By Jeffry A. Frieden
The opinions expressed are his own.
Europe is in the midst of its variant of the great debt crisis that hit the United States in 2008. Fears abound that if things go wrong, the continent will face its own “Lehman moment” – a recurrence of the sheer panic that hit American and world markets after the collapse of Lehman Brothers in October 2008. How did Europe arrive at this dire strait? What are its options? What is likely to happen?
Europe is retracing steps Americans took a couple of years ago. Between 2001 and 2007 the United States went on a consumption spree, and financed it by borrowing trillions of dollars from abroad. Some of the money went to cover a Federal fiscal deficit that developed after the Bush tax cuts of 2001 and 2003; much of it went to fund a boom in the country’s housing market. Eventually the boom became a bubble and the bubble burst; when it did, it brought down the nation’s major financial institutions – and very nearly the rest of the world economy. The United States is now left to pick up the pieces in the aftermath of its own debt crisis.
Europe’s debtors went through much the same kind of borrowing cycle. For a decade, a group of countries on the edge of the Euro zone borrowed massively from Northern European banks and investors. In Spain, Portugal, and Ireland, most of the borrowed money flooded into the overheated housing market. “At the height of the building boom,” Menzie Chinn and I write in our new book, Lost Decades: The Making of America’s Debt Crisis and the Long Recovery:
One Spanish worker of every seven was employed in housing construction. Half a million new homes were being built every year—roughly equal to all the new homes in Italy, France, and Germany combined—in a country with about 16 million households. The amount of housing loans outstanding skyrocketed from $180 billion in 2000 to $860 billion in 2007. Over the ten years to 2007, housing prices tripled,second only to Ireland among developed countries; by then, the average house in Madrid cost an unheard-of $400,000. (pp. 49-50)
Greece was a different story. It borrowed, as we write, “mostly to finance a continual budget deficit and an American-style consumption boom.”