The financial calamity unfolds throughout the world. After the real estate bubble burst, the net effect was to remove huge sums of money from the economy. For an economy which was predicated on leverage, this was devastating. As the asset bubble deflated, those most leveraged found themselves underwater. This is a particular problem for a world which consistently rewarded what amounted to reckless leveraging and risk.
Now that the economic reckoning appears to have commenced, there are many voices chiming in recommending appropriate courses of intervention. The markets are also commenting. I tend to believe what markets tell me. Perhaps one of the most telling stories revolves around the risk premiums associated with the debt of Greece and Ireland. The Irish have responded by initiating an austerity program. While less income means less spending and perhaps even negative economic growth in the short term, perhaps this is the appropriate behavior when you suffer loss of wealth and income.
Greece has responded similarly with an austerity program targeting to bring the annual deficit from 12% to below 3% over the next two years. However, the markets simply do not believe these efforts, based upon a history of corruption and financial parlor tricks. They are looking for "help" from Brussels in terms access to cheaper capital. There is great skepticism that such aid would result in any enduring change of behavior as evidence by Greece's continued high borrowing costs. The questions are, will Ireland be rewarded for its austerity and will Greece really initiate any meaningful austerity plan? If the answer to the latter is no, the answer to the former question will also be no. Furthermore, the only real credible threat to induce austerity plans will be the actual collapse of states like Greece. You have to wonder who is really taking the biggest risk. Why tighten your belts if you can expect a bailout?
These events have tremendous implications for the Greece's and Ireland's within our own borders. Before the Federal debt becomes unmanageable, states with the most tenuous finances and ill conceived budgeting will have to face the music. While the Greeks look to Brussels, states like California and New York look to Washington, on the assumption that some sort of rescue will be forthcoming. However, unlike Brussels, Washington does not even appear to have any inclination to impose any austerity programs on even the most poorly administered states. No scale back of actuarially unsound and financially devastating programs is likely to happen if the most profligate states can expect the Feds to bail them out. It is moral hazard writ large. Ultimately, somebody will pay.