Welcome to the 1930s

For years, we thought it would be Greece that would trigger Europe's collapse. It turns out it is England that has brought us to the edge of the abyss.

The world woke up to terrifying news this morning. Against the recommendations of nearly all experts and world leaders, against the expectations of the financial markets and the bookies, England has voted to leave the European Union.

As expected, the world's financial markets went into panic mode. The pound lost 8% of its value, hitting a low not seen since 1985. Continental European markets have lost about 8%, US markets are currently down 3%. Analysts expect further losses on Monday. 

It is all reminiscent of the panic after the Lehman Brothers collapse in September 2008, or perhaps more relevant to Europe, the height of the Greek debt crisis of 2011 and 2012.

France and Britain go to war over regulator

A war is looming between Britain and France, and Nicolas Sarkozy has his missiles pointed squarely at the City of London.

The French president made some unusually undiplomatic comments this week gloating over his Agriculture Minister, Michel Barnier, being appointed as European Commissioner for the internal market. That position is one of the most important in the EU, especially as the world recovers from the shock of the economic crisis.

He boldly and defiantly blamed the economic collapse on the “free-wheeling Anglo-Saxon” (aka British and American) economic model, saying, “I want the world to see the victory of the European model, which has nothing to do with the excesses of financial capitalism." He said the fact that a Frenchman had been appointed, while the EU had refused to even consider a Brit for the position - despite Gordon Brown’s pleading - reflected how discredited the Anglo-Saxon model has become. The bravado was an indication that Sarko intends to push Barnier hard to create a pan-EU financial regulator based on the continental European economic model that would have power over the City of London (London’s financial centre).

It was a remark seemingly calculated to elicit the most fury possible across the channel, and boy did it work. UK Chancellor Alistair Darling almost immediately put pen to paper to fire back in an editorial in the Times, saying:

"National supervisors, such as the FSA, must remain responsible for supervising individual companies…The reality is the real competition to Europe's financial centres comes from outside our borders. And that London, whether others like it or not, is New York's only rival as a truly global financial centre."

Darling signalled that he would go into Wednesday’s meeting of European finance ministers with an uncompromising stance against a pan-EU regulator that could supersede the British authorities. And thus the first Franco-British battle for economic reform commenced.

The first skirmish

The European Commission has drawn up plans for three new supervisory authorities to oversee banks, insurers and investment firms. In addition a separate body, the European Systemic Risk Board, would oversee the wider stability of the European financial system as a whole. Though the national regulators would be involved with it, it would be led by the European Central Bank. This last part would be highly controversial in Britain since it does not use the Euro and is currently not beholden to the bank in any way.

Yesterday’s meeting appears to have been a draw. Both Germany and France went in pushing hard for powerful EU supervisory bodies, but by all accounts Darling was equally fierce in his opposition to them. French finance minister Christine Legarde came out saying they had found a compromise, adding “Not everyone was on the same wavelength.”

Darling came out of the meeting insisting he had negotiated a guarantee that the EU regulator could not supersede national regulators, and it could not force states to pay up for taxpayer bailouts.

But in essence both his guarantees and Legarde’s calming words are premature. The ministers only agreed on the most general of outlines for the plan yesterday, and much still has to be worked out. The thought from some in parliament is that the big ‘macroeconomic’ authority and three ‘microeconomic’ groups are being split up as a purposeful distraction. Guy Verhofstadt, the leader of the Liberals in the parliament who favours a strong authority, indicated after the meeting that the parliament will attempt to bypass this “trick” by voting on both bodies as one. He said after the meeting:

"This "forced agreement" is difficult to understand. Member States are repeatedly saying they want a single market for financial services, but now that the time has come to agree on the basic principle of creating supra-national supervisory authorities, some of them appear totally reluctant". Moreover, by separating micro-prudential supervision from the macro-prudential one, Council tries to impose its own views and its own agenda. But the European Parliament as co-legislator will play its full role and has already decided to consider the proposals on micro and macro prudential supervision as a whole."

What comes out of this is anybody’s guess. A column in today’s Wall Street Journal suggested that the Square Mile was overreacting and taking Sarko’s bait, and the paper seems confident that in the end the city will not be regulated from Brussels. But if I were a betting man, I wouldn’t be putting my money on Britain winning this fight.

The UK already has dimished influence in Brussels because of its lack of engagement. And with a weakened government that will be preoccupied in the coming months with an election it is sure to lose, I don’t see them as being a very difficult foe to vanquish.

This is a shame really. As badly as financial reform is needed, Darling is correct to say that London is the leading financial centre of Europe and should have a significant say in new regulatory structures, regardless of the sins the city and its hedge funds have committed in the past to get us into this mess. One should keep in mind that Merkel and Sarko’s push for a strong EU financial regulator with power over the city is not entirely altruistic. Part of their motivation is a desire to scale down the city’s prominence in the European financial sector and give more power to Frankfurt and La Defense.

But as some commentators have pointed out, if the EU overegulates without some reform from its trading partners, there is a risk that financial services companies will flee Europe altogether. Rather than moving from Britain to France and Germany, they could be more likely to high tail it over to Switzerland.

And speaking of Switzerland, I’m about to get on a plane to fly there. My dad is having a belated Thanksgiving dinner. I’m wondering if the minaret ban vote will come up during the dinner conversation with his Swiss colleagues. It could be an interesting night!

Bankers Beware: Brussels to Reveal Pan-EU Regulator

One year after the meteoric collapse of Lehman Brothers, both Washington and Brussels are preparing to unveil massive regulation overhauls that, if they come to pass, will have the extraordinary effect of putting the world’s entire financial system under the thumb of two powerful – and competing - regulatory regimes.

So far both America and Europe have failed to institute meaningful reform to the financial system that would prevent a similar financial collapse from happening again. This was almost painfully evident during President Obama’s stern speech to Wall Street last week on the one-year anniversary – full of tough words but backed by little action taken in the past year to better regulate American financial institutions.

This reality was angrily pointed out by some American commentators, who said that a regulatory overhaul should have been made central to the massive bail-outs a year ago. The Obama administration counters that regulatory reform at the height of the crisis would have destabilized a system already on the verge of collapse. This situation has been mirrored across the pond, where both national governments and the EU have resisted making significant regulatory reform so far.

But now it is clear that the financial sector is once again on stable ground. Whether this is a direct result of the massive cash infusion it was given over the past year is debatable, but given the windfall profits and massive bonuses that have begun to creep back in, it’s no longer tenable to argue that the sector is too fragile to introduce massive reform. It appears the Obama administration is set to introduce its overhaul in the coming weeks. Across the pond, it appears some consensus has finally been reached in order to create financial regulation at the EU level. If the plans come to pass it would mean that just two centralized, powerful regulatory regimes would govern basically the entire world’s financial sector, which would mean that the laissez-faire days of Anglo-Saxon capitalism are a thing of the past.

The EU proposal that will be unveiled on Wednesday will reportedly create three new supervisory authorities in the areas of banking, insurance and securities. The new authorities would supervise financial institutions and step in during emergency situations to take urgent action. They will reportedly have the power to shut down Europe’s stock markets during a crisis. The new authorities would also be able to rule on disputes involving financial institutions that operate across EU internal borders. For large recapitalisations or bail-outs, the decision would come directly from the European Commission by a simple majority vote of commissioners.

The UK has been the biggest objector during these negotiations, but reportedly they have been satisfied with a compromise deal that would require that member states be allowed invoke a clause taking that voting decision instead to the council, to be voted on by member states’ finance ministers, by a qualified majority vote.

Eventually the authorities will draw up themselves technical standards to be applied throughout the EU, which all EU and EEA financial institutions would be required to follow. The commission would then have to approve these standards. The purpose of this standardisation is to make sure everyone is playing by the same rulebook and that companies no longer have to spend millions on compliance efforts across different regulatory regimes in Europe.

A separate European Systemic Risk Board will also be created, according to EUObserver. That board would watch the financial system for risks or problems, and it can issue warnings early when it identifies problems.

Significant details of the Obama administrations plans for a regulatory overhaul have not yet emerged, but if they are as ambitious as these Brussels plans, the world could be looking at a very different regulatory environment in the near future.

Rioting in Iceland

When there's rioting in Iceland, you know we're in trouble. The small Scandinavian country in the middle of the Atlantic isn't usually associated with domestic strife, but rather high quality of life and abundant natural resources. But yesterday thousands of people took to the streets to protest the government's handling of the economy, which has plunged in recent months as a result of the larger global turmoil. Gross national product is down two-thirds, there has been a 45 percent rise in unemployment and the country is defaulting on loan repayments. In October the country's financial system collapsed and its currency plunged under the weight of billions of dollars in foreign debt taken on by its banks.



These weren't just mild demonstrations. Riot police had to fight with a large number of violent protesters outside the country's parliament. Pepper spray was fired at the protesters and 30 arrests were made.

Coming on the heels of the riots in Greece last month, many in Europe are becoming increasingly worried that the economic turmoil could lead to violent clashes between disaffected people and their governments across the continent. Eastern Europe is seen as particularly vulnerable to such violence, with some even predicting a "spring of discontent" in the region to be around the corner.

Eastern Europe has been hit hard by the financial crisis, especially Bulgaria, Romania and the Baltic states - all recent EU entrants. As the Guardian recently reported, incidents have been steadily increasing. Last week police in Vilnius, Lithuania had to tear-gas a crowd of demonstrators protesting tax rises and benefit cuts designed to save the state from bankruptcy. Sofia, Bulgaria has also seen recent widespread violence in which 150 people were arrested. Riga, Latvia has seen street battles as well.

These Eastern European economies are increasingly experiencing unexpected turmoil after years of posting double-digit growth. Their anger will likely be compounded by the fact that they were expecting that growth to continue, particularly after they joined the EU. The post-cold war governments are still new and relatively weak, and could be unprepared to deal with widespread unrest. And the increasing hostility isn't just being directed at the governments. Attacks on minorities are also becoming increasingly common, particularly against Roma (gypsy) communities. Recently 700 members of the far-right Workers' Party in the Czech Republic fought with police when they were prevented from marching on a Roma area.

Of course Iceland is just about as far as you can get from Eastern Europe without leaving the continent. If the global economic turmoil can cause rioting in a country with one of the highest quality of life ratings in the world, could rioting be far behind in the major Western economies? And even if it isn't, how will the major economies of Western Europe respond to growing political unrest to their east, in countries with which they are now united? Clearly the EU has an obligation to help Eastern Europe through the financial turmoil, but if the situation becomes fundamentally dangerous, can the EU do anything to stem the violence without a proper policing military force?

The "spring of discontent" will be an anxious time for Europe.