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A 1963 plane crash can help us understand the eurozone crisis and why it threatens us all
A trillion euros of cheap loans by the ECB and a second Greek bailout only bought a little time. The eurozone crisis is back, with the markets in fright and Spanish bond yields up to 6%. Most Guardian readers could be forgiven for stifling a yawn: we have been living with financial crisis since 2008 and most of it only seems to matter if and when there are domestic implications. So it is important to explain how and why the current crisis threatens us all.
The German government and allied northern creditors represent the crisis as a southern sovereign debt problem; on the other side commentators like the Financial Times’s Martin Wolf argue it is a north-south trade imbalance problem. Neither account engages with how this crisis is also (or even primarily) a banking crisis rooted in the design of the European financial system.
Given the difficulty of explaining these to the non-specialist, unfamiliar with arcane terms like rehypothecation or balance sheet interconnections, the dangers of the present system are perhaps best understood by analogy with problems the aviation industry encountered when it made the transition to jet aircraft.
In October 1963 a BAC 1-11 prototype, in routine stall testing for airworthiness certification, fell out of the sky and crashed. The problem was a “deep stall” which could not be recovered by the pilot using the standard drill of stick forward, elevators down and add thrust. Deep stall was a consequence of a change of design configuration when jet aircraft with T-tails were introduced; in some stalls turbulent air from the stalled wings could spill up and prevent the elevators at the top of the tail from working.
The banking equivalents of the T-tail are twofold. First, there is rehypothecation: the reuse of collateral in a chain of transactions that means the European banking system has huge liquidity requirements as soon as things go wrong. Second, there is a web of interconnections between bank balance sheets caused by cross-border lending that ties all the north European countries together in mutually assured destruction in the event of major insolvency.
In eurozone banking, as in the T-tail jet, not every problem ends in disaster. But if a plane or banking system with this configuration gets into stalling territory, it is likely to slip into a catastrophic deep stall. In the event of a chain of south European defaults, there is no political mandate for the injection of tens of trillions of euros of liquidity into the European financial system; nor any plan for dealing with bank insolvencies arising from cross-border lending that would induce large-scale bank failure inside and outside the eurozone.
Aircraft that fall out of the sky can be re-engineered, as the BAC 1-11 was. At that time, the private interests of plane makers and airline operators coincided with the social interest of regulators and the flying public. European banking is unfixable because our technical knowledge is rudimentary and the basic political condition about coincidence of private and social interest is not satisfied.
In banking private interests in the profitability of the financial system would obstruct or divert the necessary reforms. If the eurozone is to be maintained, we can envisage a list of reforms to reduce cross-border lending or to make it less dangerous (for example, by promoting cross-border bank mergers of low-profit utility banking). But none of these fixes are at present politically feasible. Maybe the crash has to happen before we can mobilise the will to restrain finance.
â€¢ Karel Williams is the author of Deep Stall? The Eurozone Crisis, Banking Reform and Politics, available at www.cresc.ac.uk/publications/