Greece May Not Be the End of It

Europe stood at the precipice of another financial crisis last week as Greece, for all intents and purposes, went bankrupt. The interest rate on Greek bonds briefly shot up to an eye-popping 38 percent--the result of a market frozen by investors' worries about a default. To stave off collapse, European leaders and the International Monetary Fund hastily arranged a bailout totaling as much as $185 billion--more than three times the amount officials initially estimated. The lenders are extracting their pound of flesh: Greece will have to slash its public deficit and gouge wages as a way of rehabilitating its economy.

While EU politicians characterized this as a bailout for a troubled country, in truth it's a rescue package for Europe's banks. Financial institutions in France and, to a lesser extent, Germany, have flooded Greece with cheap credit for a decade. Even after crises in Ireland, Iceland, and Latvia in 2008 and 2009 made clear that Europe's weaker economies had become bad credit risks, the banks didn't pull back. According to Barclays Capital, French and German financial companies now hold more than $100 billion in Greek government bonds. Indeed, many of the banks that enthusiastically plowed money into Greece are the same ones that bet--and lost--the house on toxic subprime debt, including Germany's Hypo Real Estate (with $10.5 billion in Greek bonds) and Belgium's Fortis ($5 billion). But the biggest culprits have been French banks like BNP and Société Générale, whose high-roller business practices will now be subsidized by taxpayers all over Europe. And, just as in the subprime debacle, regulators seem to have been asleep at the switch: even through the recent crisis, Europe's banking overseers classified Greek bonds as "risk-free," allowing banks to buy vast quantities without holding onto extra capital to cover potential losses.

The fear is that Greece's bailout carries a "moral hazard": now that Europe's bankers know that the EU and the IMF will open their pocketbooks when trouble hits, financiers could be more likely to let problems fester in Spain, Portugal, and other heavily indebted countries until they've reached massive proportions. More seriously, saddling Europe's dwindling number of financially solid countries with ever more debt and guarantees at a time when worries over governments' abilities to pay back loans are already rising, could in the end lead to a crisis that goes far beyond Greece.