Eurozone optimists are suffering from cognitive dissonance
MY abiding memory of the credit crisis was the delusion that continued to grip the City and Wall Street long after it became apparent to objective observers that a terrible recession was about to begin. Most people kept their heads firmly in the sand when HSBC’s US sub-prime unit reported losses, for example, or when the credit markets started to go haywire.
It can’t possibly be that bad, we were assured repeatedly. Until about 2006, the (preposterous) received wisdom in the US was that house prices could never fall in nominal terms. Then it was that they wouldn’t fall by much. Then that they would bounce back quickly. Every time, the mainstream view was wrong. Even when Bear Stearns had to be gobbled up by JP Morgan, and Fannie Mae and Freddie Mac were rescued, many observers remained deliriously upbeat. Northern Rock’s woes in the UK did shock the public, but most people thought that they would soon be able to return to business as usual. There might be a recession, we were told, but it will be short-lived. What nonsense that turned out to be.
It was not until a large chunk of Wall Street finally collapsed one Sunday night that the reality-deniers changed their tune and that panic set in. But until Lehman went bust, the mood was a classic case of what psychologists call cognitive dissonance. Because the reality was too grim and too threatening to contemplate, people convinced themselves that the economy couldn’t really be that bad after all and that everything would be all right in the end. My big fear is that we have fallen into a similar psychological trap with the Eurozone. Just because nobody wants more financial chaos, many have convinced themselves it won’t happen.
Take the news that two major firms have stopped providing trade insurance to exporters to Greece. It is absolutely devastating – that is an unmistakeable sign of a real credit crunch. But many people keep trying to downplay the gravity of the situation, clinging instead to the view that Greece probably won’t leave, that even if it does nobody else will, that Spain will sort itself out, that Germany will see sense, that some magical solution will be found to avoid too much pain and disruption. But these are generally evidence-free assertions made by people who don’t want to lose their jobs or assets or who are subconsciously or culturally programmed to be overly optimistic.
That said, the market’s psychology is better than it was in 2006-07. People are moving out of troubled areas. Regulators are busily scenario planning; central banks are not asleep like they were last time. Banks are taking new precautions by geographically matching their assets and liabilities within the Eurozone in case countries leave. Companies with exposures to Greece have, in the main, taken more precautions than at this stage in the previous crisis. But in most cases the reaction has been insufficient. The real risks have not been fully priced in. Few are concerned about the crazed bubble in “safe haven” UK, German and US government bonds.
Of course, just as those perma-bears who feared in the dark weeks of December 2008 that Western civilisation might not survive were proved wrong, extreme doom-mongers will also turn out to be wrong this time. Quitting the euro is the only way that Greece will ever bounce-back; the euro’s disintegration is a necessary evil. But my real problem is not with ultra-pessimists but with optimists. The widely-held view that a substantial shock will somehow be avoided is delusional. A major euro crisis is inevitable – it is time for some hard-headed realism.