Will the EU Fiddle While Eastern Europe Burns?

"We should not allow that a new Iron Curtain should be set up and divide Europe."
– Ferenc Gyurcsany, Prime Minister of Hungary

Will Germany prove content to fiddle as Eastern Europe burns? The risk seems real.

Angela Merkel, Germany’s chancellor, knows her party will be facing a tough series of elections this fall. She also knows Deutschland is struggling... and writing a huge check to bail out a clutch of flailing non-German nations would be a deeply unpopular act.

So when Ferenc Gyurcsany, the prime minister of Hungary, proposed a lump-sum Eastern Europe bailout package to the tune of $241 billion, the EU’s richer members spat out their croissants.

In a moment of quiet political panic, Chancellor Merkel stalled. “Saying that the situation is the same for all Central and Eastern European states, I don’t see that,” she said.

Political Will (And Lack Thereof)

This lack of political will helps explain why the U.S. dollar is strong and the euro is in the tank.

The European Union has 27 client states, 16 of which have adopted the euro. The USA has fifty states, all of which use the greenback.

The difference is that, if Washington decides the state of California needs emergency funds, South Carolina can’t fold its arms and say “Yeah, right” (much as it might like to). America’s fifty states are bound together under a unified political system, which makes large fiscal transfers a workable option. The 27 client states of the European Union, on the other hand, do not have the same ties that bind.

This throws a huge monkey wrench into Europe’s flow of funds, as we are seeing now with Germany’s hesitation to do what might be needed. Ms. Merkel does not want to commit political suicide at home for the sake of helping out her poor neighbors. These “political roadblocks” will be thrown up again and again as the EU nations see their broader fortunes diverge.

Iceland Redux?

The thing is, Germany, France, and the other “rich” EU members may ultimately have no choice in the matter. A bailout of Eastern Europe might wind up being a necessity in order to save Western Europe’s banks.

An estimated $1.7 trillion worth of loans (if not more) has poured into Eastern Europe. Out of that fairly large sum, a huge chunk has gone toward foreign-currency-denominated mortgages. Western European banks have done most of this lending, some of them on a staggering scale. According to various reports, one Austrian bank alone has lent sums to Poland, Romania and Ukraine totaling 70% of Austria’s GDP.

This is the same type of mistake made by Iceland’s now-belly-up banks: loading up the boat with exotic mortgages, then sailing forth blithely between the Scylla and Charybdis of repayment risk and forex risk.

And thus, if Eastern Europe goes down the tubes, in all likelihood so do Western Europe’s banks. And if that happens, you can probably kiss the Euro goodbye... and with that, the free movement of people, goods and capital between European borders... and in that scenario Europe on the whole is pretty much toast.

So I hate to break it to you, Chancellor Merkel, but you should think pretty seriously about writing your neighbors that bailout check. (Unless, of course, you’re willing to deal with the political consequences embedded in a potential full-on collapse of the European banking system.)

Comments

[bc818:]

Hasnt this sort of behavioral economics been tested in the lab? when an individual is given a choice between what's best for them and what's best for the group, they almost always choose what's best for them and screw the group....fun times ahead.

Mar 05 04:55 PM

[aquaculture:]

How right you are!

Mar 05 06:13 PM

[nova:]

This is the time for a sound business sense instead of emotions.

Rich EU Euro-zone countries must admit that an integration of Eastern European countries into a "United Europe" was not a good idea. The differences are so huge that bridging them is close to impossible.

Consequently, these rich Euro-zone countries have to fix their own economies, take losses, and move forward using sound and realistic policies.

The same is going for the USA. The government must allow free-market processes to resolve its financial & economic catastrophe. The government must assure that the process although painful is still "orderly" providing an adequate support for most vulnerable segments of American population.

Failed financial institutions, banks, and business enterprises must go clearing spaces for successful ones. The Great Depression has taught people a simple lesson: do not put good money into bad money endless pits.

Mar 05 06:30 PM

[Dragoman:]

Another feeble Eastern Europe article in SA. Does anyone study primary sources anymore or just regurgitate other ill-informed blogs?

1. According to the Bank of International Settlements, the total foreign debt of Emerging Europe (EU-10, Russia, Turkey) is 1,6 trillion USD. According to the World Bank, their GDP is 3,5 trillion USD. Would you get stressed if the TOTAL mortgage on your family home was 1/3 of your annual income?


2. Emerging Europe (EU-10, Russia, Turkey - population 320 million) has short-term foreign debt of 375 billion USD. By contrast, Ireland (population 4 million) has short-term foreign debt of 447 billion USD. Would you feel profligate if you credit card bill was 1/100th of your neighbour's?

The Eastern Europeans have low national debt and large foreign reserves (T-bills, sterling, eurobonds), yet according to S&P, the new European Union members' debt is junk and Ireland is AAA-rated.

The GDP of Emerging Europe is 3,5 trillion USD and China has GDP of 4,2 trillion USD. The Eastern Europeans have strong infrastructure, excellent education and massive natural resources. Yet the Chinese will save the world with a fraction of the Eastern European's schools, roads, gas and electricity?

What is it that the media hates about Eastern Europe so much? Why are there no articles by Eastern Europeans published?

Mar 05 06:33 PM

[driftwood2:]

Those guys are screwed. The amount of money lent to eastern Europe is staggering. It's bound to brings the western Europeans down even if a bailout for eartern Europe is arranged. We just need debt writeoffs on a huge scale across the entire world.

Mar 05 06:59 PM

[Fabien Hug:]

Europe is in a lot of troubles; it is an economic alliance led by politic motives. The worst is that every opinion in the politic specter found something to eat in this alliance. The left thought great, the capitalists will pay to raise the standard of living of our eastern brothers and the capitalists thought great, we open new markets and we'll make a killing.
Not to mention politicians who thought they are going to beat the US.
Now something has to give.

Mar 06 10:31 AM

[Straight Sh...:]

Thank you for introducing facts into the stream of ignorance that continually pours into almost all American commentary concerning Eastern Europe. It would take a bulldozer to cut through all the ignorant sludge that passes for knowledge and thinking about this area by my fellow citizens.
If only the casinos that pass for banks in the U.S. and most of Western Europe were as conservatively run as those in East Europe, the world would not be in this titanic banking crisis.


On Mar 05 06:33 PM Dragoman wrote:

> Another feeble Eastern Europe article in SA. Does anyone study primary
> sources anymore or just regurgitate other ill-informed blogs? <br/>
>
> 1. According to the Bank of International Settlements, the total
> foreign debt of Emerging Europe (EU-10, Russia, Turkey) is 1,6 trillion
> USD. According to the World Bank, their GDP is 3,5 trillion USD.
> Would you get stressed if the TOTAL mortgage on your family home
> was 1/3 of your annual income?
>
>
> 2. Emerging Europe (EU-10, Russia, Turkey - population 320 million)
> has short-term foreign debt of 375 billion USD. By contrast, Ireland
> (population 4 million) has short-term foreign debt of 447 billion
> USD. Would you feel profligate if you credit card bill was 1/100th
> of your neighbour's?
>
> The Eastern Europeans have low national debt and large foreign reserves
> (T-bills, sterling, eurobonds), yet according to S&amp;P, the new
> European Union members' debt is junk and Ireland is AAA-rated.<br/>
>
> The GDP of Emerging Europe is 3,5 trillion USD and China has GDP
> of 4,2 trillion USD. The Eastern Europeans have strong infrastructure,
> excellent education and massive natural resources. Yet the Chinese
> will save the world with a fraction of the Eastern European's schools,
> roads, gas and electricity?
>
> What is it that the media hates about Eastern Europe so much? Why
> are there no articles by Eastern Europeans published?

Mar 06 01:47 PM

[misiosnechacz:]

I think that the guy knows about eastern europe as much as he hear in his local radio. I realy don't know how it looks like in some countries but I can tell You I read IVQ of all polish banks and they made profit (few exceptions). But in 2008 noone of the banks had loss. Ukraine is diffrent story. Eastern Europe it's region where is few states and everyone of them is in a diffrent situation. It's like You would put USA, Canada, Mexico into one basket. Do your own digging especcialy in that area.

Mar 06 07:43 PM

[261133:]

This is so stupid and ridiculous it's not even worth to answer. Some posts
are dealing with facts and fact is with the exception of Ukraine, Eastern Europe is in good shape, much better than the socalled rich EU-Countries.
Ireland who tried to beat the US in "Worst capitalist" is a dead man walking and the UK is not much better (thank god the Tommies don't have the Euro)
As to Germany, Merkel is right and the real game plan is to leave that monstrum of 27 members and get back to the Elite-Club with Germany,Austria,France... .

Mar 06 11:00 PM

[Zoltan L. K...:]

The Iron Curtain was demolished through excessive lending from the West in order to promote democracy for the advantage of humanity. Now those Countries have still trouble with their indebtedness. This situation seems like a problem for all of the EU. The taxpayers in those (CEE) countries have already payed for the consolidation (bailout) of the former state owned banks and diminished their national debt capacity.

Mar 07 06:59 AM

[Mad Hedge F...:]

Things are worse than they appear. While American banks have their subprime crisis, European banks are being dragged under by their lending to emerging economies in Eastern Europe. Led by UniCredit in Italy, Austria’s Erste Group Bank and Raiffeisen International, France’s Societe Generale, Belgium’s KBC, and Hungary’s OTP, banks have lent $1.6 trillion to companies in these formerly communist countries at cheap rates, with minimal documentation, and few questions asked. The easily available credit caused local money supplies to explode, and sparked bull markets in both stocks and currencies. Emerging Europe grew at double and triple rates in the West, as local companies pumped up on steroids became the master of leverage. Now $400-$600 billion is due for rollovers this year from nonexistent credit markets, and the chickens….make that vultures, have come home to roost. Economic growth has fallen off a cliff, with Poland’s seasonally adjusted industrial output down in December a precipitous 7.4% YOY. The Polish stock market fell 48% last year and the zloty is off 40% against the dollar from its June peak. The Central European Equity Fund (CEE) has crashed 80% in eight months. The crisis is so severe, it may postpone Poland’s entry into the Euro block, which had been scheduled for 2011. Home mortgage borrowers are in especially bad shape. Up to 50% of their loans were denominated in Swiss francs, so the collapsing Polish currency has caused a near doubling of borrowers’ monthly payments and principals since last year. Austria really has its knickers in a twist, as these heavily syndicated loans account for 80% of GDP. A 10% default rate could wipe out the entire banking system there. Germany has the smallest loan exposure, but has the most to lose, with 25% of its exports headed east. It is now in negotiation with its partners in the EC to cobble together a bailout with the help of the IMF to provide bridge financing for these loans, and hopefully ward off a further economic collapse. It looks like the headlines in Europe are about to get uncharacteristically sensational

Mar 08 11:26 PM

[samwise:]

very generalized article and I appreciate the criticism. the Euro is going to fail? I can see the possibility and certainly the claim has been made repeatedly since its inception but the Euro's been around a while now and needless to say it's not a problem getting US dollars or even Swiss francs for that matter so what makes the Euro so vulnerable? my understanding of the euro is that the Europeans hated it because it caused everything to go up in price when it was instituted. if everyone hates your money because it makes everything expensive, that currency is probably going to survive and not fail at all. TMHFT above brings up some pretty scary points--and the collapse of the global financial system definitely puts a lot of nastiness in play. Uncle Sam's pouring trillions into this hole, however, and watching GE borrow billions in government guranteed debt says to me Eastern Europe is a possible beneficiary of these investment dollars. Sure doesn't sound like anyone else wants to be the knight in shining armor. Business guys wishing to grow their enterprises might be missing some opportunities if they don't invest in that area of the world and with prices this cheap, could be a good time to do just that.

Mar 10 06:56 PM