First, banks: I was present in Paris in October 2008 at the first meeting ever held of the euro zone heads of government. The diagnosis of the banks I presented was of problems of liquidity but also of structure. But most in Europe at the time believed they were dealing only with the indirect consequences, the fallout, from an Anglo-Saxon financial crisis, and of course thought that a wayward Britain had allowed itself to be locked into the American financial boom.
They did not then know that half the sub-prime assets had been bought by banks across Europe. No one had yet fully appreciated the depth of the entanglements between European banks and other global financial institutions, or how big the banks’ exposure to falling property markets was. I remember the shocked looks which passed along the table when I argued that European banks were even more vulnerable than American banks because they were far more highly leveraged – and indeed still are.
And even now a fundamental truth about the current state of European banks remains unspoken: that German, French, Italian, and British banks that have lent recklessly to the periphery are owed billions not just by the Greeks but by the Irish, Portuguese, and Spanish, and have losses still to take from toxic assets and the real estate collapse.
And when, years from now, people explain why Europe slept, they will also explain how, out of short-sighted self-interest, we treated the Greeks’ problems as if they were ones of liquidity (addressed by giving loans), not solvency, and how by short-term maneuvers to delay the necessary denouement, we maximized the risk of a disorderly end-game. Indeed, with interest rates on the rise, capital outflows from all the periphery countries to the core are already making funding more difficult in each troubled country, dragging us into even higher interest rates, longer recessions and, possibly, higher deficits.