The EU's 'Shock and Awe' Debt Crisis Package

European Union leaders have yet again come up with a detail-free plan to address the European debt crisis, with the hope being that this one with be massive enough to have the needed "shock and awe" effect to calm markets. Whether or not it will be enough to have more than an immediate impact remains to be seen. How will European banks recapitalize without consolidating their holdings, at a time when bank shares have been falling? Who will actually pony up the money to reinforce the European Financial Stability Facility (EFSF)? How realistic is the Greek austerity budget? And how compatible is the entire package with the dismal long-term prospects for growth? The viability of the plan depends on the as yet uncertain answers to all of those questions.

As for the criticism that Europe could have saved itself a year and a pretty penny by adopting this plan when the initial Greek debt crisis emerged, it is technocratically correct but otherwise unrealistic. It's similar to someone pointing to an airplane in flight and saying, "That's great, but why bother with the takeoff?" To understand why, it's worth noting that the Greek and subsequently European debt crisis has in fact been shorthand for what was all along really three crises. The first was a debt-driven liquidity crisis (and in the case of Greece, an actual solvency crisis). The second was a political crisis. The third was an institutional crisis.*

With regard to Greece's liquidity and solvency, the former required two things, both of which were politically toxic: a brutal austerity budget in Greece and European bailouts. We've seen how difficult the first two have been to implement, even at a gradual pace over the past year. Anything faster could have resulted in revolution and martial law in Greece, and a veto by the German parliament that would have left Italy and Spain entirely unprotected from the contagion. As for Greek solvency, it has long been clear that holders of Greek debt would have to take haircuts, which have now been set at 50 percent. It's worth remembering, however, that the mere suggestion of private participation in restructuring Greek debt a year ago drove markets into a panic. Had it been imposed immediately, it could have set off a capital flight from the eurozone, bank runs and even more catastrophic interest rates on government debt than we've seen so far.

The political component of the crisis has to do with European fiscal solidarity, which has been a hard sell in terms of public opinion -- particularly in Germany -- but also elite opinion, and was by no means a sure thing a year ago. It's easy to argue, as many did at the time, that a solid gesture of unconditional political support to Greece a year ago would have headed off the contagion before the damage was done to Italy and Spain. It's also certainly correct. What's harder is to implement the necessary policies when that support does not exist. Given the lack of consensus and support for even the limited and predictably insufficient packages to date, it's clear that a package on the scale of the one unveiled today was simply beyond reach. Indeed, it was beyond reach as recently as late-July, when the EU rolled out its last attempt to calm markets.

This political crisis was exacerbated by an institutional crisis, due to the terms of the treaty establishing the euro and the mission of the European Central Bank. Again, the fatal shortcomings of both were foreseen at the time of the decision to adopt the common currency and widely commented upon over the past year. How the union might cobble together a system of collectivized debt and fiscal oversight, while broadening the ECB's mandate beyond a strict adherence to anti-inflationary monetary policy, all in the absence of broad popular support for any of these measures, remained nonetheless a challenging task. That it has been accomplished in broad stokes and using lots of duct tape, without requiring treaty modifications, is largely a result of the gradual recognition over the past year that the alternative was far worse. Again, many observers foresaw this, but the kind of technical acumen that analysis required is not necessarily broadly present among the voting public, and does not necessarily drive public opinion even if it were.

Finally, all three crises lead back to a fourth crisis, one that I've been developing over the course of the past year: the global crisis in legitimacy. Remember that the initial Greek debt crisis emerged when the incoming government of Greek Prime Minister George Papandreou revealed the true levels of Greek debt and budgetary deficits, numbers that its predecessor had cooked. More recently, the French-Belgian bank Dexia recently went under just weeks after European-wide bank stress tests had concluded that levels of bank capitalization were sufficient, a development that led to the requirement in today's package for banks to almost double their levels of capitalization, from 5 to 9 percent. And even today's package itself is in fact a vague sketch of hoped-for results, in terms of Greece and Italy's budget reforms, bank recapitalization and boosting the EFSF. It communicates more a political wish list than an actual plan.

Of course, the state of Greece's finances -- as well as its governance shortcomings -- were open secrets, as were the limitations of the recent bank stress tests and the insufficiency of all the previous EU packages meant to address this crisis. In today's global landscape, information will always find the light of day. And when it does, it creates the legitimacy crisis that is really at the heart of today's political and economic crises, whether in the Arab world, downtown New York or Europe.

*The original verison of this article accidentally omitted this sentence.