Global Perception and the Financial Crisis

A few weeks ago, a colleague asked me what I thought about “the American financial crisis.” I told him I didn’t think it would stay American for very long. “No,” he said. “Our banking system isn’t exposed to all that subrpime stuff.”

If it isn’t obvious already, my colleague isn’t an economist. Nor am I, for that matter, but what’s becoming clear is that not only is the Eurozone pretty well-exposed to the toxic mess of the credit crisis, the ECB has fewer tools to deal with it than the Fed. That’s what makes the failure of this weekend’s EU summit to come up with a collective plan such a big deal. So far, a lot of the European discussion has centered on regulation and responsibility (ie. punitive action), while remedial action has been ad hoc and unconvincing.

Edward Hugh of AFOE suggests that in the absence of a concerted response, the crisis could realistically bring down the Eurozone. He also points out that even if a systemic meltdown is avoided, the longterm impact of any bailout on member states’ budget deficits will be enormous.

Hampton rightly pointed out that whatever the perception, there’s collective responsibility for the crisis. That’s certainly true, both in terms of Eueopean banks’ willingness to participate in the American subprime boondoggle, as well as in the ways European housing bubbles helped drive growth here.

But that won’t necessarily change the perception, and that comes down squarely on the U.S. Here’s Dr. V Anantha Nageswaran, writing at the Indian Economy Blog:

It is important to remember that what have been impaired are not just mortgage related assets but also trust in the U.S. financial system and capitalism, across the world. The consequences of that are not easily identifiable and would linger on long after this crisis is over. It is equally important to remember that the Treasury rescue plan contains nothing to repair the impaired trust and integrity.

According to Nageswaran, the impact of that loss of trust won’t be benign:

[B]y the time this is over, the U.S. dollar [will] no longer be the world’s reserve currency and America [will] have lost its AAA credit rating.

In discussing how national security and economics are inevitably related, Matthew Yglesias notes the impact the cost of the Iraq War has had on the American economy. Yglesias is correct, but he fails to note the other half of the vicious circle. The wealth we’ve poured into the Iraq War was in large part the illusory product of the housing bubble.

Essentially we developed an accounting gimmick (derivatives of subprime loans) that inflated the value of American poverty, and used it as collateral to bankroll a war on the world’s dime. And we called that the Coalition of the Willing. It’s true that the world’s lenders were willing participants, but we were the ringleaders. And just like no one will be holding Honduras responsible for the geopolitical fallout of the Iraq War, neither will they hold sovereign wealth funds responsible for the subprime fiasco.