Greece and the financial system of Spain, with the grotesque nationalisation of Bankia to cap it off, are the new bogeymen Europe is invoking to scare the children. What seemed impossible is now not only imaginable, but considered desirable by an increasingly vociferous chorus. Europe has never been so close to a rupture “from below” (Greece) or to the bailout of one of the major countries (aid to Spain’s banks).

Both options are extremely delicate. The most basic principle of prudence would urge one to avoid them – out of fear, because they could have potentially devastating contagion effects, and because there is still room to manoeuvre. Europe can still lift its foot off the austerity brake, and the European Central Bank (ECB) has tremendous leeway. Spain doesn’t need intervention quite yet.

In the end, something always comes up in extremis to cut through the Gordian knot of the crisis. But maybe not this time. Anything is possible after the breaking of the taboo: the French president, François Hollande, is all for a European rescue of the Spanish banks; Chancellor Angela Merkel has suggested a referendum on the euro in Greece and is determined to push through her contingency plans in the event the Greeks prove right the old adage that all major European crises start in the Balkans.

All this is forcing Europe to rewrite the script for the upcoming summit at the last minute. A few days ago that summit was to be focused on Hollande’s debut and on his ideas about shifting the debate towards growth, but the tension is now forcing a radical revamp of the agenda. Merkel and Hollande and company must answer two key questions: should Greece leave the euro, given that the bailouts are not working and the Greeks are disillusioned? And should Spain ask Europe for money to help Spanish banks shore up the gaping hole in the housing market, which may not be doable? Only the questions that are a little ingenuous are truly profound, which helps those questions get summed up in one: does Europe even believe in its own project?

All roads lead to Berlin and Frankfurt

There are only two ways to respond to that, neither of which is entirely convincing. On the one hand, with the by now habitual language of alarm and apocalypse, which is understandable given the gravity of what has happened in the past 15 days, though it’s open to criticism for its tendency to exaggerate that’s so typical of this Faustian crisis. The second option is denial – in other words, to do nothing, as the Commission turns into a pillar of salt while it waits for Berlin and Paris to decide what road to take.

“The two things – a Greek exit with serious consequences and an intervention in the Spanish banks – are increasingly likely,” warned Harvard professor Ken Rogoff, author of a monumental history of financial crises over the past eight centuries, by telephone from New York. “If they do happen and we see no tremendous intervention in the markets by the ECB, or by Berlin, Paris and the European institutions taking clear steps toward some form of political union, there will be bank queues, capital outflows from the entire periphery and a trail of national bankruptcies.”

Tano Santos, of Columbia University, describes intervention in Spain as “extremely dangerous”. “At the precise moment it happens, liquidity will dry up for the whole country, and there is not enough bailout money for a case the size of Spain.” The same holds true for Greece, which accounts for only two percent of European GDP but whose exit from the euro, according to Citi, would cost the financial system close to half a billion euros. The blow would be contained only by a flood of liquidity from the ECB, provided that the flight of bank deposits remained localised.

Just when the debate was getting back to austerity or growth, the situation has turned complicated in such a way that that controversy is now almost secondary. Once again, the banking sector is hanging by a thread, as it was in the most dire moments following the bankruptcy of Lehman Brothers.

All roads lead to Berlin and Frankfurt. A constellation of factors may force Germany to open its wallet to prevent Europe from being pushed into the worst of all worlds. “But there are also reasons to believe that Berlin has learned nothing from its history, and that the disciplinary approach it has imposed crosses all the red lines,” observes Paul De Grauwe of the London School of Economics. Rogoff sums it up harshly: “Either Germany accepts inflation (wage increases, incentives, an American-style ECB, whatever it takes) or we will see defaults and political casualties – and things will get extremely hard for the Germans themselves.”

Only a return to growth can help

Ultimately, the greatest risk is always political. Lack of leadership. Therein has lain the problem of Europe for some time. The solutions to the eurozone’s problems are not unimaginable, indeed they are possible, but the political will to get them off the ground is missing.

There is no obvious exit to the great problem afflicting the EU – public disillusionment, partly due to the democratic deficit, and partly down to the crisis of legitimacy of the Union. The EU has never been especially popular among the Nordic countries. What’s new, though, is that the euro crisis is sinking its popularity even south of the Pyrenees, where it once looked like the last feasible Utopia.

In the south more and more people are blaming the excesses of austerity on the EU and the ECB, while in Germany and the other northern countries people are blaming the Union for having forced them to help the slackers in the south. “Paradoxically, every solution consists of more Europe,” concludes Charles Grant of the Center for European Reform.

In the short term, that will be through the ECB (“only the central bank interventions have credibility,” explains analyst Juan Ignacio Crespo, “because they involve more than just words.”). In the medium term, only a return to growth can help: Paris and Berlin will have much to say on that this week in Brussels. And in the long term there is a need for something like a European debt agency, more fiscal union, and an EU that resolves to be more than just an economic club. For that we need leaders in Paris, Berlin, Brussels and Timbuktu. Where are those leaders?

EU summit

“Latin bloc” to make bid to lead EU

The eurozone’s so-called “Latin bloc” is in full revolt, writes the Daily Telegraph, with the leaders of France, Italy, and Spain — backed by world powers — seeking to push for “a radical shift in Europe's economic strategy” at today’s crucial EU summit. The package of measures includes demands for full activation of the European Central Bank as a lender of last resort, as well as eurobonds to finance an infrastructure blitz, which Berlin has so far rejected. The London daily notes —