Mark Zandi is chief economist of Moody’s Analytics and co-founder of Moody’s Economy.com. He is the author of Financial Shock: A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis.
How has the 2008 global economic crisis impacted the situation in Europe?
Well, the 2008-2009 financial crisis and recession put tremendous economic and financial pressure on the global economy, including Europe. Europe suffered a worse economic downturn than the U.S. loss of GDP, unemployment soared into the double digits, and of course, European economies – much like here in the U.S., China, and the rest of the world – responded with fiscal stimulus, tax cuts, spending increases to try to combat the recession; which exacerbated their fiscal problems. So a combination of a very weak economy and bigger budget deficits and debt all laid the foundation for the fiscal crisis that ensued, and began not long after in 2010, beginning with Greece.
What factors led to the debt crisis of 2009?
Well, the Europeans borrowed heavily. Before the recession, many of the economies, particularly in the periphery – Greece and Italy would be good examples – where they borrowed; the governments borrowed quite heavily to cut a lot of debt. And in some of the other countries households borrowed, banks borrowed. Ireland would be a good case in point. So they were heavily leveraged going into the Great Recession. When the Recession hit that made everything a lot worse, because of undermined incomes, profits, growth in the economy. It was difficult to service that, and so it exacerbated the situation. The credit rating agencies really didn’t play a role in the European crisis. They do rate the debt of sovereigns, but generally they’ve been following the market – the market investors have been downgrading their own ratings of the bonds, long before the rating agencies did. So I don’t think there is any substantive role that the rating agencies played in the European debt crisis.
We have a stable, growing economy in Germany, and a reeling economy in Greece. Could you compare their economic policies?
Well, the Germans have followed a more fiscally prudent policy. They, of course, haven’t borrowed nearly as aggressively, their government has been more cautious of them borrowing. And German households are really good savers, they don’t borrow money. German banks have been more aggressive, they’ve lent money to some of the more trouble sovereigns – Greece, Spain, Ireland, Italy – but in general, the German economy had very low debt levels. They also managed the Recession well; they had a number of different techniques for cushioning the blow on their economy. One good example of that is their unemployment insurance program allows for keeping workers on and cutting the hours of the entire workforce so they didn’t see the same kind of job losses and high unemployment as was seen in the rest of Europe, and in the U.S. as well, so that cushioned the blow to consumers, to the economy more broadly. So they navigated through the Recession, they got hurt badly, but they navigated better than most economies. Of course, the periphery country are just the opposite. They had borrowed heavily; households, government, banks had borrowed very heavily, well before the Recession. In some of these economies, you had a very significant housing bubble – even bigger than in the U.S. – in Spain, very big housing bubble. Of course, they burst and the debt became a very significant problem. And then the way they managed; the policy management during the Recession was a bit botched. They didn’t know how to respond and didn’t do a very good job, and the debt exacerbated the situation. So, the case of Germany and the other core sort of countries is very different from the periphery how they navigated through the downturn.
Germany, Greece, and others have borrowed money. Has the rate at which they’ve been borrowing at been an issue as to the current crisis?
The many European economies – particularly the more troubled economies – borrowed heavily prior to the downturn. Some of the borrowing was by governments; Greeks, case in point. Some of it by households. Spain would be a good case in point. And in some, it was very aggressive borrowing by the banks. Ireland would be a good case in point. So it varies country to country, but generally speaking we’re having the European debt crisis is because they have debt – lots of debt and they took on a lot of debt, and now they’re trying to figure out how to repay it.
Aside from Greece, what other countries have borrowed heavily?
Well, the biggest borrowers would be Greece, Italy, Spain, Ireland and Portugal. These are the most troubled periphery European countries; they are the most indebted. But France has also borrowed heavily, and even some of the core economies have borrowed more; their debt levels are up, at least compared to where they were before the Recession. But the biggest countries were the ones I just mentioned.
What can European countries and institutions do to either get more credit or increase their ratings?
They have to show fiscal discipline, that means they have to reduce their budget deficits over time. You can’t do it overnight, because that will undermine their economy; so that means spending cuts, tax revenue increases. They also have to improve the competitiveness of their economy; they have to grow their way of out the debt problem. The best way is to grow faster so they can repay it. They have to implement structural economic reforms: changing labor laws, changing rules and laws related to global trade, opening up their service sector so they can be more competitive, so that their businesses can compete more globally and their economy can grow in a more sound way. And then Europeans have to bind together more fully; they have to guarantee each other’s debt, ultimately, so it’s not German debt or Greek debt, it’s European debt, because that’ll bring interests down. But the quick, pro quo is that everyone must stick to the rules of that, meaning government spending policy, tax policy. They’re pretty great on the rules for monetary policy. That’s what the Eurozone is all about, that’s the European Central Bank, but they need to get it together with regard to fiscal policies. The end game here is a more tightly bound European economy where each nation seeds some authority over their policies, but what they get out of that is a much sounder European economy, so they’ve got a lot of work to do.
Are you optimistic about the outcome in Europe?
I’m optimistic the Europeans will keep this together. I think they’re all in, I think they’ve agreed that they want to keep the Eurozone together. This is most evident in the policies of the European Central Bank; they’re being very aggressive in trying to keep the Eurozone together. Most recently they agreed to buy the bonds of the troubled sovereigns and the quid pro quo is that the sovereigns have to give up some sovereignty over their fiscal policy. This isn’t the end of the story; there’s going to be a lot of ups and downs and all-arounds, and rounds of financial panic. In fact, you almost need the financial turmoil to be able to generate the political will to do the things that are necessary to nail the crisis down. I think they’ll do it. I don’t want to be polyamorous about it. This is politics and things could go wrong. The German population could say that they’re out of there, and don’t want to be a part of it, and they’re the strongest economy and they do have to pay for a lot of it. The Greeks – we’re seeing riots in the streets because unemployment is 25% and rising, and if I’m a Greek family and can’t pay for my sick kid, I’m going to be pretty upset and I could be out of here. Just like Argentina did back 10 years ago, things could go badly wrong. At the end of the day, I think there is an understanding certainly among policymakers, and even among the electorate, that if they don’t keep this together, they’ll go down that alternative path. That’ll be a dark path, much darker than the one they’re going down now, and given that ill be optimistic they’ll keep it together and work it out.
Have the U.S. and others across the world overblown the economic crisis in Europe? Or is it as real and problematic as it seems?
Oh, the European debt crisis is real. This is a big problem. Europeans would be the first to say that. The whole Eurozone experiment is at risk here; this whole thing could fall apart. So there is no way to understate the significance of this, most importantly for the Europeans. It would be devastating for the global economy, including the U.S., and it’s already having big impact; causing everyone a problem, but no one would get hurt more than the Europeans. So there is no way to understate the severity of what is going on here.
What can the U.S. do to help the crisis?
Very little. There’s not much that American policymakers can do, except perhaps offer technical support if it’s needed. There are some very technical issues in some of these peripheral countries – how do I manage a tax system? How do I get people to pay their taxes? How do I manage a retirement system? But, perhaps, the best way the U.S. can help the Europeans is to nail down our fiscal problems. So we should focus on our own issues. I think they’ll be able to get it together, there’s not a whole lot our policymakers can do to help them.
What would you say if you were advising European leaders and they asked you what needed to happen there?
You’ve got to commit. You’ve got to say you’re all in, and will make it work, because if we go down a different route and it falls apart, it’ll be devastating to all involved. So we have to commit and what that means is everyone is all in. everyone will put in all their resources. Take the U.S. Can you imagine if Louisiana or Texas got in trouble and New York and California wouldn’t come to their help? No chance, we’d come together and help each other about. That’s what the U.S. is all about, and that’s what the united Europe is all about. So, you’ve got to be all in and you’ve got to say, “this is going to work and we’re going to make it work.” Once you do that, life becomes a lot easier because investors recognize this and say they won’t charge an exorbitant interest rate to buy your bonds and debt. By the way, American history is a testimonial to this. The U.S. didn’t just happen, we went through a similar kind of thing back in the late 1700s, and it was only by commitment that we got it all together. It’s when Alexander Hamilton said, “You know what, if U.S. treasury debt is worth less 100 cents on the dollar, I’m willing to buy it from you.” As soon as he said that, U.S. treasury debt was 100 cents on the dollar. So, it’s just the commitment – an incredible commitment at work – and that’s what the Europeans have to do. They have to be all in. If they’re all in, this will work out just fine.
What if some countries just can’t be salvaged?
No, you don’t jettison them, that’s the point. You have to commit, you made this. It’s the Hotel California, once you come in there’s no way out. Once everyone recognizes it’s a Hotel California, it’ll stick together. There cannot be, in my opinion, any bending on that, you have to be steadfast in that resolve and make sure that works out. At the end of the day, Greece is the weak link, but it’s an incredibly small economy, you can fit it in Rhode Island, and already two thirds of their debt is on the Europeans’ balance sheet. This is really a minor problem now in the grand scheme of things. The Europeans should be able to figure this out and I’m confident they will.