The following commentary was authored by Wolfgang Münchau from Eurointelligence.
''The anniversary of the collapse of Lehman Brothers was without a doubt the single most symbolic moment of the financial crisis. But, at least for Europe, it was not the quintessential turning point. That came on Tuesday, 30 September 2008, when Brian Cowen, the Irish prime minister, gave a blanket guarantee for the entire banking sector. His decision bounded the other eurozone leaders into following suit. The rest is history.
I would go as far as to classify the decision as one of the most catastrophic political decisions taken in post-war Europe. This not so much because of the decision itself – it was necessary to stop the rot at the time – but because of a lack of action to embed the decision into a strategy to solve the problems of the banking sector – lack of capitalisation, abundance of toxic assets, poor management, and of course, excessive size.
The consequences of that strategy will only become apparent in the years to come. We saw a small glimpse last week when Ireland recognised the black hole inside the banking sector, which will cost the country a cool 32% of GDP this year alone. I myself recently estimated that the cost of Irish bank rescue would ultimately run up to about 30% of GDP, which seemed a shockingly large number to some of observers. As it turns out, I was unrealistically optimistic - as I so often am. The Germans, too, are notoriously optimistic about the underlying states of its banking sector, large parts of it are not properly capitalised.
The fundamental error committed by Europeans governments at the beginning of the crisis was the failure to shrink the banking system, and to force the bondholders to share the cost of the rescue operations. Last week, the Irish government took only the minimalist step to participate the holders of subordinated debt. My explanation is that the banks must have succeeded in scaring the politicians into believing that forced bond-to-equity conversions would signify the end of civilisation as we know it.
Why not just default? History has shown that countries recover from default relatively quickly. But in Europe, default is considered such a gigantic blemish, that Europeans go to extremes to avoid it.
Latvia marched through one of the most brutal economic depressions in modern history. A currency devaluation would have eased the pain, but it went against official dogma.
Ireland and Greece, too, preferred to cripple their economies for generations to come in order to avoid the political blemish of a default, or even an agreed rescheduling of the sovereign debt. Both countries are fundamentally insolvent – if you assume, as I do, that there will be zero growth for five, or even ten years, with further steep declines in asset prices.
Even the Greeks, with a debt-to-GDP ratio approaching 150%, want to get through this without default. This week's Greek budget law is very optimistic for 2011, but this is going to be a long haul. The question about solvency is whether Greece can achieve sustainable growth to pay off its debts in the long run.
It would be much easier to accompany this process with at least a partial default. But Europeans detest the whole idea. The euro zone was built on the trinity of No Default, No Exit, No Bailout, a logically incoherent combination, but one that nevertheless has deep roots. Of the three, the EU reluctantly agreed to drop the latter, while defending the first two to the death.
The single most absurd spectacle of it all, almost comic in fact, is the debate that is raging in Brussels. The big issue there is whether sanctions against deficit sinners should be automatic, or subject to a political vote. It is an almost exact re-run of a debate that took place before the euro even started. Twelve years later, during which the EU failed to impose sanctions on a single occasion, not even to Greece, this is still the main issue of debate.
So while Ireland and Greece are burning, the EU has taken the eyes off the ball, and reverted to the more familiar ideological debates. The fact that Ireland was, until very recently, never a deficit sinner, does not seem to impress anyone. Ireland, but also Spain, went from virtuous to almost bankrupt overnight. All the proposals I have yet heard discussed in Brussels have in common, that, if applied retroactively, they would not have made a single bit of difference to the present situation.
The big issue in the euro zone is not narrow fiscal discipline but national solvency, which is much broader concept. Because of the blanket guarantees, it is no longer possible to separate private and public debt. There is just plain and simple debt. We are now in the paradoxical situation where the survival of the banks is more assured that the survival of those who saved it.''
