How should we think about systemic risk in Europe today? The EU has been moderately successful at crisis management. But the ability to muddle through is reaching its limits when, as now, several crises intersect at once.
You can see the problem most clearly in Greece — a country battling both an economic meltdown and a refugee crisis — with not much help from the rest of the EU. Last week when the European Commission issued a report criticising Athens over its failure to control its borders, Macedonia took the unilateral decision to close its southern crossing with Greece — leaving thousands of refugees in transit on the Greek side of the border. In Athens, meanwhile, parliament discussed pension reform, forced upon the country by their creditors as a quid pro quo for continued financial life support.
Greece may be the starkest example, but it is not the only country facing overlapping crises. It is not even the most important one facing this dilemma. That would be Italy. While Rome’s problems are different from those of Greece, the country’s long-term sustainability in the eurozone is just as uncertain, unless you believe that its economic performance will miraculously improve when there is no reason why it should.
Italy was overwhelmed by the increase of refugees from north Africa last year. On top of that it faces unresolved economic problems — no productivity growth for 15 years; a large stock of public sector debt that leaves the government with virtually no fiscal room for manoeuvre; and a banking system with €200bn in non-performing loans, plus another €150bn of debt classified as troubled. Then consider that its three main opposition parties have, at one time or another, all questioned the country’s membership of the eurozone. Even if none of them look like coming to power in the near future, it is clear that Italy only has a limited amount of time to fix its multiple problems.
The struggle to repair the banking system is a good example of just how big the task is. Last week, the Italian government and the European Commission agreed a convolutef scheme to relieve the Italian banking system of some of these toxic assets. It uses all the dirty tricks of modern finance, including the infamous credit default swap, a financial product that mimics insurance against default on a bond, which was particularly popular during the pre-2007 credit bubble. These instruments allow investors to hedge against default risk. But more often than not, their true purpose is to conceal information, to fool investors, or to circumvent regulatory restrictions.
The EU is struggling to respond to a surge of desperate migrants that has resulted in thousands of deaths
There are no such evil motivations behind this structure in the case of Italy, but the idea that the country’s solvency crisis could be fixed through financial trickery is, of course, absurd. For me the scheme is less a symbol of devious financial engineering, than a sign of desperation. There was little else the Italians could have done under the EU’s tight rules on state aid.
The European Commission previously blocked a proposal to create a classic “bad bank”, a state-owned company that would have bought the toxic debt directly from the commercial banks — thus giving them immediate relief. Doing so would have constituted illegal state aid under European law. The goal of the CDS scheme is more modest. It will bring no direct relief, but will help create an efficient market to sell some of this toxic debt over time. We should therefore expect the Italian banking system, and the wider economy, to continue to struggle.
I shudder to think how Italy would cope with an additional shock of the kind Greece is experiencing after the Macedonian decision — a sudden inflow of immigrants from Syria. This might occur, for example, through further border closures on the Balkan route, which has been the preferred gateway for Syrian refugees on their way to Germany. Such a shift could see refugees divert via the Adriatic Sea to Italy.
There are signs that Italy’s patience with the EU and Germany, in particular, is wearing thin . Matteo Renzi, prime minister, has been openly attacking the policies of the EU on energy, on Russia, on the fiscal deficits, as well as German dominance of the entire apparatus.
It is not the euro crisis alone that has brought Italy to the brink of questioning its position in the eurozone. It is a combination of many crises and is likely to gain more momentum from the Brexit debate.
There is an element of bad luck in this. Europe’s policy of muddling through, of doing the minimum required, and hoping to mop up the rubble later, might even have worked if the refugees had stayed at home. The EU’s mistake was not to have chosen a path that would lead to invariable ruin, but to render itself defenceless against the next unforeseen shock.