The crisis faded when ECB President Mario Draghi promised “whatever it takes.” Most assumed the problems were solved.
That was wrong. The underlying issues never went away. In fact, they got worse. European debts are higher now than during the crisis. Banks remain stuffed with government bonds. Political systems have fractured.
Europe is now sitting on a powder keg, and I worry the explosion may not be far away. The fuse could be lit on 8 September, when French Prime Minister François Bayrou faces a confidence vote he will almost certainly lose.
What follows is one possible scenario: a plausible chain of events showing how Europe’s vulnerabilities could turn catastrophic.
Greece was less than two per cent of the eurozone. France is its second largest economy, a founding member. French government debt stands at €3.35 trillion, roughly 114 per cent of GDP.
Over the past years, France has become ungovernable, with parliament split three ways between centre, far-right and far-left. No bloc has a majority. Any two can unite to block the third.
Bayrou needs parliament to pass his €44 billion austerity budget which includes scrapping public holidays, freezing pensions, cutting services. Both left and right have vowed to defeat him. That much looks certain. What happens next is not.
After Bayrou falls, President Macron could dissolve parliament. That would likely produce another fragmented result. More probably, he will appoint another minority government. Either way, France faces months of political chaos.
Investors currently lend to France at 3.5 per cent. But ungovernable countries must pay higher rates. Each additional percentage point France incurs will cost the government €34 billion annually.
But that is not the only problem. When interest rates rise, existing bonds lose value. Thus, if new French bonds pay 6 per cent, old bonds paying 3 per cent must become cheaper to sell. Herein lies a big headache for Europe’s financial system.
French banks hold large amounts of French bonds. Though these represent only 3.3 per cent of what banks own, they equal 71 per cent of their capital safety cushion. Think of it this way: if those bonds lose value, most of the banks’ protective capital vanishes.
Banks today are better capitalised than they were during the previous Euro crisis. That is a positive. But unlike 2012, when banks mainly held their own government’s debt, today their exposure crosses borders. German banks’ total claims on French counterparties exceed €200 billion; their French government securities alone are €37 billion. Italian and Spanish banks are similarly exposed.
This is where an obscure payment system, TARGET2, becomes crucial. For years, I have tracked TARGET2 as my favourite indicator of eurozone stress. It records flows between national central banks in the euro system. When Italians move money to German banks, Italy’s balance goes down and Germany’s goes up.
These balances should hover near zero in normal circumstances. Instead, Germany’s claims are currently about €1.04 trillion. Italy owes roughly €410 billion. Spain owes €440 billion.
These numbers are much higher than they were in 2012. They show that there are enormous financial imbalances within Europe that never went away, no matter what Mario Draghi promised in 2012.
But here is the rub: those TARGET2 flows always assumed that Germany is a safe destination for capital. Yet today, Germany itself is struggling.
After last year’s government collapse, the new coalition in Berlin is fighting itself and is deeply unpopular. The German economy has been stuck near zero growth for three years. GDP actually fell 0.3 per cent in Q2 2025.
All this makes you wonder: If French turbulence rocks German banks, where does capital flee next?
The European Central Bank now has tools for such crisis moments. Its so-called Transmission Protection Instrument (TPI) allows it unlimited bond purchases. But the ECB is only allowed to use it to help countries that broadly comply with the EU’s fiscal rules. The problem is that hardly any European country does anymore – and certainly not France.
France’s deficit was 5.8 per cent of GDP in 2024 and projected to be around 5.5 per cent for 2025 – against a 3 per cent limit. Its debt is nearly double the EU’s 60 per cent limit.
Deploying TPI for France would be legally and politically contentious, with court challenges likely (as with previous ECB programmes). So, would the ECB come to France’s rescue? Maybe not.
Neither could Germany as it has done in the past. German voters, who are increasingly concerned about their own economy’s stability, will not accept bailing out France. Neither will the Dutch, Finns or Austrians.
The situation today is more precarious than it was in 2009. And the figures are worse, too. Since 2012, France’s debt has climbed from 90 per cent of GDP to 114 per cent, Italy’s from 123 to 138 per cent, and Spain’s from 86 to 104 per cent. Countries that had room to borrow then, now have none.
Markets understand this problem. They know heavily indebted governments cannot launch stimulus programmes or rescue banks. So, once confidence cracks, the crisis becomes self-reinforcing and contagious. We got to know this problem as the “sovereign-bank doom loop” back then, and we will encounter it again next time.
It would mean French government debt difficulties becoming German banking problems. German banking stress would then trigger Italian nervousness. Italian wobbles would transfer to Spanish banks. European governments and banks are all in this together, thanks to Europe’s monetary union.
But do not panic just yet. Perhaps none of this will happen. After all, this is just a scenario. In another scenario, things could play out quite differently: Markets might shrug off Bayrou’s defeat. Politicians might conjure some last-minute compromise. The ECB might ignore its rules. Something might interrupt the chain reaction.
Yet, the pessimistic scenario I sketched above is not impossible. It may not even be implausible. What I described is all real: the astronomical debts, the ungovernable politics, the interconnected vulnerabilities. Europe’s financial powder keg is real.
After 2012, Europe constructed mechanisms to contain crises in small economies like Greece. Nobody prepared for a crisis originating in the core, in France itself, with Germany too weak to respond. And frankly, how could they have prepared? This is not a case of “too big to fail” but of “too big to save.”
On 8 September, we will learn whether Bayrou survives. If he falls, we will discover whether Europe’s powder keg explodes, or the fuse burns out.
Dr Oliver Hartwich is the Executive Director of The New Zealand Initiative think tank. This article was first published HERE.
What follows is one possible scenario: a plausible chain of events showing how Europe’s vulnerabilities could turn catastrophic.
Greece was less than two per cent of the eurozone. France is its second largest economy, a founding member. French government debt stands at €3.35 trillion, roughly 114 per cent of GDP.
Over the past years, France has become ungovernable, with parliament split three ways between centre, far-right and far-left. No bloc has a majority. Any two can unite to block the third.
Bayrou needs parliament to pass his €44 billion austerity budget which includes scrapping public holidays, freezing pensions, cutting services. Both left and right have vowed to defeat him. That much looks certain. What happens next is not.
After Bayrou falls, President Macron could dissolve parliament. That would likely produce another fragmented result. More probably, he will appoint another minority government. Either way, France faces months of political chaos.
Investors currently lend to France at 3.5 per cent. But ungovernable countries must pay higher rates. Each additional percentage point France incurs will cost the government €34 billion annually.
But that is not the only problem. When interest rates rise, existing bonds lose value. Thus, if new French bonds pay 6 per cent, old bonds paying 3 per cent must become cheaper to sell. Herein lies a big headache for Europe’s financial system.
French banks hold large amounts of French bonds. Though these represent only 3.3 per cent of what banks own, they equal 71 per cent of their capital safety cushion. Think of it this way: if those bonds lose value, most of the banks’ protective capital vanishes.
Banks today are better capitalised than they were during the previous Euro crisis. That is a positive. But unlike 2012, when banks mainly held their own government’s debt, today their exposure crosses borders. German banks’ total claims on French counterparties exceed €200 billion; their French government securities alone are €37 billion. Italian and Spanish banks are similarly exposed.
This is where an obscure payment system, TARGET2, becomes crucial. For years, I have tracked TARGET2 as my favourite indicator of eurozone stress. It records flows between national central banks in the euro system. When Italians move money to German banks, Italy’s balance goes down and Germany’s goes up.
These balances should hover near zero in normal circumstances. Instead, Germany’s claims are currently about €1.04 trillion. Italy owes roughly €410 billion. Spain owes €440 billion.
These numbers are much higher than they were in 2012. They show that there are enormous financial imbalances within Europe that never went away, no matter what Mario Draghi promised in 2012.
But here is the rub: those TARGET2 flows always assumed that Germany is a safe destination for capital. Yet today, Germany itself is struggling.
After last year’s government collapse, the new coalition in Berlin is fighting itself and is deeply unpopular. The German economy has been stuck near zero growth for three years. GDP actually fell 0.3 per cent in Q2 2025.
All this makes you wonder: If French turbulence rocks German banks, where does capital flee next?
The European Central Bank now has tools for such crisis moments. Its so-called Transmission Protection Instrument (TPI) allows it unlimited bond purchases. But the ECB is only allowed to use it to help countries that broadly comply with the EU’s fiscal rules. The problem is that hardly any European country does anymore – and certainly not France.
France’s deficit was 5.8 per cent of GDP in 2024 and projected to be around 5.5 per cent for 2025 – against a 3 per cent limit. Its debt is nearly double the EU’s 60 per cent limit.
Deploying TPI for France would be legally and politically contentious, with court challenges likely (as with previous ECB programmes). So, would the ECB come to France’s rescue? Maybe not.
Neither could Germany as it has done in the past. German voters, who are increasingly concerned about their own economy’s stability, will not accept bailing out France. Neither will the Dutch, Finns or Austrians.
The situation today is more precarious than it was in 2009. And the figures are worse, too. Since 2012, France’s debt has climbed from 90 per cent of GDP to 114 per cent, Italy’s from 123 to 138 per cent, and Spain’s from 86 to 104 per cent. Countries that had room to borrow then, now have none.
Markets understand this problem. They know heavily indebted governments cannot launch stimulus programmes or rescue banks. So, once confidence cracks, the crisis becomes self-reinforcing and contagious. We got to know this problem as the “sovereign-bank doom loop” back then, and we will encounter it again next time.
It would mean French government debt difficulties becoming German banking problems. German banking stress would then trigger Italian nervousness. Italian wobbles would transfer to Spanish banks. European governments and banks are all in this together, thanks to Europe’s monetary union.
But do not panic just yet. Perhaps none of this will happen. After all, this is just a scenario. In another scenario, things could play out quite differently: Markets might shrug off Bayrou’s defeat. Politicians might conjure some last-minute compromise. The ECB might ignore its rules. Something might interrupt the chain reaction.
Yet, the pessimistic scenario I sketched above is not impossible. It may not even be implausible. What I described is all real: the astronomical debts, the ungovernable politics, the interconnected vulnerabilities. Europe’s financial powder keg is real.
After 2012, Europe constructed mechanisms to contain crises in small economies like Greece. Nobody prepared for a crisis originating in the core, in France itself, with Germany too weak to respond. And frankly, how could they have prepared? This is not a case of “too big to fail” but of “too big to save.”
On 8 September, we will learn whether Bayrou survives. If he falls, we will discover whether Europe’s powder keg explodes, or the fuse burns out.
Dr Oliver Hartwich is the Executive Director of The New Zealand Initiative think tank. This article was first published HERE.
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