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AFTER THE SUBPRIME MORTGAGE CRISIS: WHAT STRATEGY FOR EUROPE?

AFTER THE SUBPRIME MORTGAGE CRISIS: WHAT STRATEGY FOR EUROPE?. Robert BOYER PSE (Paris-Jourdan Sciences Économiques). Babbot Room, The Octagon, Amherst College, March 26, 2008. INTRODUCTION. Entering a new and quite uncertain epoch:

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AFTER THE SUBPRIME MORTGAGE CRISIS: WHAT STRATEGY FOR EUROPE?

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  1. AFTER THE SUBPRIME MORTGAGE CRISIS: WHAT STRATEGY FOR EUROPE? Robert BOYER PSE (Paris-Jourdan Sciences Économiques) Babbot Room, The Octagon, Amherst College, March 26, 2008

  2. INTRODUCTION • Entering a new and quite uncertain epoch: • What will be the consequences for the US of the sub-prime mortgage crisis? • How interdependent is the world with respect to the American economy? • Is a finance-led growth regime a fatality?

  3. How should new regulations restore the structural stability of such a regime? • Will Europe be drastically affected by the sub-prime mortgage crisis? • What alternative strategies for the European Union?

  4. The strategy of this presentation • An institutional analysis of the origins of financialization • A simple macro model of finance-led growth • An interpretation of the origins of financial crises • Diversity and legacy of European institutional configurations: an alternative to financialization

  5. SYNOPSIS OF PRESENTATION • The pressures towards a finance-led regime. • The homeland of financialization is the US…but potential macro-economic instability. • From the Internet bubble to the sub-prime mortgage crisis.

  6. How Europe will be affected? • The European Union: the search for alternative models. • Conclusions

  7. I. THE PRESSURES TOWARDS A FINANCE-LED REGIME • Back to social history • The 60s: a de facto compromise between managers and wage earners

  8. The 80s: An international competition led regime weakens the bargaining power of wage earners

  9. The 90s: The ex post alliance of investors and managers

  10. The 2000s: The emerging tensions within the finance industry and the rise of the lawyer

  11. Financialization is part of a long term structural transformation of contemporary capitalism, after the crisis of Fordism

  12. THE HOMELAND OF FINANCE LED GROWTH: THE US…

  13. An accumulation regime at odds with Fordism: the centrality of the stock market

  14. The multiple channels of financialization

  15. A simple macroeconomic model

  16. Various regimes

  17. A finance-led regime is possible if: • The financial wealth / income ratio is high • The investment is profit led • This regime is structurally stable if: • Wage formation is not too much competitive • The rate of return required by shareholders is not too high

  18. The Central Bank has to react quickly to financial bubbles

  19. Testing the model for some OECD countries

  20. The US: the only finance-led regime

  21. …..BUT A POTENTIAL MACROECONOMIC INSTABILITY • The development of financial market first extends the likelihood of a finance-led regime… • But up to some threshold, the economy enter into a zone of structural instability.

  22. FROM THE INTERNET BUBBLE TO THE SUB-PRIME MORTGAGE CRISIS.

  23. This regime is generating speculative bubbles that burst out… • …But are cured by an active monetary policy… • …And the positive impact of financial innovations… • …For instance the securitisation first prevents the fragility of banks A strong paradox: an unstable accumulation regime rescued by the deepening of financial innovations

  24. …But private innovations, such as subprime loans, exploit this opportunity to shift the risk… • …The boom of this market reaches its limits, the reversal of confidence challenges macroeconomic stability… • …And again the Central Bank is the rescuer of last resort in order to preserve the viability of the financial system

  25. Figure 1 – A typical sequencing of financial crises Viability of the regulated innovation Regulation by the government New cycle Lender as a last resort Entry in the zone of financial fragility Success / High profit Private innovation Rapid adoption No public intervention: collapse of the innovation

  26. Figure 2 – A first example: energy derivatives and the ENRON collapse Energy derivatives Unprecedented profit Creative accounting Bankruptcy Prevention from any public control by lobbying Potential for new crisis New rules of accountability for CEO and CFO But not any reform of accountability principles A structural weakness

  27. Figure 3 – A second example: rise and collapse of Northern Rock High profit/ Rapid capture of market shares Financing by bonds of mortgage loans Initially, Bank of England did not bail out More bonds issued Banking run No reaction of Financial Service Agency Worsening of the crisis A failed innovation Conflict between Bank of England, Treasury, FSA Systemic crisis Nationalization of Northern Rock Search for self regulation

  28. Figure 4 – A third example: the sub-prime mortgage Reversal of the housing market Melting down of the sub-prime market New and growing market Securitization shift the risk Sub-prime mortgage Absence of public regulation Limited FED intervention Searching for new regulations Unlimited access to liquidity from FED A systemic financial crisis A creeping banking crisis Diffusion of Non Performing Assets (NPA) Mergers among banks Recapitalization by sovereign funds

  29. HOW EUROPE WILL BE AFFECTED?

  30. The financial led regime is not observed in Europe

  31. Actually, in other OECD countries alternative alliances may exist and govern different accumulation regimes

  32. The different channels of the diffusion of American financial crisis • Many European financial institutions have non performing sub-prime loans or derivatives: how important are they? • The impact of the American recession upon world trade…possibly compensated by Asian dynamism. • The negative impact of the appreciation of the euro upon growth and employment in Europe.

  33. A long lasting revaluation of financial risk, as a source of credit crunch. • The imperfection of the European policy mix (a single monetary policy but contrasted national budgetary policies): a clear limitation to the reactivity of the EuropeanUnion.

  34. V. THE EUROPEAN UNION: THE SEARCH FOR ALTERNATIVE MODELS • A change of epoch: from the primacy of the wage labor nexus to the omnipresence of a financial logic • The European treaties codify this swing in the hierarchy of the economic institutions

  35. Figure 1 – The hierarchy of the European procedures: the primacy of the monetary regime

  36. Any growth strategy has to take into account the shift in the conception of economic policy Source : Freely inspired of EC/DGE "Reinforcement of mechanisms for economic policy coordination", July 28, 1999.

  37. A survey of alternative strategies S1 – Promote a better policy mix in order to rejuvenate growth S2 - Convert Information and Communication Technologies (ICT) into a knowledge based economy (KBE) S3 - Gender equality and the response to ageing as sources of a welfare / services driven growth S4 - A recurring temptation of some member states riding the financial globalisation

  38. Figure 2 – First strategy: A pragmatic coordination of monetary and fiscal policies in order to promote growth and creation of jobs.

  39. Table 2 – Institutional conditions of this first strategy

  40. Figure 3 – Second strategy: convert Information and Communication Technologies (ICT) into a knowledge based economy (KBE)

  41. Table 3 – Institutional conditions of this first strategy

  42. Figure 4 – A third strategy: gender equality and the response to ageing as sources of a welfare / services driven growth

  43. Figure 5 – Strategy four : Riding the financial globalisation, as a recurring temptation of some member states

  44. Table 2- What growth regime for the early 21st century?

  45. CONCLUSION C1 -The US is the first economy to experience the benefits and the risks of a finance-led regime. C2 -The recurrence of powerful financial innovations is at the origin of most financial crises in the US, but their macroeconomic consequences differ drastically.

  46. C3 -The collapse of the sub-prime mortgage is the last one and the most severe since WWII. It sheds a crude light upon the danger of a bold financial liberalization C4 -This is an incentive to reassess the role of financial re-regulation, in order to try to reduce the instability potentially associated to intense financial innovations.

  47. C5 –With the possible exception of UK, no European economy is following the American trajectory. This reduces the risk of an equivalent melting down, but many channels will diffuse the American recession to the rest of the world. C6 -A priori, financialization may well be detrimental to most non US economies. Consequently they should resist to further financial liberalization.

  48. C7 –The mission of European Union should be to contribute to the disciplining of the international finance and the promotion of welfare enhancing growth strategies.

  49. MANY THANKS FOR YOUR ATTENTION Robert BOYER CNRS (PSE- Paris Jourdan Sciences Economiques), EHESS, CEPREMAP 48, Boulevard Jourdan 75014 PARIS + 33 (0)0 43 13 62 56  boyer@pse.ens.fr Site WEB : http://www.jourdan.ens.fr/~boyer/

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