The European Union’s Response to the 2007-2009 Financial Crisis

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In some cases hyperlinks allows you to access all versions of a report, including the latest. Note that many reports are periodically updated.The purpose of this report is to assess the response of the European Union (EU) to the 2007-2009 financial crisis in terms of the financial regulatory changes the EU has made or is planning to make.

The financial crisis began in the United States during the second half of 2006 with a sharp increase in U.S. bank losses due to subprime mortgage foreclosures. Because the U.S. and EU banks were using a similar business model, the EU banks experienced similar distressed financial conditions that U.S. banks faced. Large banks on both sides of the Atlantic found themselves severely undercapitalized and holding insufficient liquidity.

However, because in the European Union financial regulations are enforced at the European level as well as the member country level, finding and implementing effective remedies for the causes of the financial crisis have been slower and different than the United States.

Before finding remedies, EU member countries and the U.S. banks were recapitalized through government assistance. The recapitalization approaches taken by the United States were similar for all banks through the Troubled Asset Relief Program (TARP) and the Temporary Liquidity Guarantee Program (TLGP).

The EU took several recapitalization approaches ranging from consolidating the savings banks in Spain to the establishment of "a bad bank" in Germany. Banks were nationalized in the United Kingdom and the Netherlands. In all cases, the financial services providers were recapitalized with taxpayer money.

On July 21, 2010, the United States enacted the Dodd-Frank Wall Street Financial Reform and Consumer Protection Act, which analysts consider to be a roadmap to remedies of the financial crisis. At the same time, the European Parliament remains deadlocked on a bill that the European Parliament Committee for Economic and Monetary Affairs approved in 2009 that would strengthen the regulatory authorities for banking, securities trade and insurance and pension sectors, and would give the EU the power to overrule member countries on financial issues.

Analysts attribute the European financial crisis to European banks adopting the business model called "originate-to-distribute," as opposed to the traditional model of originate-to-hold. The model was developed by large U.S. banks. Seeing the record breaking profitability of U.S. banks prior to the crisis, large European banks adopted the model. The originate-to-distribute model allows financial institutions to expand their lending seemingly without violating the underlying capital requirements set by regulators. To exploit weaknesses in the underlying regulatory structures, the model generated financial instruments, including collateralized debt obligations and mortgage-backed and other securities. To garner profits, the model also used poor underwriting of mortgages, regulatory arbitrage among regulators, as well as little coordination among national regulatory authorities. The model contributed to the failure of the regulatory structures on both sides of the Atlantic by undermining the enforcement of capital requirements, which might have mitigated the impact of the financial crisis. Bank losses led to bank undercapitalization, which meant banks did not have enough capital to absorb the losses from housing foreclosures and other asset losses.

This report examines the EU responses to the financial crisis through changes to the financial regulatory structure at the EU level as well as the member country level. The countries examined are Germany and the United Kingdom, which have single financial regulators; the Netherlands, which has a twin peaks regulatory structure; and Spain, which has a functional structure. This report will be updated as development warrants.

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