by Philip Whyte
Disasters often provoke unseemly bouts of finger-pointing. This has certainly been true of the global financial crisis. In the Anglo-Saxon world, libertarians have blamed it on governments, and governments on ‘bankers’. But in continental Europe, many blame Anglo-Saxons for their supposed reluctance to regulate financial markets. The crisis, they believe, would never have happened if the British and the Americans had regulated and supervised their financial sectors like the French and the Germans. On this view, the UK needs to change, notably by clamping down on hedge funds. Does this narrative stack up? Or have some Europeans just turned Anglo-Saxons and hedge funds into their scapegoats of choice?
Tirades against Anglo-Saxons long predated the crisis, but they have gathered in intensity since it began. In the run-up to the G20 summit in April, Luxembourg’s prime minister, Jean-Claude Juncker, stated that this crisis “started in the US. The Anglo-Saxon world has always refused to add the dose of regulation which financial markets needed.” At the end of the same summit, the French President, Nicolas Sarkozy, announced the death of “unregulated Anglo-Saxon finance”. And in July, Germany’s chancellor, Angela Merkel, told a political meeting in Nuremberg that “with us, dear friends, Wall Street or the City of London won’t dictate again how money should be made, only to let others pick up the bill.”
In any analysis of the causes of the crisis, the UK and the US clearly deserve a share of the blame. They tolerated unsustainable domestic credit booms which wreaked havoc on themselves and the rest of the world. But they were hardly the only countries to experience credit-fuelled housing booms. Denmark, France, Ireland and Spain did too. Nor were they the only countries which allowed ‘shadow banking’ entities to proliferate and banks’ exposures to complex financial instruments to grow. It was a funding crisis at two ‘special investment vehicles’ (SIVs) that brought the regulated German bank, IKB, to its knees. And German banks built massive exposures to collateralised debt obligations (CDOs).
What of hedge funds? Listen to French and German leaders, and you would think that hedge funds were central to the financial crisis. France and Germany have leaned on the European Commission to propose a directive that would regulate hedge funds; they have criticised the Commission’s resulting legislative proposal as too weak; and they have accused the British of dragging their heels. France and Germany are not entirely wrong: the example of Long Term Capital Management in 1998 shows that some hedge funds can pose a threat to financial stability. Even so, it is hard to avoid the conclusion that France and Germany have used the crisis as an opportunity to advance one of their hobby horses.
Both the EU’s de Larosière report and the UK’s Turner review agree that hedge funds did not cause the global financial crisis. They did not drive the growth in sub-prime lending. They did not cause house prices to fall. And they did not force regulated banks (such as Germany’s Hypo Real Estate) to hold CDOs on their balance sheets. So it is quite wrong to imply, as some French and German politicians do, that the crisis would not have occurred if hedge funds had been more tightly regulated. It is also wrong to suggest that the British are reluctant to regulate hedge funds. The British government has accepted the Turner review’s recommendation that “regulation should focus on economic substance, not legal form”.
The Turner and de Larosière reports point to a broad, technocratic cross-Channel consensus on the causes of the financial crisis and the lessons to be learned. Does it matter if this is not reflected in political rhetoric? Yes, for two reasons. First, political obsessions can often drag policy in undesirable directions. (Remember that when Germany chaired the G7 in the months leading up to the crisis in 2007, it was so fixated with regulating hedge funds that it was blind to what turned out to be the central problem: the excessive leverage and effective under-capitalisation of the regulated banking sector). Second, rhetoric can poison negotiations unnecessarily, making agreement more difficult to reach.
Populist broadsides against Anglo-Saxons and hedge funds are unlikely to help the prospect of pan-European regulatory reform. If French and German politicians are not careful, the scenario which they paint of a recalcitrant Britain at odds with the rest of Europe could become a self-fulfilling prophesy. It is no secret that sections of Britain’s media and political class are primed to detect sinister motives in anything emanating from Europe. More often than not, such fears are just paranoid fantasy. But for once, the British may be forgiven if they conclude that France and Germany are exploiting the crisis to promote some of their longstanding objectives and to weaken London’s position as a financial centre.
Philip Whyte is a senior research fellow at the Centre for European Reform.