Why Europe's attempt to muddle through isn't working

Activists of the Occupy Frankfurt movement have set up a fireplace near the Euro sculpture in front of the European Central Bank in Frankfurt, Germany Nov.3, 2011. The ECB announced to lower their key interest rate to 1.25 percent. AP Photo/Michael Probst

(Money Watch) COMMENTARY Some may think the EU is managing to muddle through its financial woes. After all, it has been two years since the debt crisis started and the European Union, despite all the predictions, is larger - not smaller - than when all this began. We were told the financial world would collapse when Greece defaulted on its bonds and yet it has not. Even if Europe is staggering more than a tourist in the French Quarter on Mardi Gras, it is still on its feet. Here's why it won't stay that way.

Let's examine the Great Greek Default Debacle that wasn't. Six months ago this writer warned, "The risk here isn't the direct impact [of Greece's default] but the fallout. Institutions that found themselves suddenly holding worthless bonds would suddenly get calls from their bondholders asking for money. Other dominoes would then follow."

So, why are the dominoes still up?

Because the European Central Bank and company gave the banks the time and means to dump their debt. The negotiations with Greece stretched out so long it seemed as if the entire problem began when Alexander the Great was still running things. All that time allowed a large number of private creditors to dump their debt. And who was dumb enough to take that debt from them? Why the taxpayers of Europe, of course.

The ECB is so scared, it's willing to loan Euro banks cash on a whim
Greek bailout is a farce disguised as a triumph
Bigger EU firewall won't stop financial contagion

Greece was bailed out for the first time in May 2010 by the EU and the IMF. At that time, lenders in other EU nations held $68 billion worth of Greek sovereign debt, according to the Bank for International Settlements. If Greece had defaulted, then lenders would have lost $51 billion at a 25 percent recovery rate.

Over the next 15 months, those banks' holdings of Greek bonds fell by $31 billion. As Bloomberg reports, this cut

creditors' losses at last week's swap by at least 45 percent. Lenders are protected against further losses thanks to sweeteners from the EU to encourage the exchange. Meanwhile, Greece's debt remains almost unchanged and the risk of future default is now mostly borne by the public. The same playbook is being used with Portugal and Ireland.

The ECB took Greek bonds off the books of the banks in return for some nice freshly printed Euros -- even though this meant lowering its standards to the point where it would have accepted an abandoned house in Detroit as collateral. So what really happened here is a transfer of risk from the banks to the taxpayers. (This should sound very familiar to U.S. citizens.) If this wasn't bad enough, the transfer was done at the cost of increasing Greece's total debt. This latest bailout added $173 billion in debt in return for $133 billion in debt forgiveness.

By the way, a large portion of the bailout money Greece just got went right back to the ECB and company to repay the first bailout.

Do you really think this is sustainable?

  • Constantine von Hoffman On Twitter»

    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald, TheStreet.com, CSO, and Boston Magazine.

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