Another month, another few tens of billions of additional banking sector bailouts, these days dressed up as sovereign bailouts. But this is now getting serious, and (as a result of the succession of bailouts), we are approaching the point at which a bank will become at risk that even I would support bailing out: the ECB.
The logical way out of the Irish solvency crisis is for the government-owned banks there to default on their debts – money foolishly lent to them by foreigners who ought to have taken the hit when the loans went bad. But last summer most of those debts were repaid and replaced with ECB loans. Anything actually useful in the way of default by the Irish banks would now mean losses for the ECB. For some months now the situation has become similar for Portuguese banks, as they have become almost totally dependent on the ECB. And of course a number of European banks (not just Greek ones) unloaded their Greek government debt onto the ECB long ago.
So when the Greeks default (as they surely will before the end of 2013), the ECB will make losses. The Irish face an invidious choice between having their banks default on the ECB and a default on government debt. They would choose the former, probably, if that wouldn't place the ECB itself at risk, and if it were only the Irish involved the ECB would probably survive that.
But now the Portuguese government has fallen because the legislators are unwilling to agree to its deficit reduction programme. Many commentators said that made a Portuguese bailout inevitable, and of course the Portuguese have now requested assistance – commentary suggests €70-€90bn. But the loans to Greece and Ireland came with strict conditions attached in terms of deficit reduction, whilst the Portuguese are asking for a bailout precisely because they are unwilling to reduce their deficit.
Under these circumstances, how is there supposed to be a bailout? Are we just chucking them nigh on €100bn on the basis that it's loose change that we don't need back? Are we imagining that they will be more likely to agree to deficit reduction and pay back loans if it is foreign governments rather than foreign banks? But how is that to be tested? There is a general election coming, and the Portuguese government does not have constitutional authority to agree to restrict the incoming government's choices on deficit reduction.
If the Portuguese default, there will be large further losses for the ECB. Adding in the near-certain losses from Greece and potential losses from Ireland, the ECB might start to become seriously curtailed in its ability to maintain liquidity - its own solvency would be at risk. With a bit of ignoring a Treaty here and some sloppy accounting there, it could presumably ultimately get out of that by printing money, but its grip over the European banking system would be seriously undermined and one assumes there would be further constitutional challenges in Germany. At that point I think we would finally be past the stage of the euro clearly surviving intact but with fewer members and, at last, into the realms of non-trivial risk of the euro itself collapsing.
Be under no illusions; drink no champagne. Disorderly collapse of the euro would be an economic disaster beyond our ability to forecast. I think that to mitigate that risk, if the ECB were approaching insolvency the Member States of the euro probably ought to recapitalise the ECB and try to reconstitute themselves, with some new Treaties with stricter rules – especially on the central bank's provision of loans to banks.
This whole policy approach has sped though the land of Foolishness, made a brief pit stop at Absurdity, and is now on the outskirts of Madness. Rather than impose losses on senior bondholders of banks who had been paid interest rates for taking risks, we've destroyed the functioning of private capitalism, bankrupted three (and counting) developed countries, violated the EU Treaty structure, destroyed German acceptance of the whole euro project, and are well on the way to bankrupting the ECB.
In the fourth year, now, of banking sector bailouts, with no clear end in sight, and with policymakers still dragging their heels on the key structural reforms required in the financial sector (instead posturing ignorantly about bonuses – as if those were anything to do with the price of fish – planning to raise capital requirements to silly levels and introducing swathes of ill-conceived additionals restrictions on hedge funds, short selling, and in other ways), and following the deepest recession since the 1920s, how is it that in the British media everyone still repeats the mantra that the banking sector bailouts of 2008 "saved the world"? Don't you get it, even a little??