The economic unification became a currency union in 1999 with the creation of the euro zone. The common currency was adopted despite a lack of political union, a sequence which many at the time described as putting the cart before the horses.
Along with the common currency came a wave of regulatory changes that provided the banking sector with more opportunities for growth—and the chance to become the fool. The rule changes enabled the banks to treat the debt of all euro zone countries equally; Greece, as far as the rules were concerned, had the same risk as Germany.
The markets had thought differently, with Greece having to pay more to borrow than countries such as Germany. The northern banks, seeing easy money, started lending to Greece, happily receiving higher fees for the “same risk.”
It was the beginning of a self-fulfilling feedback loop with the banks at the center. Southern Europe (especially Greece), started borrowing more, allowing them to buy more, which caused them to grow, which collapsed the cost of their borrowing, with led them to borrow more, and so on.
The buying spree benefited everyone, especially the northern European countries. The South boomed as things got built and bought, and the North boomed as factories churned out products to sell to the South. The banks sat in the middle, happily taking a spread.
This feedback loop was uniquely European, dependent on the false sense of stability provided by a common currency, which amplified the bankers’ naive belief that a country could not default.
This loop kept going until the sheer weight of the debt amassed by Greece became too huge for the markets to ignore. It kept going until the markets, shocked by the U.S. housing crisis, prompted skepticism, which forced Greek borrowing fees to rise. The European banks, in too deep to stop, were still willing to lend, but others less so.
By 2010 this could go on no more. The markets refused to lend more to Greece and a bailout was necessary.
But the bailout was primarily focused on saving the banks, not Greece: Rather than forgive a portion of the Greek debt and hand the banks a loss, Greece was to continue paying its bills. New money was lent by a variety of public sector entities (i.e.The European Commission, the IMF, and the European Central Bank) to pay off the old bills. The banks were consequently made whole, with most of the money from the new loans passing through Greece right back to the banks. For acting as a conduit to a northern European bank bailout, Greece was asked to change its ways—to spend less, tax more, and restructure the public sector.
This did not work. Greece was plunged into an even more dire depression. Two years later it was once again unable to pay its bill and required a new bailout. This time Greece’s debt was cut, roughly by 40 percent, but by then the banks had far less to lose, with many of the loans having already matured and been fully paid.