vs. US

What’s the difference between the structure of the United States of America and European Union?

In semi-technical terms: The EU “is more than just a confederation of countries, but is not a federal state,” whereas the US is composed of member states that are overseen by a federal government.² In plain language: countries like Germany, Spain, and Portugal play largely by their own rules and are only bound together by the Euro, whereas states such as Alaska, South Carolina, and Hawaii, although very different in almost every way possible and eager to set off in their own direction, are all squeezed back into the mold of the general US will by a strong federal government. Sure, they might leak a little at the edges with respect to marijuana legalization, gun rights, and gay marriage, among other topical issues, but at the end of the day they are all tethered to the Federal government.

Effectively, this means that the EU functions like a club of adults that can meet and engage without much supervision, whereas the US is more of a family of juvenile delinquents that needs the supervision of a parental entity. The social bonds of the member countries of the EU are almost purely economic whereas the social bonds of the member states of the US are more of a mixture of economics, Constitution-steeped ideology, mild contempt for one another, and collective angst against the Federal government – a powerful glue to be sure.

In short, the EU is only a monetary union, whereas the US is both a monetary and “political” union.

Let’s return to Varoufakis’ argument. He states that the Greek economic crisis would not have occurred if the EU had a Federal government akin to the current US Federal government to regulate the actions of its member countries.

Here is why I disagree: the United States at the height of the economic crisis in September 2008 is equivalent to Greece at the height of its economic crisis in April 2010, when it lost access to capital markets.

Private creditors in the United States watched the sub-prime mortgage (debt) market explode, as they knew it would because they had created the crisis with the help of the credit rating agencies,³ investment banks,⁴ and truly awful federal oversight.⁵ They were subsequently bailed out by the US Federal Government with US taxpayer money⁶ when the troubled banks should have defaulted.⁷

Private creditors in Greece watched the government bond (debt) market explode, as they knew it would because they had created the crisis with the help of credit rating agencies,⁸ investment banks,⁹ and truly awful federal oversight.¹⁰ They were subsequently bailed out by the EU, IMF, and EFSF with EU taxpayer money¹¹ when the government should have defaulted.¹²

The key takeaway that refutes Varoufakis’ argument: the Federal government in the United States did not even come close to preventing the economic crisis; therefore, if the EU had been set up with a similar type of Federal government system, there is no reason to believe that it would have succeeded where the US government failed.

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Why was the outcome post-crisis so different for the US and Greece?

The US has its own central bank that was quick to absorb hundreds of billions in debt, recapitalizing failing banks and filling in the festering pits left in the collective balance sheet of the financial sector by the voracious and inscrutable sub-prime securities market after it had eaten its fill unfettered, and could engorge itself no longer.

Rather than amputating the limb and risking a massive but necessary reconstitution of the economy along the lines of a new financial system, the Federal Reserve decided to ease the pain with a seductive economic opiate known as Quantitative Easing. They shared needles with Japan and the EU, shooting up 3 times during the recession. In a weak and feverish state, the Fed watched the slow recovery, praying that the economy would be strong enough to (1) break its addiction to easy liquidity, and (2) withstand the toxic shock that will come as an inevitable consequence of raising the Federal Funds Rate which has been kept near 0 for the past 5 years.

Greece is bound to the monetary policy of the ECB, which has interests outside of the 2% of yearly GDP that Greece contributes to the Eurozone. Thus Greece did not have easy access to the opiate of QE, and was forced to choose between (1) defaulting on its debt or (2) severe, cold turkey austerity measures in order to restructure its debt. The Greek government chose the latter.

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Sometimes a Pig is just a Pig

Economists and financiers tend to make things a lot more complicated than they actually are. The reality is that the financial crisis in Greece shares the exact same roots as the U.S. financial crisis of 2008: “a systematic breakdown in accountability and ethics”.¹³

Greed and corruption are innately human factors that will always be present in a system that reduces to humans at a basic level. The inequality we see today is a direct result of unsupervised self-interests and the steady decomposition of the wealth redistribution and justice mechanisms that sustain every great democracy. We don’t have to look any further to discover the underlying causes of a crisis that has left 50% of Greece’s youth unable to develop skills or earn a living,¹⁴ cut 800,000 citizens off from basic medical access,¹⁵ and forced HIV rates up by at least 200%.¹⁶ As long as the global economy and its guardians continue to reward risky, short-term, self-serving actions, we will continue to see socially and economically destructive crises increase in regularity and severity.

Perhaps I would have agreed with Varoufakis is he had specified a timeframe in which the Federal government in the US was doing a particularly good job of thinking and acting in the long-term in order to enable the success of future generations. For example: A Roosevelt-esque New Deal 2.0 with a focus on public education, infrastructure, and science R&D is long overdue. That government was in power 80 years ago.

Unfortunately, it seems that our troubled economy has steeped Congress in a bitter vitriol, cementing party lines and making any type of major decision little more than a headcount of the number of Democrats and Republicans present in the building.

On a civilian level, the protracted nature of the recession and the Federal Government’s reaction – bailout the guilty – made it impossible for citizens to set aside individual differences and rally together to solve a larger problem; instead, it has made many of us cynical, jaded, and indifferent.

As the founding fathers of this country proved, a Federal government done right and overseen by great men and women is a powerful and enduring force. I’m not convinced that an EU version of our current Federal government could have prevented the economic crisis in Greece that currently threatens to tear the entire union apart.

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Works Cited

“Conclusions of the Financial Crisis Inquiry Commission.” Get the Report. Rock Center for Corporate Governance, Stanford, 2011.
Emergency Economic Stabilization Act of 2008, “TARP”, Pub. L. No. 110-343, 2008.
Evans-Pritchard, Ambrose. “Germany's record trade surplus is a bigger threat to euro than Greece.” The Telegraph. Telegraph Media Group Limited, 05 May 2015.
Featherstone, Kevin. “The Greek sovereign debt crisis and EMU: a failing state in a skewed regime.” Journal of Common Market Studies 49.2 (2011): 193-217.
Foy, Henry. “Charities struggle to plug gaps in gutted Greek welfare state.” ft.com. The Financial Times LTD, 24 June 2015.
“Greece Youth Unemployment Rate.” Trading Economics, 02 July 2015.
Kashyap, Anil. “A Primer on the Greek Crisis: the things you need to know from the start until now.” University of Chicago, Booth School of Business. June 29 2015.
Scatturo, Michael. “Greece’s 200% increase in HIV shows hos disastrous austerity can be for public health.” Quartz, 16 May 2013.
Story, Louise, Landon Thomas Jr., Nelson D. Schwartz. “Wall St. Helped to Mask Debt Fueling Europe’s Crisis.” The New York Times. The New York Times Company, 13 February 2010.
Taylor, John B. “Evaluating the TARP.” Written Testimony for the Committee on Banking, Housing, and Urban Affairs. United States Senate, 17 March 2011.
“The EU Overview.” The Association of European Vehicle Logistics. ECG Association, 02 July 2015.
Utzig, Sigfried. “The Financial Crisis and the Regulation of Credit Rating Agencies: A European Banking Perspective.” ADBI Working Paper Series, No. 188 (2010).
“Yanis Varoufakis and Joseph Stiglitz.” New Economic Thinking. Youtube, 09 April 2015.
Zettlemeyer, Jeromin, Christoph Trebesch, and Mitu Gulati. “The Greek Debt Restructuring: An Autopsy.” Peterson Institute for International Economics. Working Paper Series, WP 13-8 (2013).

Footnotes

See [13].^
See [11].^
FCIC [1], p. 212: ‘The Commission concludes that the credit rating agencies abysmally failed in their central mission to provide quality ratings on securities for the benefit of investors. They did not heed many warning signs indicating significant problems in the housing and mortgage sector. Moody’s, the Commission’s case study in this area, continued issuing ratings on mortgage-related securities, using its outdated analytical models, rather than making the necessary adjustments. The business model under which firms issuing securities paid for their ratings seriously undermined the quality and integrity of those ratings; the rating agencies placed market share and profit considerations above the quality and integrity of their ratings.’^
FCIC [1], pp. xviii-xix: ‘We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis. There was a view that instincts for self-preservation inside major financial firms would shield them from fatal risk-taking without the need for a steady regulatory hand, which, the firms argued, would stifle innovation. Too many of these institutions acted recklessly, taking on too much risk, with too little capital, and with too much dependence on short-term funding. In many respects, this reflected a fundamental change in these institutions, particularly the large investment banks and bank holding companies, which focused their activities increasingly on risky trading activities that produced hefty profits. They took on enormous exposures in acquiring and supporting subprime lenders and creating, packaging, repackaging, and selling trillions of dollars in mortgage-related securities, including synthetic financial products.^
FCIC [1], p. 53: ‘Deregulation went beyond dismantling regulations; its supporters were also disinclined to adopt new regulations or challenge industry on the risks of innovations. Federal Reserve officials argued that financial institutions, with strong incentives to protect shareholders, would regulate themselves by carefully managing their own risks. In a 2003 speech, Fed Vice Chairman Roger Ferguson praised “the truly impressive improvement in methods of risk measurement and management and the growing adoption of these technologies by mostly large banks and other financial intermediaries.” Likewise, Fed and other officials believed that markets would self-regulate through the activities of analysts and investors.’^
TARP [2] is the most direct restructuring of $475bn of private to public debt. QE is less direct, but it exposes the taxpayer to risk by offloading illiquid and opaque securities from banks and transferring them to the Fed’s balance sheet instead.^
Taylor [10], p. 6: ‘In sum, in my view there is no convincing evidence to support the view that the TARP had a stabilizing effect on the financial markets or the U.S. economy. On the contrary there is evidence that the chaotic rollout of the TARP exacerbated the crisis. Even if one can find some stabilizing effects, it is clear that other actions could have been taken that did not have these rollout costs. Finally, there is a considerable consensus among economists that the legacy costs of TARP are large, especially the perpetuation and amplification of the destabilizing “too big to fail” problem in our financial system caused by the expectations of more bailouts in the future.’^
Utzig [12].^
Story [9].^
Featherstone [4]. This article is paywalled, but here‘s a tidbit from the abstract: ‘This article explores the antecedents and management of the crisis and assesses the outcome. At the EU level, a paradox was evident in the denial of agency and resources that might limit the obligation of states to rescue an errant peer. Domestically, within Greece, the unprecedented external monitoring and policing of its economy - though matched by some initial successes - raises in the longer term sensitive issues of legitimacy and governability, with uncertain prospects for avoiding further crises.’^
Zettlemeyer [14].^
Kashyap [7].^
FCIC [1], p. xxii.^
Down from a high of ~60%. See Trading Economics [6].^
Foy [5].^
Scatturo [8].^