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In the millions of words written on Europe’s debt crisis, Germany is typically cast as the wise adult to Greece’s profligate child. Prudent Germany, the narrative goes, is loath to bail out freeloading Greece, which borrowed more than it could afford and should face the music.
Would it surprise you to know that Europe’s taxpayers have provided as much financial support to Germany as they have to Greece? An examination of European money flows and central bank balance sheets suggests so.
What the widely accepted European morality tale ignores is that irresponsible borrowers can’t exist without irresponsible lenders. Germany’s banks were Greece’s enablers. Thanks in part to lax regulation, German banks built up precarious exposures to Europe’s periphery countries in the years before the crisis. By December 2009, according to the Bank for International Settlements, German banks had amassed claims of $704 billion on Greece, Ireland, Italy, Portugal, and Spain, far more than German banks’ aggregate capital. In other words, they lent more than they could afford.
When the European Union and the European Central Bank stepped in to bail out the struggling countries, they made it possible for German banks to bring their money home. They bailed out Germany’s banks as well as the taxpayers who might have had to support them if the loans weren’t repaid. Unlike much of the aid provided to Greece, the support to Germany’s banks happened automatically, as a function of the currency union’s structure.
Here’s how it worked. When German banks pulled money out of Greece, the other national central banks of the euro area collectively offset the outflow with loans to the Greek central bank. These loans appeared on the balance sheet of the Bundesbank as claims on the rest of the euro area. This mechanism, designed to keep the currency area’s accounts in balance, made it easier for the German banks to exit their positions.
Now for the tricky part: As opposed to the claims of the private banks, the Bundesbank’s claims were only partly the responsibility of Germany. If Greece reneged on its debt, the losses would be shared among all euro-area countries, according to their shareholding in the ECB. Germany’s stake would be about 28 percent. In short, over the last couple of years, much of the risk sitting on German banks’ balance sheets shifted to the taxpayers of the entire currency union.
It’s hard to quantify exactly how much Germany has benefited from its European bailout. One indicator would be the amount German banks pulled out of other countries since the crisis began. According to the BIS, they yanked $353 billion from December 2009 to the end of 2011 (the latest data available). Another would be the increase in the Bundesbank’s claims on other central banks in the euro region over the same period. That amounts to €466 billion ($586 billion) from December 2009 through April 2012, though it would also reflect non-German depositors moving their money into German banks.
By comparison, Greece has received a total of about €340 billion in loans to recapitalize its banks, replace fleeing capital, restructure its debts, and help its government make ends meet. Only about €15 billion of that came from Germany. The rest is from the ECB, the European Union, and the International Monetary Fund.
Before Germany’s banks pulled back their funds, they stood to lose a lot if Greece left the euro. Now any losses would be shared with the taxpayers of the entire euro area—particularly France, whose banks still have a lot of outstanding loans to Greece. Perhaps this is what some German officials mean when they say that the euro region is better prepared for a Greek exit.
Ultimately, though, the cost of letting Greece go would come home to Germany. If bank runs and market turmoil forced Portugal, Spain, Italy, and others out of the euro area as well, the losses could wipe out much of the capital of German banks, not to mention the longer-term damage the euro breakup would do to the exports that drive Germany’s economy.
To prevent such an outcome, with or without Greece, Germany will have to say yes to everything it has so far refused to do, and more. This would include allowing the ECB to stand behind the debt of sovereigns. The euro area also needs a mechanism that would transfer money to economically troubled countries such as Greece just as automatically as the region’s payment system bailed out Germany—an element economists have long said is crucial to making the region a workable currency union. As we have advocated, a joint unemployment insurance fund could be a first step toward such a fiscal union.
The question is whether Germany’s leaders will recognize their country’s obligation to the currency union—and act in their country’s long-term best interests—in time to save the euro. We’re not optimistic, but we’d very much like to be wrong.
To read William D. Cohan on big paychecks outside finance and Simon Johnson on a safety board for financial crashes, go to: Bloomberg.com/view.