In the last quarter we saw the market move 200 points or more 18 times. We saw it move over 400 points four days in a row. What is causing such gyrations? Surely the U.S, economy is not that volatile. While the economy is struggling, it is not careening as wildly as the equity markets.
The reason for the volatility can be summarized in one word: Europe. For over a year Europe has been dealing with a mounting sovereign debt crisis. The focus has been on Greece, but Italy, Spain and Portugal are also under scrutiny and France may not be far behind. The problem is that these countries, particularly Greece, will have difficulty paying their bills as they come due. Since many banks in Europe hold bonds issued by these countries, the fate of the banks is in doubt as well. This is what is being referred to as the contagion effect.
There are several obvious solutions to the problem, but none are very satisfactory. For instance Greece could default on their debt. But, because of the contagion effect, no one is quite sure where that would lead, and furthermore, it would set a precedent for bad behavior in the European Union, and many countries don’t like that prospect, particularly the Northern European countries.
Greece could be excused from the EU. Even that does not avoid default, and in addition it would be very difficult to do.
The likely outcome will be that the EU collectively will have to guarantee every bank in Europe and every country from insolvency, but that is unpopular too as it would be like you being asked to guarantee your neighbors, or partners, or fellow board members debts. Furthermore, the longer this crisis […]