Last week the ECB published a report containing an incredible revelation: Cypriot and Spanish households are wealthier than German households.
How is this possible? We are dealing with an accounting fiction. Spain and Cyprus have a much higher rate of home ownership than Germany, and most household wealth consists of real estate. Both countries saw sharp booms in their housing markets while the German market remained flat.  The boom has gone away, but now the bubbles remains trapped in the balance sheet amber.
The ECB report’s reasoning provides us with a wonderful litmus test for understanding the euro crisis. In order for the ECB’s behaviour to make sense, you must believe that German households are in fact poorer than their southern counterparts.
Once you accept this premise, a German bailout of Cyprus (to give an example) makes no sense. Solidarity involves a transfer from the wealthy to the poor, not from the poor to the wealthy.
So are (or better said, were) Cypriot and Spanish households wealthier than their German counterparts? In order to answer the question you also have to decide what is more real: what is taking place on the ground or the world according to the balance sheets of the banks.
On the one hand, the idea that German households are poorer than Spanish households is nonsense on its surface. Widespread unemployment, rising poverty, and thousands of people being evicted from their homes in Spain belie this claim. It is also strange to think that thousands of Spaniards are emigrating to a country whose households are poorer.
On the other hand, the report helps explain a basic but perverse truth: Spanish households are being forced to remain wealthy. The Spanish housing bubble has burst and prices must continue to drop; but it is far more convenient from an accounting point of view to act as though no such thing has happened. Better to throw someone out onto the street than to admit that their property is not worth as much as it should be.
For us to accept that Spanish households are, in reality, much poorer than German households, we must also accept the fact that the Spanish financial sector is much worse off than the official sector claims. And by extension, the French and German financial sectors are also much worse off than is indicated.
The response to the crisis has consisted of years of denial of this hard truth. Immense imaginary wealth was created out of thin air during the boom years. We are now witnessing a valiant attempt to confiscate wealth that does not exist and that will not exist. Austerity is the political mechanism by which creditors are able to convert their fictitious claims into more tangible gains. Instead of assuming its responsibilities in this situation, the ECB maintains the illusion that nothing is amiss.
The ECB has persisted with its obsessive focus on price stability, expressed in terms of HIPC, to the detriment of other objectives. But in targeting price stability, the ECB made the choice to systematically exclude owner-occupied housing from its methodology, which their recent report shows us to be an extremely relevant measure. The ECB thus focused on an indicator that is distorted and incomplete (HIPC), creating a situation whereby measuring inflation across Europe was akin comparing apples to oranges. Registered inflation would be different across Europe if housing were considered.
The ECB spent a decade choosing to minimize the impact of the housing market on inflation, only to turn around and publish a report showing that it turns out Spanish households are wealthier than German households. They failed to identify the boom, and now they deny the existence of the bust.
Spain may have surpassed Germany when it comes to football; this is certainly not the case when it comes to finance and we should not pretend otherwise.
 The report actually suggests that Cypriot and Spanish households were wealthier than German households at a given moment in the past. The news is largely being reported as though this were the case in the present.
 In the words of the authors: “The euro area has witnessed a very heterogeneous development of house prices in the early 2000s, with some countries (notably Germany, the Netherlands, Portugal and Austria) experiencing flat house price developments, and other countries (notably Belgium, Cyprus, Spain, France and Luxembourg) being subject to substantial house price booms. Because real estate makes up the bulk of assets (see e.g. Chart 2.1 below), these divergent house price developments are likely to have contributed substantially to cross-country differences in reported wealth. Similarly, the dynamics in prices of various types of financial assets affect the value and the participation rates in these assets. In addition, steep increases in house prices may have contributed to the accumulation of household debt.”
 Michael Lewis described how this occurred in Iceland in “Wall Street on the Tundra”: “Yet another hedge-fund manager explained Icelandic banking to me this way: You have a dog, and I have a cat. We agree that they are each worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners, but Icelandic banks, with a billion dollars in new assets. “They created fake capital by trading assets amongst themselves at inflated values,” says a London hedge-fund manager. “This was how the banks and investment companies grew and grew.”
 Fortunately Eurostat has begun to publish a housing price index.
 The big competitiveness and unit labour costs debate, which has served as an excellent excuse to suppress the labour share of GDP, would also be different because the inflation numbers would be different.