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The euro area crisis is in its 18th month. The conflagration continues to blaze. Rather than constructing a firewall to protect euro area countries other than Greece, European authorities have allowed the flames to spread to Ireland and Portugal and threaten Spain as well. What went wrong? The leaders of the euro area have not applied two key lessons of crisis management: (1) use overwhelming force, and (2) ownership is everything.
Former Mexican president Ernesto Zedillo famously commented on the Mexican crisis of 1994-95, "Markets overreact, and that means that policy must overreact." The implicit recommendation is to apply the Powell Doctrine, named after General (and former Secretary of State) Colin Powell, who enunciated it as chairman of the Joint Chiefs of Staff before the first Gulf War. (The doctrine was invoked as well by Ben Bernanke as chairman of the Federal Reserve and by Timothy Geithner as US Treasury Secretary in 2009.) Use overwhelming force in the form policy actions and necessary financing to convince markets that the problem has been addressed. European leaders have not done this. Instead, policymakers first criticize markets, credit agencies, and speculators with no effect. After some delay they apply a modest dose of financing and adjustment policies. Market sentiment improves marginally, but soon deteriorates further.
In most financial crises over the past 20 years, the turn in financial market sentiment has come within 18 months. The one exception was Argentina in 2001-02. Even in the case of the recent global financial crisis, the start of the acute phase was September 15, 2008 with the Lehman bankruptcy. The turn in global financial markets occurred before the middle of March 2009 – seven months later. The Group of Twenty authorities collectively committed to do whatever it took to stabilize their economies turn in financial markets was a necessary condition for the start of economic and financial repair.
Markets may have overreacted to the euro area crisis, but policy demonstrably has not overreacted in response to markets. Europeans have not applied the first lesson of crisis management.
Europeans also have not applied the second lesson of crisis management: ownership is everything. Given that this is a euro area crisis, it is crucial that the program’s design and implementation be embraced by the euro area as a whole, not just by the governments and citizens of Greece, Ireland, and Portugal. The complex political economy of the euro area – 17 governments and two common institutions in the form of the European Commission and European Central Bank – has not brought out the required degree of ownership. Doubts about the program and its effectiveness articulated in Berlin, Helsinki, and Paris have undermined political support for it in Athens, Dublin, and Lisbon. That is what markets have been witnessing over the past two months.
The next few days offer the likely last chance for Plan A for the euro area, which had a significant risk of failure even if it had been back by overwhelming force and euro area ownership. Otherwise, it will be on to a very uncertain Plan B. Markets wonder if the euro area will hang together. If it does not, the leaders of each of the member countries most certainly will be hanged separately.
