Procrastination and the European Financial Crisis

Procrastination, especially when it involves a painful solution to a looming problem, is a common human affliction.  For example we find it very difficult to decide to sell something at a loss even in a falling market.  Procrastination many times ends only when an urgent crisis is on the doorstep.

The European debt crisis is a good example of how millions of humans banded together as countries collectively exhibit this basic human foible.  European leaders have made several attempts to fix the debt crisis only to have fallen short with their solutions.

This Bloomberg story form Oct. 26, 2011 captures the essence of the cycle very well:

European leaders “have risen to the challenge,” German Chancellor Angela Merkel said. French President Nicolas Sarkozy proclaimed their July 21 summit a “historic turning point” and Luxembourg Prime Minister Jean Claude-Juncker called it the “final package, of course,” to extinguish the debt inferno.

Then they went on vacation. Before they returned to work, the deal fizzled.

This cycle has happened several times now and seems poised to happen again.  Given the complexity of the European Union they need all the countries (leaders and voters) to be ready to make a painful choice to fix the debt problem.  Some prefer to endure the minimal pain of today and put off a painful solution.  The most likely outcome is a final solution when a real crisis is much nearer and leaders and voters are peering over the edge of the abyss.  Examples of enough pain to precipitate a full solution might be – Greece going bankrupt, French bond prices rising rapidly or a run on a big European bank.  Looming financial contagion would be a reminder of the 2007-8 financial crisis that brought on global meltdown and the Great Recession and drive a real solution.

27 European leaders are meeting now at the 14th crisis summit in the last 21 months.

One of the interesting features of this crisis is the role that financial markets play.  Bonds sold by banks, bank stock prices and other financial instruments are sold in the free market place.  The prices on these financial instruments are set by investors who make their own evaluation of value – risk and reward.  For example, regardless of what European leaders say, buyers and sellers of Greek bonds decide what they believe the risk of a Greek default is and therefore what a Greek bond is worth to them.  Investors vote every day on whether they believe the European debt crisis has been solved.

At the end of the day financial markets and investors will decide whether European leaders have truly solved the debt crisis or not.  Politicians may be able to sway voters and the media with emotional appeals, spinnning the message and slick TV ads, but investors have many choices and will decide what European bonds and stocks are worth to them.

A former IMF banker provides a good assessment of this tension:

Europe is finally moving in the right direction but there is a sense that the remedies will fall short of the shock and awe response that is required to stabilize market expectations.

Hopefully my pessimism is wrong and European leaders and voters will address their debt crisis this time and remove the cloud that is stalling economic recovery.

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