The Difficult Path to Recovery

Events in Europe should give us pause, as Eric Dash and Nelson D. Schwartz note in “Crisis in Europe Tightens Credit Across Globe.” (NYT)

Europe’s worsening sovereign debt crisis has spread beyond its banks and the spillover now threatens businesses on the Continent and around the world. From global airlines and shipping giants to small manufacturers, all kinds of companies are feeling the strain as European banks pull back on lending in an effort to hoard capital and shore up their balance sheets. The result is a credit squeeze for companies from Berlin to Beijing, edging the world economy toward another slump.

The deteriorating situation in the euro zone prompted the Organization for Economic Cooperation and Development on Monday to project that the United States economy would grow at a 2 percent rate next year, down from a forecast of 3.1 percent growth in May.

There is little reason to believe that we are even close to seeing the end of the economic crisis that began in 2007-08. While commentators in the US will focus on how the poor economic performance will impact on Obama’s reelection efforts, Gideon Rachman (FT) asks whether a modern version of the 1930s would lead Europe back to a dark era of nationalist parties and conflict.

One thought on “The Difficult Path to Recovery

  1. I have never bought into theory of “contagion” in finance. Contagion is a term of art in biology, not finance. This is a case of anthropomorphizing something which shouldn’t be. It’s not even a good metaphor. There is no bacteria or virus which will spread throughout the financial system, sickening and killing all.

    Yes, there are many stakeholders who have made some bad bets and will have to own up to significant financial losses at some point in the near future. OTOH, you have a large number of institutions who did not make bad choices and will be in a position to pick up the pieces which are worth keeping, at fire sale prices no less. These institutions will be strengthened by the process which the losing stakeholders fear will play out, the same losing stakeholders who want the taxpayers to foot the bill.

    What needs to happen is to start marking the losses as such and let the “contagion” spread. As the financially sound institutions pick up the marked down assets of the unsound ones, the system will eventually stabilize.

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