What Caused The Economic Problems In Europe?

This article (via Mark Thoma) looks at some economic data in an attempt to determine whether the Southern European countries got into financial trouble because they are lazy and prefer not to work hard. There was no evidence of this in the data that was analyzed. Perhaps its easier to punish them for being lazy than if they were hard working.

We do know, however, that there was a massive cash flow from Northern Europe to Southern Europe. Northern Banks were willing to purchase the government bonds because they were rated AAA and they could use the bonds as collateral to borrow from the wholesale markets. They got a safe return on their investments; they were able to leverage the investments by borrowing, and they did not have to reserve capital against the loans because they were rated AAA. This increased their return on equity which determines executive compensation. This looks pretty much like the what happened in the real estate bubble when banks purchased mortgage backed securities that were rated AAA.

The borrowing by Southern Europe was to some extent the result of trade imbalances. They financed their trade deficits with Northern Europe by borrowing from Northern Banks. Economic growth along with tax revenues was greater in the Northern export based economies. The opposite occurred in Southern European countries.