Jesse Norman is Conservative MP for Hereford and South Herefordshire. He blogs here.
Five weeks ago I wrote in rather apocalyptic terms that we were very close to a renewal of the secondary banking crisis. Money markets were seizing up, credit default swap spreads were widening sharply, the US dollar-denominated debt markets were closed to banks, and a much larger number of banks were being directly funded by the European Central Bank than ever originally contemplated. I predicted that events would move far faster than the next anticipated deadline, the Greek sovereign debt repayment in March 2012.
Since then, the impact has started to hit home. Two weeks ago the Franco-Belgian bank Dexia failed, was broken up and bailed out. Sovereign debt yields are rising. The ECB direct bank funding list continues to grow. Ninety day rollover funding for the banks has become 60 days, then 40 days, now 30 days. Spain, a model of fiscal rectitude, has had its rating cut. France's AAA rating is officially at risk.
Everything now hinges on Mrs Merkel. The dilemma facing her is this: if Greece defaults within the Eurozone, then there will be a fairly straight transfer of value from Germany to Greece, and the deflationary effect of Euro membership will continue to bear down on the Greek economy. But a Greek default outside the Euro is widely seen as the end of the so-called European project. Hence the huge appetite within the Eurozone for a resolution that (a) prevents a default, (b) recapitalises the banking system, and (c) does so in enough size to restore confidence and inhibit further speculation.
The large injection of new funding into the European Financial Stability Facility gives a short breathing space. But we are in uncharted waters. It remains unclear whether the political will exists to have the banks take the hit on their sovereign debt holdings that a proper reconstruction would demand. No-one knows what the inter-linkages are between the many highly fragile elements of the financial system. Yet the present situation cannot continue.
However, there are two things we do know: first, the Chancellor's early decision to tackle the debt crisis head-on has been a vitally significant one. After all, who predicted in May 2010 that mighty France would be at risk? Secondly, the treaty processes required to implement any rescue will take years. So there is time to decide, calmly and carefully, what specific treaty changes we want.