Today’s Telegraph had one of the best main-stream media write-ups on the developing Eurozone credit crisis:

“Have politicians got the courage to make those who earn money share in the risk as well?” Merkel boomed in Berlin on Wednesday – in a speech that was disgracefully under-reported by the Western media.

The Telegraph article by Liam Halligan, titled Haircuts for all as vexed Germany takes a firm grip on the clippers, goes on:

Bondholders and almost all other Western governments don’t want to hear it. But Merkel is completely right. The most galling aspect of this entire sub-prime debacle is the disgraceful extent to which those who bankrolled the banks – as they took on ever more debt, “levering-up” their balance sheets 20-, 30- and 40-fold – have been protected from their consequences of their actions. Powerful vested interests have so far ensured – amid much scare-mongering of what would happen if sanity prevailed – that such losses have been shoved on to taxpayers instead.

So, it took a woman to do the man’s job that Obama, Bernanke et al shied away from. Angela Merkel is burning her political bridges by promising to pull the plug on the bailout madness. It doesn’t look like she can turn back without committing political suicide. Far from causing an unintended disaster with her remarks one month ago, Angela Merkel appears to have now decided to make a stand against unlimited bailouts for bank creditors. Writing about this on November 5th in The Return of The Stress (Act II) I had said:

Europe is a financial house of cards that is teetering at the point of collapse, and Angela Merkel, with her warning that bondholders would have to share some of the pain, abruptly turned the overhead fan knob to the full-on position.

In retrospect, it should be clear that it was politically worth last spring’s effort to try to kick the can down the road by attempting to contain the rot at the Greek border. However, the upward creep in PIGS credit default swaps starting in September, covered in this blog under The Return of The Stress, betrayed the failure of containment: bond market participants were nervously crowding near the small exit door in the crowded theatre. The extent of market nervousness was laid bare by an article titled Ratings Differences Highlight Eurozone Risk, which calculated the implied S&P ratings of Eurozone nations based on the implied probability of default gleaned from their market-determined credit default swaps. The result was that the true credit rating for all five PIIGS should be junk, between 6 and 10 notches below their official S&P rating, and all of them ranking below Iceland which allowed its banks to default two years ago. And most ominously, in recent weeks the spread between German bond yields and non-Eurozone Scandinavian bond yields has started to widen. The markets are saying that contagion would eventually spread to countries and banks that were truly too big to save without bankrupting Germany itself.

As more dominoes fall – Ireland last week, Portugal this week? – the dominant perspective on the underlying European bank solvency problem will be redefined overnight from ‘too big to fail’ into ‘too big to save’. Perhaps some leaders like Angela Merkel have already made this transition. In any case, many more will do the same if or when the problem gets out of hand for Spain or Italy. With developments moving rapidly, politicians who understand the implications of ‘too big to save’ and who want to remain relevant will be forced to come down on the side of ending unlimited life support for banks. The effect of this political posture will be to push any teetering dominoes over the edge.

Within Europe, Germany holds all the cards, and is calling all the bluffs. At last, an adult appears to be taking charge. It follows that senior and junior bank creditors, as well as large depositors, are now at risk of significant capital loss. However painful and messy, and with politicians having exhausted all other options as we enter the third year of global crisis, the effort to reform Europe’s financial and fiscal core now appears to be under way. If all goes well, a stronger and harder-working Europe should emerge on the other end of the traumatic events that lie ahead. Whether it will still be a Europe of 27 and a Eurozone of 16, or something more compact, and whether this will all be over in three months or three years, remains to be decided.