Nobody gains from financial crises — except far-right extremists

After a severe financial crisis, it’s common to see a surge in political polarization and in the popularity of populist parties, especially on the far right.

We’ve seen this decade after decade, and it’s clearly the case now around the world. Just look at the Law and Justice Party in Poland, Podemos in Spain and Jobbik in Hungary. The U.S. has certainly seen its share of political polarization, too.

ADVERTISEMENT

This shift matters, as the emergence of far-right parties increases policy uncertainty and can threaten economic growth and democratic institutions. Those parties often bundle together radical economic platforms with xenophobic policies and racist rhetoric.

As a result, it’s important to understand whether (and how much) financial crises lead to increased support for extremist parties and why there is a connection. 

In a recent study, my colleague and I analyzed these questions in the context of Hungary after the 2008 financial crisis. That country experienced a particularly severe household debt crisis starting in 2008 and a sharp increase in support for the far right. 

Prior to the crisis, Hungary experienced a household lending boom with a large fraction of new housing loans denominated in foreign currency, particularly in Swiss franc. By 2008, two-thirds of housing loans were denominated in foreign currency, exposing households to substantial exchange rate risk. 

While the exchange rate was stable before the crisis, between 2008 and the election in 2010, the domestic currency depreciated by 23 percent against the Swiss franc. This meant that many homeowners suddenly owed significantly more money on their mortgages than they originally planned.

To be more specific, the indebtedness of households increased by 4 percent of pre-crisis GDP and increased fears about future depreciation. 

Obtaining credit records for nearly all loans originated in Hungary during that time — about 1 million loans — we looked at where borrowers lived, the size of the loans and the currency of the loans (local or Swiss).

We then ranked zip codes by the prevalence of risky foreign currency debt to see if it correlated to support for the far-right political party. 

We found that areas with the most exposure to foreign currency debt experienced a much sharper rise in support for the far-right party. Distress from foreign currency debt explained about 20 percent of the success of the far-right political group. That’s a sizeable fraction of that group’s success.

Why do households in financial distress turn to extremist parties? Our research suggests that a compelling explanation is what we call “creditor-debtor conflict.” Debt contracts put the entire burden of adjustment to the crisis on debtors, forcing them to cut back on spending and look for other sources of income to meet rising loan payments. 

Populist parties might therefore choose to represent the debtors’ interests and advocate debtor-friendly policies to win the support of distressed borrowers, especially since the burden of high debt obligations is often perceived as unfair.

In the specific context of Hungary, debtor-friendly policies, such as large-scale debt restructuring, were aggressively championed by the far-right party, Jobbik.

Although our study was conducted in Hungary, the change in political preferences around the world after the financial crisis suggests that our results might be more general.

We need to think about how the burden of financial crises are shared across populations because severe economic distress can lead to increased support for the populist and extremist parties.

This matters even when extremist parties aren’t part of the government because they can impact policymaking and influence the strategy of moderate parties. Therefore, even moderate electoral success of populist parties can have a profound effect.

Going forward, an important question is what we can do about this trend. As financial distress is a particularly powerful driver of populist party support, moderate parties should attempt to limit the build-up of risky debt during booms and do more to help struggling borrowers during crises.

In addition to providing direct economic benefits, such strategies for intervening in credit markets could help reduce the risk of political polarization going forward. 

Emil Verner is an assistant professor of finance at the MIT Sloan School of Management and co-author of "Financial Crisis, Creditor-Debtor Conflict, and Political Extremism."