There are lots of financial problems in Europe. Greece and Ireland are in economic shreds, while Portugal, Spain and perhaps Italy are headed south. Of the 126 countries with rated debt, Greece is now ranked 126^th. As the Germans are not only the biggest creditor of various deadbeat European countries but also their only serious hope for future funding, Germany has become the moral arbiter, to decide which financial behaviors will be tolerated and which will not.

 

German deputy finance minister Jorg Asmussen expressed his view on the progress made by the Greek government in reforming to Mr. Lewis: "They (the Greeks) have not sufficiently implemented the measures they have promised to implement. They have a massive problem still with revenue collection and structural reform." In short, if Germany is going to bail them out, Greeks need to change who they are.

 

So, that's the issue: Either the Germans must agree to new system in which they would be fully integrated financially with other European countries (like the 50 united states are) or the Greeks must introduce structural reform, aka changing themselves to be as efficient and productive as the Germans. Neither event is likely.

 

Until now, the funding for Europe has come primarily from the European Central Bank ("ECB") in Frankfurt. The ECB, modeled with the same discipline as the German Bundesbank, has bought $80 billion of Greek, Irish and Portuguese government bonds and lent another $450 billion to European governments and banks, much of these loans collateralized by Greek bonds. If Greece defaults, the ECB is required to call the loans and European banks would have to repay nearly $450 billion to the ECB. This could force other European banks and governments into default as well.

 

Obviously, at the bottom of this mess is national behavior and culture. For better or worse, Germans now "own" Europe. If the rest of Europe is going to continue to enjoy the benefits of what is essentially a German currency, they will need to become more German.

 

During the last decade, according to Mr. Lewis, much of Europe used Germany's credit rating (in the form of the euro) to indulge their material desires. They borrowed as cheaply as Germans could to buy things they couldn't afford. German people did not. There was no credit boom in Germany and real estate stayed completely flat. As Mr. Lewis points out: "Germans save whenever possible; it's in their genes."

 

However, Germans were hit by the financial crisis on the investment side. They lost $21 billion in the Icelandic banks, $100 billion in Irish banks, $60 billion in various U.S. subprime-backed bonds, and a very large number left to be determined in Greek bonds.

 

Germans love rules. They expect to honor them and expect others to as well. Many of the German investments that failed were in AAA rated securities. AAA is supposed to mean risk-free. Therefore, when the Germans did their "due diligence" and they "checked all the right boxes" and there was no apparent risk, they made the investment.   They focused on form over substance.

 

Similarly, when they joined the European Union, the Germans were, according to Mr. Lewis, drawn to the idea of joining the EU by the rules of Maastricht that would force each country to operate with fiscal responsibility. Like their investments in the mid 2000s, the Germans "ticked all the little boxes but ignored the overall stench." The Germans trust and believe. "They like to trust and they like to believe." Unfortunately, much of the world does not behave like the Germans do. As Mr. Lewis concludes: "In this financial world of deceit, Germans are natives on a protected island who have not been inoculated against the virus carried by visitors."

 

It will be interesting to watch as the drama plays out. How much financial pain will Germany endure and how much behavior change can we expect from Greece and others? Time will tell.

 

For more information:http://www.vanityfair.com/business/features/2011/09/europe-201109