Europe's Worst-Case Scenario : Planet Money What's the worst that could happen? Bank runs, political riots and falling governments, for a start. Also, the end of the euro as we know it.
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Europe's Worst-Case Scenario

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Europe's Worst-Case Scenario

Europe's Worst-Case Scenario

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(SOUNDBITE OF ARCHIVED RECORDING)

HILDA SOLIS: I have a lot of empathy for those five workers to one job. They are looking for entry into the workforce, and we owe them as much support as we can to help them transition into new jobs.

(SOUNDBITE OF SONG, "CALAMITY SONG")

THE DECEMBERISTS: (Singing) Had a dream, you and me and the war at the end times.

DAVID KESTENBAUM, HOST:

Hello and welcome to PLANET MONEY. I'm David Kestenbaum.

ALEX BLUMBERG, HOST:

And I'm Alex Blumberg. It is Friday, September 2. And that was Labor Secretary Hilda Solis you heard at the top.

KESTENBAUM: Today on the podcast - worst case scenario, European debt edition. We look at the European debt crisis. And we ask, how scared should we be? What is the worst case scenario?

BLUMBERG: But first, the PLANET MONEY Indicator from our very own Jacob Goldstein.

JACOB GOLDSTEIN, BYLINE: Today's PLANET MONEY Indicator - 6 million. Just over 6 million Americans have been out of work and looking for a job for six months or more. That's according to the big jobs report that came out this morning.

KESTENBAUM: So, 6 million people? That's a lot of people. And you're saying they have been out of work for half a year or more.

GOLDSTEIN: Yeah, it's very grim. You know, this was a bad jobs report overall. I could have picked a lot of numbers. But I picked long-term unemployment because last month, and for a while now, it's been so much higher than at any time since before World War II. This is both in terms of the absolute number of people who've been out of work and looking for a long time and in terms of the long-term unemployment rate. This is a really big change for the U.S. economy.

And it's really scary because the longer people are unemployed the less likely they are to find a new job. Their skills erode over time. They tend to spend less time looking for work. There's this sort of stigma that employers sometimes attach to people who haven't had a job for a long time. And, you know, economists have been looking at this problem. It's really something people are worried about. And I was reading this Fed paper that came out this week. I put a link to it on the blog. And I brought into the studio what I think is sort of the key quote. It says, quote, "after a long period of unemployment, affected workers may become effectively unemployable."

BLUMBERG: Whoa. That is dramatic language for a Fed report.

GOLDSTEIN: It really is. I mean, this is a very big problem and really something to worry about for the long term.

KESTENBAUM: All right. Thanks, Jacob. I always hesitate to thank you for giving us something to worry about in the long term, but thank you anyway.

GOLDSTEIN: Thanks, guys.

KESTENBAUM: OK. It isn't a particularly upbeat show today. As you know, the Greek government is basically not able to pay its debts. Ireland and Portugal are also in danger - maybe Spain, even Italy. Investors are a little spooked about Italy right now. Europe clearly is really in a crisis.

BLUMBERG: And we talk a lot about how important China is to the global economy. Europe is much larger. The economy of the European Union is larger even than the United States. It is the largest economy out there basically.

KESTENBAUM: Today's podcast is an attempt to answer a question that, Alex, you and I have been asking around the office. What is the worst-case scenario? How scared should we be? We called up David Beim. He's an international banking expert at Columbia University here in New York. He worked as a banking executive for a number of years. He's written about the savings and loan crisis here in the United States.

BLUMBERG: And he laid out for us his worst-case scenario, which we're going to go through for you right now. He says that his worst-case scenario could begin right now because the countries of Europe are preparing for these votes that everything kind of hinges on.

KESTENBAUM: And if you've been a somewhat careful follower of the financial news from Europe, you might be saying wait, wait, wait. Didn't they already resolve this?

BLUMBERG: Right. You might remember certain headlines from earlier this summer.

KESTENBAUM: Like this one here - Europe agrees to sweeping rescue plan for Greek crisis. And, Alex, I feel like I've been reading these like over the last couple years. And it's just sort of like this infection that won't go away. And you think, oh, now they fix it. Oh, now they fixed it. And it just seems to be getting worse.

BLUMBERG: Well, for this most recent agreement, European leaders agreed, but they still need to get their parliaments to ratify the terms of the agreement. Specifically, they need their parliaments to vote to expand this bailout fund that's been set up. This fund has already been used to bailout several European countries. And the vote is over whether to basically double its lending capacity to 450 billion euros, which is over $600 billion.

KESTENBAUM: David Beim told us that a no vote would be really bad - could set off a whole series of horrible events, which he'll lay out. And he says some of these countries may well vote no. If he puts himself in the shoes of one of the richer northern European countries, like Finland or the Netherlands or even Germany, he might want to vote no.

DAVID BEIM: If I were there, I'd vote no. I wouldn't want to keep pumping money down to these countries. This is just a fool's game.

BLUMBERG: Think about it. You're a Finnish citizen or German or Dutch. And you're being asked to put billions of your country's euros at risk to help out your really distant cousin - who, OK, you're related. You share a currency. But you don't speak the same language. Maybe you've never even met. You don't want to put a lot of money on the line to help them out. It's not your fault.

KESTENBAUM: There are 17 countries that use the euro - 17 countries that will have to vote. And just think. With the bailouts in the United States, we had one Congress to get it through. Remember how hard that was? Here you have 17 parliaments.

BEIM: Even if 16 of them agree, if the 17th one says, well, we'd like to agree, but our voters are about to vote us out of office if we do, then you don't have a deal. Let's just suppose that one of the political systems balks. And it might be the Netherlands, for example. Just use that as an instance. Suppose the Dutch voters say, you know what? We don't want to pump any more money into Greece and Portugal and these other spendthrift crowds. That's not our business. We just don't want to do it. And if our government votes to do it, we're going to vote our government out. That could happen.

And so political opposition has been rising in the northern countries. It's been rising in Netherlands. It's been rising in Germany. It's been rising in Finland. Even in Slovakia, there's an element of this. And they are resisting it. Now, supposing it just happened - I'm not saying it will. But supposing it happened, that come September one of these countries says, no, we're not going to contribute to this fund. At that point, what is the consequence? Pretty severe.

BLUMBERG: In David Beim's worst case scenario, this is step one. And it sets off a series of dominoes. The first domino to fall would probably be in Greece.

KESTENBAUM: Because without a larger bailout fund approved, he says, Greece is going to have a lot more difficulty paying back the money it already owes. So whoever so far has lent the Greek government money at this point might say, now I am really worried.

BLUMBERG: So, who lent the Greek government money, you ask. Well, lots of people - German and French banks, for example, lent quite a bit. But they'd probably be, OK, if Greece defaulted. It wouldn't put them under. The real problem, though, comes from another group that lent the Greek government a lot of money - Greek banks. Greek banks have lent the Greek government so much money relative to their size, says Beim, that any Greek government default could wipe out the Greek banking system.

KESTENBAUM: And this is where we get the second domino falling in David Beim's worst case scenario. Say your a Greek citizen. You have money in a Greek bank. You know your government took your money and lent it - a lot of it anyway - to the Greek government. Now, you hear on the news that the Greek government might not be able to pay back the money it owes your bank. That might lead you to ask a very pointed question about your bank.

BEIM: Can they pay you back?

KESTENBAUM: Because they took your money that you put into the bank and lent it to the government.

BEIM: And lent it to their government. And when the government defaults, the banks default. And that means they may not be able to pay all of their deposits. And so if you're a rational depositor, you run - not walk but run to the bank to try and get your money out.

KESTENBAUM: Let me just say. Taking your money out of a Greek bank, that should be a very easy thing to do while you're in the euro, right...

BEIM: That's right.

KESTENBAUM: ...Because it's all in euros. So, you could just transfer it. There are no real fees, right? You just transfer it right over the border. Transfer it to Germany, where ever you want.

BEIM: Transfer it to a German bank and say, please, hold this for me.

BLUMBERG: Why isn't everybody doing that now?

BEIM: I think they will. I think they aren't doing it now because everybody says, we're going to be fine. We're supported by the rest of Europe. And don't worry about it. The rest of Europe will take good care of us. But I don't think it can take care of them for very much longer.

KESTENBAUM: Alex, can we just reflect on how circular this whole thing is. You've got a government that depends on the banks and its own country to lend it money when it needs money. So the banks are holding up their own government. But then if the banks get in trouble, it's supposed to be the government that comes to their aid and bail them out.

BLUMBERG: Yeah, it's like a Wile E. Coyote thing, where he like runs off the edge of the cliff. And he keeps going for a while in the air, then he looks down and realizes - wait - there's nothing holding him up. And then he falls.

KESTENBAUM: This circular situation is not unusual in Europe. Often you have banks holding a lot of their government's debt. And the thing so far that has kept all these countries from falling - at least in Greece, Ireland, Portugal, maybe Spain - was this bailout fund. And now if there's a no vote, the size of the bailout fund is not as big as a lot of people would like, and it becomes a big question mark.

BLUMBERG: And that brings us back to the worst-case scenario. And what are we at - domino three? Let's call it domino three. So as we've said, the Greek government owes the Greek banks money. It can't pay those banks back. That leads people who have money in the Greek banks to freak out.

BEIM: And at that point, there could be political riots and the fall of the government. You know, that kind of thing could happen.

KESTENBAUM: OK, next domino - now you have to imagine people in Portugal or Spain sitting in their living rooms watching all this on TV. And they say, hey, maybe this will happen in my country. Maybe moving my money out of my bank here, that's a good idea. And so they go to their computers, and they transfer their money.

BLUMBERG: It's a little bit of a different image than the one you get when you think of bank run. You know, those grainy photographs from the Depression where men in suits and hats are lined up outside their bank. In this, the modern era, it's just millions of people all over Europe firing up their smartphones or opening a new browser window - boom, catastrophe.

KESTENBAUM: And if that happens, you would get this tidal shift of money out of the banks of these indebted countries. And then those banks, they could collapse.

BEIM: Now if Greece defaults, probably similar events start happening elsewhere. So you probably have also bank runs in Lisbon. You probably also have bank runs in Madrid. And you might find them in Milan as well. This would be a contagious kind of event as people begin to panic. I'm not saying it has to happen that way, but there is a significant risk that this could just be a cascading problem. And it looks like the structure that has been put in place to have the strong countries support the weak is not going to go any further. That is the risk. If that's so, then the whole structure of the euro might collapse. It just might be that the euro doesn't work anymore.

BLUMBERG: This from David Beim is the moment of dread. This is the thing he really worries about. Some countries, probably the richer ones, at this point will want out of the euro. They don't want to be on the hook financially for this mess. They don't want to be bailing out banks in other countries.

BEIM: It could happen that the northern countries, especially a few small ones, asked to be excused. They say look. Our voters are not willing to ratify this contribution. This is getting too expensive for us. We'd like, please, to reestablish our own currency. We don't want to crash you guys. So just let us out.

BLUMBERG: This is the part of the disaster that is a little fuzzy because there is no provision for leaving the euro. The Maastricht treaty, which set up the euro, doesn't have a section for how you leave. Some people likened it to a roach motel. You can get in, but you can't get out. There's no script for this part of the movie. So it's unclear what happens.

KESTENBAUM: But however this happens, it is a mess. If rich countries leave, the European Union becomes a union of weak countries - unable to bail itself out. And then you have massive uncertainty and fear in the markets.

BLUMBERG: And as we saw in 2008, uncertainty itself can be deadly. If people don't know how a situation will play out, they get scared and pull their money out of banks. And when a bunch of scared people pull their money out, that's when credit freezes, and the real economy comes to a halt. In America, in 2008, the uncertainty was all tied to the U.S. housing market and the financial instruments which were based on it. Europe, in 2012 or 13 or 14, if this happens, it would be fear about a currency - the euro and the collapse of the whole euro experiment.

BEIM: It would take a while to unravel. It would be a very messy couple of years. It would be very negative for global growth. It would affect the United States' growth.

KESTENBAUM: Another recession?

BEIM: Yeah, I think would mean another recession. It would mean a collapse of demand in Europe. And therefore for anybody who exports to Europe, including China and the United States, it would be a mess. It would not be something you'd want to see.

BLUMBERG: In terms of just as an average person on the street in the United States - you know, in early 2008, I should have been very afraid of what was going to happen in the financial system. How afraid should I be now about what's going on in Europe?

BEIM: I think afraid enough that you'd like to turn some of your stocks into cash, which is what a lot of people are doing including me (laughter).

BLUMBERG: So, worst case though is another recession. But I don't necessarily need to build a bunker.

BEIM: I think that's right. I think that's right. Furthermore, the earnings of U.S. companies...

BLUMBERG: I'm not sure you believe that's right. I just got very - that was the - that answer made me more scared than anything you've said so far.

(LAUGHTER)

KESTENBAUM: All right, Alex. So, that was David Beim's worst-case scenario. And I have to say. In doing this podcast, I sort of scared myself a little more. But we don't know - you know, this is a worst-case scenario, right? There are a lot of ways for it not to go this way.

BLUMBERG: And it's always hard as a journalist to sort of report on a speculative future. I mean, it's much easier to report on something that's happened than something that possibly might happen. But, you know, sometime worst-case scenarios do actually happen.

KESTENBAUM: Yeah, we just lived through one.

(SOUNDBITE OF SONG, "CALAMITY SONG")

THE DECEMBERISTS: (Singing) And all that remains is the arms of the angels.

KESTENBAUM: We will have more for you about the European debt crisis from Europe. Caitlin and Zoe are in Germany as we speak.

BLUMBERG: Let us know what you want to know. Send us email - planetmoney@npr.org. We're also on Facebook and Twitter.

KESTENBAUM: Or leave us a comment on the blog - npr.org/money. I'm David Kestenbaum.

BLUMBERG: I'm Alex Blumberg. Thanks for listening.

(SOUNDBITE OF SONG, "CALAMITY SONG")

THE DECEMBERISTS: (Singing) And they're picking at your bones. Will call cold. We'll come home. Quiet now. Will we gather to conjure the rain down?

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