News Analysis: Even if Europe Averts Crisis, Growth May Lag for Years

What is going on?

The problem, say close watchers of both the subprime financial crisis in 2008 and the European government debt crisis today, is that many investors think there is a quick and easy fix, if only government officials can come to an agreement 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.

But a bailout doesn’t mean wiping out the huge debts that have taken years to accumulate — just as bailing out American banks in 2008 didn’t mean wiping out the huge amount of subprime debt that homeowners had borrowed but couldn’t repay.

The problem — too much debt — could take many years to ease.

”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 senior fellow at Bruegel, a research organization in Brussels.

This isn’t 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 case 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 during the past decades. What is different is that while in the United States more of the borrowing was done by consumers and businesses, in Europe it was mainly governments that piled on the debt, facilitated by the 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 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. That means running down their debts during years of austerity and tax increases.

In short, it still means years of painful adjustment.

“We have adjust to lower growth,” said Thomas Mirow, president of the European Bank for Reconstruction and Development, referring to Europe as well as the United States. “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 and 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 mixed after the German Parliament approved the 440 billion euro ($600 billion) bailout fund aimed at keeping the crisis from hurting large European countries.

The trouble is that even this fund, which requires the approval of all 17 nations in the euro currency zone, is already seen as inadequate for the scale of Europe’s woes. Instead, a new idea is to bolster the fund by allowing an institution like the European Central Bank to use it as a guarantee for much greater lending, perhaps up to a couple of trillion euros.

This is the cause of the new optimism in markets, but some worry that even that idea may not fully address one of Europe’s most dangerous problems: fully recapitalizing its banks.

“We’re not seeing any real acknowledgment of the scale of the banking sector problem,” said Simon Tilford, the chief economist at the Center for European Reform in London. And even if the fund were enhanced with a couple of trillion euros of firepower to buy up troubled government debt from the financial system, that would still only shift the debt from European banks to taxpayers and do nothing to pay it off.

“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.”

Josh Brustein contributed reporting.

This article has been revised to reflect the following correction:

Correction: September 29, 2011

An earlier version of this article used an incorrect unit in converting Europe’s 440 billion euro bailout fund to dollars. It is $600 billion, not $600 million.

Article source: http://www.nytimes.com/2011/09/30/business/global/even-if-europe-averts-crisis-growth-may-lag-for-years.html?partner=rss&emc=rss