Hesitation by leaders drove cost of Europe's crisis higher
Wednesday, June 16, 2010
The U.S. government and the International Monetary Fund warned European officials as early as February that escalating financial problems on their continent had to be addressed quickly to forestall a larger threat to the world economy, but those urgings were discounted, according to participants in the private discussions.
By the time European officials acted several months later -- prompted by a near-meltdown in Greece and gathering chaos in other countries -- the price tag for stemming the financial contagion had soared.
After the meltdown of the U.S. housing market showed how one country's financial problems can spill across borders, the IMF and leaders of the world's top economies have spoken of a heightened sensitivity to "systemic risk" and a greater focus on preventing it.
But the upheaval in Europe, sparked by the threat of a Greek default, underscored a paradox in how economic powers confront evolving crises. Political systems and their leaders often prove hesitant to take dramatic action on the sort of partial evidence available when a threat is emerging, avoiding decisions on controversial and expensive measures until there is no choice. But once the markets have delivered a full verdict, the crisis is in full swing and stopping it becomes harder and more expensive.
Despite mounting market evidence, warnings from the IMF and what U.S. officials described as "alarm bells" being sounded by the U.S. Treasury, European leaders this winter continued to take a minimalist approach and conclude that Greece could solve its own problems. It was only after world bond markets had all but abandoned the country, interest rates had begun rising in other European nations, and banks had become hesitant to lend each other money -- a phenomenon reminiscent of the 2008 global credit meltdown -- that European officials acted in earnest.
Over the intervening months, the cost of helping Greece avoid default increased about fourfold, to $140 billion from roughly $35 billion at the start of the year. Confidence in the European economy was so badly battered that European leaders together with the IMF had to pledge another nearly $1 trillion to reassure investors. The world's nascent economic recovery was put into jeopardy.
"If we had been able to address it right from the start, say in February, I think we would have been able to prevent it from snowballing the way that it did," French Finance Minister Christine Lagarde said in an interview.
Her conclusion was shared in hindsight by many of the key figures involved in the Greek crisis, according to interviews with more than a dozen direct participants in the discussions.
Some senior European economic officials acknowledged that the Americans had pushed for an aggressive response but said they weren't the only ones. Other European officials said no one, including the United States and the IMF, fully understood the gravity of the situation until late April nor pushed intensely to address it.
Although the measures finally taken by European leaders in May helped stabilize markets, the experience raises questions about one of the basic principles now shaping debate over the world economy in the wake of the global finance crisis that spiked in 2008 -- namely that with the right information and tools, political and financial leaders can minimize systemwide risks and forestall problems before they become too serious.
Much as Federal Reserve Chairman Ben S. Bernanke insisted for months in 2007 that U.S. financial problems would remain mainly limited to the subprime mortgage market, key Greek and European financial leaders maintained that Greece would be able to borrow the money it needed on the open market, restructure its economy and not pose any larger threat.
And just as Congress initially balked at a proposed bailout for U.S. banks, Europe's political leadership assumed it could tame markets with mere statements of support for Greece, and would not commit public money until the need was certain -- a delay that allowed the financial decay to reach crisis levels.