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Riskier than Most Realized: How the Crisis Is Hitting Europe

By Jack Ewing

Its economy harbored far more risk than most people realized, and businesses are more in hock than their US counterparts. Now Europe's fate may depend on events outside its borders.

As Prime Minister of the German state of North Rhine-Westphalia, Jürgen Rüttgers wanted to save one of his industrial state's biggest employers. So what did he do? He hopped a plane to Detroit, of course. On Feb. 18, Rüttgers met with General Motors Chief Executive Rick Wagoner in an effort to persuade him not to shutter a factory in the city of Bochum, where 5,000 workers make sedans and minivans carrying GM's Opel badge. Rüttgers returned with little more than a weak assurance that GM has no plans to close any Opel factories -- yet.

Europe's banks may not have written subprime mortgages, but it turns out they financed something worse: subprime countries.
DPA

Europe's banks may not have written subprime mortgages, but it turns out they financed something worse: subprime countries.

Rüttgers' pilgrimage to the Motor City says a lot about the way the global downturn has unfolded in Europe. In the U.S., the trouble started with subprime mortgages -- a problem that barely exists in Europe. But that hasn't kept the region from falling hard and fast, exposing just how tightly Europe's fate is linked to events in the U.S. and the rest of the world.

Not so long ago, Europeans thought they had dodged the worst of the financial meltdown. Now the region is suffering its first recession since the introduction of the euro a decade ago. In Spain and Ireland, corporate bankruptcies have doubled since 2007, and they're up 11 percent on the Continent as a whole. Across the European Union, unemployment hit 7.4 percent in December, vs. 6.8 percent a year earlier. And output in the euro zone countries could fall by 2 percent this year, the International Monetary Fund predicts a bigger decline than the 1.6 percent contraction in the U.S. "No one, including us, expected the crisis to be so severe," says Siemens CEO Peter Löscher.

The Continent's banks may not have written subprime mortgages, but it turns out they financed something worse: subprime countries. The former communist East is sinking into recession as Western banks choke off the easy credit that fueled Asian-style growth. Now, some pundits say, the former Soviet bloc countries are headed for a crisis on the scale of Asia's in 1997 and 1998.

And how about subprime companies? European corporations are deeply in hock, with $801 billion in corporate debt maturing this year-nearly one-third more than in the U.S. Some, such as Munich-based chipmaker Qimonda and Swedish automaker Saab, say they are insolvent. A glut of debt-fueled private equity is proving to be a curse for others. Dutch petrochemical group LyondellBasell Industries sought bankruptcy protection for its U.S. operations on Feb. 9, just 14 months after buying Houston-based Lyondell Chemical in a $19 billion debt-financed deal.

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Just as in the U.S., the collapse of Lehman Brothers last August helped send Europe into a nosedive. Stock markets tumbled, credit markets seized up, and business confidence plummeted. But the crisis also demonstrates that the European Union's economic problems are almost as diverse as its 27 members, ranging from slumping exports in Germany and Eastern Europe to anemic consumer spending in France to property bubbles in Britain, Ireland, and Spain. "It's the first downturn that affects the whole world with such violence," says Léo Apotheker, co-CEO of German software maker SAP.

Meanwhile, there's no single government to fashion a coherent rescue plan. Only the European Central Bank has broad powers over the region's economy, and it has fewer policy tools than the U.S. Federal Reserve. Before the introduction of the euro a decade ago, a country such as Spain could have let its currency fall to make its cars, wine, olive oil, and other goods more attractive to foreigners. That's not an option anymore. Instead, as Europe's highfliers are laid low, companies must cut wages to regain competitiveness. "People aren't aware that monetary union requires new ways to adjust to a recession," says Fernando Ballabriga, an economics professor at the ESADE business school in Barcelona.

Europe's woes are a big worry for the rest of the global business community. The European Union is by far America's largest trading partner and a key destination for Asian exports. And the Continent remains a crucial market for General Electric, Procter & Gamble, Toyota Motor, Sony, and thousands of other multinationals-many of them now facing hard times there. Honda Motor has closed its plant in the British city of Swindon for four months; Ford Motor says it will eliminate 850 jobs at factories across Britain by May; and aluminum maker Alcoa is laying off hundreds of European workers and selling operations in Germany, Hungary, and Italy.

Wildcat Strike

That's not the way it was supposed to be. Europe's economy was built for stability more than speed, and policymakers scoffed at the reckless Americans and their greedy bankers. Slower growth was a price Europeans were willing to pay for job protection and a generous safety net. "The German social market economy is a good model" for balancing free markets and social protections, German Chancellor Angela Merkel told the World Economic Forum in Davos, Switzerland, on Jan. 30.

By some measures, she's right. Europe has averted bank failures on the scale of Lehman Brothers. While some British banks are deeply troubled, institutions such as Spain's Banco Santander and BBVA and Germany's Deutsche Bank are in better shape and have so far managed to avoid a government bailout. In most countries, unemployment has risen gradually, while consumer spending has proved resilient.

But it's not hard to find evidence of economic trouble. At a Renault plant in Sandouville, in France's Normandy region, about 150 workers staged a wildcat strike to protest plans to close assembly lines for several weeks this winter. Along Barcelona's fashionable Passeig de Gracia, the restaurants may be busy, but a Volkswagen showroom displaying the sporty new Scirocco is empty -- no surprise considering that Spanish auto sales plunged 40 percent in January from a year earlier. And above street level, windows are festooned with signs advertising offices for rent and apartments for sale.

As a global financial hub, London has been particularly hard hit by the crisis. On Bromley High Street, a popular shopping area 10 miles south of the city center, tony home furnishings retailer Habitat has shut down, Gem's pawn shop sits in space recently occupied by a real estate agency, and Poundland -- the British equivalent of a dollar store -- has expanded. Area residents are scaling back their expectations, too. Tucked behind Bromley's train station is a red brick office building that's home to the local JobCentre Plus, a government agency for the unemployed. Inside, the job seekers include Bharat Mistry, a 46-year-old IT manager laid off by Morgan Stanley in London. He says he's interviewing for jobs at half what he was making. "And even for those," Mistry sighs, "there's stiff competition."

Companies with substantial business in the U.S. have seen the crisis coming. Stephen Featherstone, managing director at London-based Llewelyn Davies Yeang, one of Britain's biggest architectural firms, has cut staff about 10 percent in the past year after cancellation of a major project in New York. "The design team was assembled and then the developer suddenly pulled the plug," Featherstone says.

Across Europe, weaker companies are going under. Waterford Wedgwood, the Anglo-Irish maker of crystal and china, filed for bankruptcy on Jan. 5. Germany's Märklin, the storied maker of model trains, on Feb. 4 asked a German court for protection from creditors. So anchored is Märklin in German culture that news of its insolvency seems to have shaken the country almost as much as if it were Daimler or Siemens, providing confirmation that these are extraordinary times. "Now the ravenous financial crisis wants to rob us of the memories of our youth," Germany's Der Spiegel magazine fretted.

Even healthy companies are preparing for the worst. Carl-Henric Svanberg, CEO of Swedish telecommunications equipment maker Ericsson, says sales have held up because carriers in emerging markets are still buying. All the same, "it's unrealistic to believe we won't be affected somehow," Svanberg said on Feb. 17 at the Mobile World Congress in Barcelona, where customers jostled for a view of the equipment on display at Ericsson's pavilion. But the din was deceptive: The show, the mobile industry's largest, drew 15 percent fewer visitors this year. Such warning signs have prompted Ericsson to eliminate 5,000 jobs as part of a plan to trim costs by $1.2 billion this year.

Europe's auto sector may be facing the toughest times it has ever seen, and it's taking plenty of towns and cities down with it. Rüsselsheim, Germany, site of Opel's largest factory, wasn't exactly vibrant even before the crisis. The city of 60,000 on the banks of the Main River, 20 miles west of Frankfurt, has seen job cuts for years. In a kebab restaurant near a factory entrance, one laid-off worker is nursing a 9 a.m. beer. Down the street, the Eis Café San Marco is trying to woo customers by offering half-price on drinks and snacks. "We just have to pray Opel won't close," says Giuseppe Basile, the café's Italian-born manager.

Export-Dependent

Europe's economy is wired differently from America's. In the US, credit-card-happy consumers have long driven growth. In much of Europe, particularly Germany and the eastern countries, exports are the locomotive, making the region vulnerable to downturns elsewhere. Three-quarters of the cars made in Germany are exported, and many of the parts used in BMWs and Volkswagens come from Slovakia, Poland, and elsewhere in the East.

The eastern countries, in turn, depend heavily on Western European consumers. Swarzedz, a century-old furniture maker based in a town of the same name in central Poland, in January said it was going out of business after slumping home sales farther west undercut demand for its bedroom sets, dining tables, and other furniture. The liquidation of the century-old company is painful for the town of 30,000, home to five churches and a museum that boasts Europe's largest collection of beehives. "Workers are frustrated, and they have a right to be," says Lukasz Stelmaszyk, Swarzedz's 34-year-old CEO.

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