It's always the quiet, risk-free stuff that gets you.
That seems to be the obvious lesson from the current crisis in Europe and the US banking crisis of 2008.
In the US, of course, it was housing-backed assets which, thanks to years of stability, and ingenious financial engineering, were rated as highly as US Treasuries (but with considerably more yield). In Europe, it's sovereign debt, with Greece being the closest analogue to "subprime."
As such, people are aiming to fix this crisis the way they wished we could have fixed the last one. This time, no special deals for the banks! This time they're going to take their haircuts and their pain, and we'll restructure the debt rather than paper over it with bailouts!
Felix Salmon recently blasted Europe for moving in the direction of banks not having to take haircuts on their sovereign debt holdings. Henry Blodget recently argued basically the same that what's needed are bankruptcies and restructurings and financial institutions going bust.
But the European crisis is not subprime, and this time, banks really do deserve a bailout! At a 100-cents on the euro even for their sovereign debt holdings!
To start with, in the US, housing-based assets, especially, subprime ones, were never really AAA assets. They were actually huge risky money makers that got shoe-horned into being AAA assets via financial engineering (CDOs).
In the case of European sovereign debt, there has been no such subterfuge.
Here's a 5-year chart of the Greek 10-year bond.
Image: Bloomberg
It's a little hard to tell in the chart, but back in 2007, the Greek 10-year was yielding 4.5%.
Now look at the German 10-year going back around the same amount of time.
Image: Bloomberg
As you can see, the German 10-year was yielding very close to the same amount ~4.5% in 2007. The point being, that Greek bonds were never some big yield reach for European banks.
This is a crucial difference, so we'll just hammer at it again: European banks were not buying Greek debt to be greedy and grab more yield under the guise of "risk free."
On that basis alone, it's a totally different animal than with subprime CDOs.
What's more, in the US, investment banks basically built a factory to churn out more and more housing-backed assets, because the demand for it was so voracious. We've never heard any evidence that European banks had some role in urging countries to crank out more and more debt. Instead, European countries spent and borrowed more to counteract the effects of trade imbalances that were the inevitable outcome of a system that didn't allow countries to devalue their currencies.
Okay, you say... "maybe European banks weren't trying to manufacture AAA-rated products like their American counterparts were, but still, shouldn't they be punished for assets that go sour?"
Here's the problem: European regulators actively encouraged banks to hold sovereign debt by counting that debt as "risk-free" for regulatory purposes. This attempt by regulators to mandate the risk free-ness of sovereign debt was on full display when, in the summer of 2010, when the first round of bank stress tests were undertaken, sovereign debt was still not counted as a risky -- and that was when sovereign debt was the #1 risk that everyone was freaking out about!
You can hardly blame banks for holding a ton of the stuff.
One problem that people have, when talking about the European crisis, is that there really aren't any obvious villains.
In the US crisis, there were villains aplenty: Regulators who looked the other way, the packagers of deck-stacked CDOs, salesmen relentlessly pushing no-doc loans, and so on.
In Europe, who's at fault?
Italy, which is currently the world's biggest worry, has actually been an exemplar of budget discipline. It actually has mostly run primary budget surpluses. What's more, the big "winners" of the boom years aren't the ones who need a bailout right now: Germany has lived high on the hog of the Euro for awhile, and yet the market is treating it very well.
The easiest villains are the people who constructed the euro, with its separation of monetary and fiscal policy, but you can hardly punish them now, unless you want to hold them responsible like you might hold responsible the engineer of a badly designed bridge.
And this gets to another big problem of restructuring the debt on the banks' dime. It doesn't fix the underlying problem, which is the fact that all these countries still don't have sovereign currencies, and a central bank that will back them up (which the US, UK, and Japan all have).
If Europe wants to have a robust economy, it needs to have robust public finances, and that can only happen when a system is put in place that ensures that sovereign debt is risk free. If banks have any reason to fear that they won't get paid 100-cents on the euro for their sovereign debt holdings, that's basically an impossible prospect.
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