The roots of this destruction of value are not unlike what occurred in the U.S. financial sector two years ago and the lessons learned from that catastrophe can provide guidance.
When U.S. banks like Citigroup and Bank of America plummeted in value, it was based on unreasonable expectations for future economic growth and lofty real estate values. The short sellers piled on the bad news and liquidity dried up further slamming the capital value of financial institutions. Denial prevailed until reality broke through.
Critics proclaimed it was a mistake of monumental proportions to let Lehman self-destruct. But behind the scenes, some cheered the collapse of Lehman as a line in the sand that the U.S government would not provide a guaranteed net of protection for every institution. But truth is it was not a line in the sand.
Rescues of massive proportions were soon to come.
After the panic that ensued post Lehman, the U.S. government started down the road of saving firms that were “too big to fail.” Mega banks such as Citigroup were given a lifeline despite cries of moral hazard. And that's what is happening with Greece today. They have been deemed too big to fail and Spain, Portugal, Ireland, and Italy are too big to go down as well. It may be a massive moral hazard problem but as Chairman Benrnake pointed out, perhaps the time to adjust behavior is after the fire is put out; it can be irretrievably destructive to let it all burn down and then pick up the pieces.
European member nations are faced with a difficult choices; intervene or accept collapse. In all likelihood, if one country fails, the entire euro experiment will fail as well. It remains to be seen whether the austerity measures will be accepted throughout Europe as it is a bitter pill to swallow for citizens.
Still, it is a necessary evil on the way to solvency. Hard medicine indeed. The crisis in Europe is another wake up call that financial accountability, just like it was in the U.S., is necessary and ultimately unavoidable.