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.
The problem, say 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 fix, if only 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.
The latest rescue package for Europe gained approval from Germany on Thursday, after Chancellor Angela Merkel (pictured) won a vote in parliament, throwing the financial weight of the continent's biggest economy behind a new deal.
But a bailout does not mean wiping out the huge debts that have taken years to accumulate. Too much debt could take many years to ease.
This isn't to say that the discussions in Europe are moot. If governments cannot agree on how to rescue Greece from its 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 US and emerging countries to a prolonged downturn, or worse.
Just like the US, Europe built up trillions in debts during the past decades. What is different is that while in the US more of the borrowing was done by consumers and businesses, in Europe it was mainly governments that piled on the debt.
Now, just as the US economy is held back by households whose mortgages are still underwater, Europe cannot begin to grow again until its countries learn to live within their means.
On Thursday, the German parliament approved the ?440 billion ($A610 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 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, but some worry that may not address one of Europe's most dangerous problems: fully recapitalising its banks.
Frequently Asked Questions about this Article…
Why have European stocks been rallying and then falling again during the European debt crisis?
Markets have repeatedly rallied on hopes that officials will agree on a quick solution, then fallen when those hopes fade. The article says investors expect a fast fix, but reality may be years of work to reduce heavy government debts, which creates recurring volatility.
Did Germany approve a rescue package for the euro zone and what does that mean for investors?
Yes — the article reports Germany's parliament approved the latest rescue package after Chancellor Angela Merkel won a vote, putting Germany behind a new deal. For investors this is a stabilising step, but the package still requires approval from all 17 euro‑zone nations and is seen by some as potentially inadequate.
What is the €440 billion bailout fund and will it stop the crisis?
The article describes a €440 billion fund approved by Germany intended to help prevent the crisis from hurting large European countries. However, the fund is already viewed by some as too small for the scale of Europe’s problems, so it may not by itself end market concerns.
Could the European Central Bank (ECB) use the bailout fund to increase lending?
Yes. The article notes a proposal to let an institution like the ECB use the fund as a guarantee to enable much greater lending — possibly up to a couple of trillion euros — which is the source of recent optimism, though it may not solve all problems.
Will a bailout erase the huge national debts in Europe?
No. The article emphasises that a bailout does not wipe out accumulated debts. Too much government debt could take many years to ease, so bailouts are more about preventing shocks than eliminating debt burdens.
What happens if European governments can’t agree on rescuing Greece?
The article warns that failure to reach an agreement could trigger a collapse similar to the 2008 financial shock, potentially ricocheting around the world and causing a prolonged downturn in Europe, the US and emerging markets.
How is Europe’s debt problem different from the United States’ debt issues?
According to the article, the US built up debt largely through consumers and businesses, while in Europe the borrowing was mainly by governments. That means Europe’s recovery depends on countries learning to live within their means, which can be a slow process.
What is a major unresolved risk in Europe’s financial system mentioned in the article?
The article highlights that fully recapitalising European banks remains a dangerous unresolved problem. Even with bailout funds or guarantees, banks may still need significant capital fixes that aren’t addressed by the current proposals.
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