In European Crisis, Experts See Little Hope for a Quick Fix
John Kolesidis/Reuters
Bills for a new income tax on display during a rally this week in Athens against the Greek government's new austerity measures.
By GRAHAM BOWLEY and LIZ ALDERMAN
Published: September 29, 2011
¶It has happened time and again in recent months as Europe’s debt crisis has played out. Stocks stage a strong comeback on expectations that a solution has been found. Then they quickly resume their decline as hopes dissipate, leaving investors puzzled and frazzled.
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¶What is going on?
¶The problem, say close watchers of both the subprime financial crisis in 2008 and the European governmentdebt crisis today, is that many investors think there is a quick and easy fix, if only government officials can agree and act decisively.
¶In reality, one might not exist. A best case in Europe is a bailout of troubled governments and their banks that keeps the financial system from experiencing a major shock and sending economies worldwide into recession.
¶The latest rescue package for Europe gained approval from Germany on Thursday, after Chancellor Angela Merkel won a vote in Parliament, throwing the financial weight of the Continent’s biggest economy behind a new deal.
¶But a bailout doesn’t wipe out the huge debts that have taken years to accumulate — just as bailing out American banks in 2008 didn’t wipe out the huge amount of subprime debt that homeowners had borrowed but couldn’t repay.
¶The problem — too much debt and not enough growth to ease the burden — could take many years to resolve.
¶“Everybody has been living beyond their means for nearly the last decade, so it is an adjustment that will be painful and long, and it will test the resilience of societies socially and politically,” said Nicolas Véron, a fellow at Bruegel, a Brussels research group.
¶This is not to say that the discussions in Europe are moot. If governments can’t agree on how to rescue Greece from its debilitating government debt, some fear the worst could happen — a collapse of the financial system akin to 2008 that would ricochet around the world, dooming Europe but also the United States and emerging countries to a prolonged downturn, or worse.
¶Just like the United States, Europe built up trillions in debts in past decades. What is different is that more of the United States borrowing was done by consumers and businesses, while in Europe it was mainly governments that piled on the debt, facilitated by banks that lent them money by buying up sovereign bonds.
¶Now, just as the United States economy is held back by households whose mortgages are still underwater and who won’t begin to spend again until they have run down their debts, Europe can’t begin to grow again until its countries learn to live within their means.
¶In short, it means years of painful adjustment.
¶“We have to adjust to lower growth,” said Thomas Mirow, president of the European Bank for Reconstruction and Development, referring to both Europe and America. “It is of course going to be very painful. But leaders have to speak frankly to their populations.”
¶The uncertainty about Europe’s future has been driving the gyrations of financial markets since the summer. Earlier this week, stocks rallied on euphoria that a new, more powerful bailout was near, but the rally fizzled Wednesday when cracks began to appear among European nations over the terms of money being given to Greece.
¶On Thursday, markets were mostly up again after the German approval of the 440 billion euro ($600 billion) bailout fund, intended to keep the crisis from spreading beyond Greece and Portugal to other European countries. Several other nations still have to ratify the agreement, but it now looks likely to be in place by the end of October.
¶Even this fund, however, is already seen as inadequate. Some worry that it still fails to fully address one of Europe’s most pressing needs: fully recapitalizing its banks.
¶Now there is talk of enhancing the fund’s firepower by allowing the European Central Bank to leverage its assets to buy up troubled government debt from the financial system. That would serve mostly to shift the debt from European banks to taxpayers.
¶ “Clearly something is cooking, but the markets will eventually choke on the taste,” said George Magnus, an economist at UBS in London. “It is about getting banks off the hook, but the darker side is it’s not doing anything real.”
¶Not everybody shares this view. Some argue that Europe is actually in better shape than the United States. Debt levels are painfully high in European countries like Italy, Ireland and Greece, but overall euro zone debt as a percentage of gross domestic product is 85 percent, less than the 93 percent level in the United States.
¶Also, European consumers did not go on the same borrowing binge, so their retrenchment need not be so severe.
“We need to do a lot to get over the crisis,” said Holger Schmieding, an economist at Berenberg Bank in London. “But once we are over it, it will be the U.S. facing years of fiscal retrenchment, not Europe.”
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Germany Approves Bailout Expansion, Leaving Slovakia as Main Hurdle (September 30, 2011)
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A resolution of the crisis could bolster confidence in these battered economies, and lead to a return to positive growth. But the danger is that the strict austerity measures being adopted will only worsen economic downturns that some think could drag on for at least a decade in Greece, Portugal and Spain. Stagnant economies only make it harder for governments to pay down their debts.
Germany pulled itself around after years as the “sick man of Europe,” with high unemployment and sluggish growth. In the early 2000s, while the countries of Southern Europe spent beyond their means, the German government initiated a series of structural reforms, deregulation and wage adjustments that helped it become an economic powerhouse.
But it is unclear how other European nations like Portugal and Spain are to achieve a similar makeover.
The 440 billion euro bailout, even if enhanced, amounts to “Band-Aid city,” said Carmen Reinhart, senior fellow at the Peterson Institute for International Economics.
“For a few weeks it buys tranquillity,” she said, “but it does not get at two critical issues: it does not reduce the massive debt overhang and it does not restore growth.”
Longer term, some political leaders and economists are pushing for a more integrated economic, fiscal and political union in Europe — what they see as the only real solution.
“I don’t think little steps are credible here,” said Kenneth Rogoff, a Harvard economist who co-wrote a book about debt crises with Ms. Reinhardt. “There needs to be a United States of Europe at the end of this, and it may well not include everyone in the euro zone.”
“They were thinking they had 20 years to get there,” he said, “and instead they have 20 weeks.”
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