A sign of a deeper malaise.

The Message of Espirito Santo

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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The market convulsions surrounding the difficulties of Portugal's Espirito Santo financial group may be waning, but the episode illustrates a deeper and longer-lasting issue: The way Europe's persistently low economic growth exposes all kinds of underlying financial vulnerabilities.

The Espirito Santo case won't be easy to untangle. As analysts dig in, they are uncovering the complex interconnections that inevitably occur in such large conglomerates. This "spaghetti bowl" element is bad news, and it points to challenges in restoring clarity and confidence.

On the brighter side, the financial and economic fallout appear to be containable. The bank is not large by global standards, and the European Central Bank and the European Commission have enough resources to prevent a re-eruption of the European debt crisis if Portugal can't cope on its own. Moreover, the ECB is spearheading more credible stress tests for banks, along with asset quality reviews.

There is, however, a bigger issue at play, highlighted yesterday by the disappointing European data on economic activity. Europe is having a hard time restoring growth -- a situation that is unlikely to change given the unbalanced nature of demand in the region, the strength of the euro, sluggish investment, high unemployment and heavy debt burdens. The longer Europe is stuck in this low-level equilibrium, the greater the likelihood of periodic eruptions of the Espirito variety.

Low growth makes it very difficult to deal with debt overhangs. It eats away at creditworthiness and discourages new investment in productive sectors. Unemployment becomes harder to solve. Foreign investors become more cautious. Governments find it increasingly hard to pursue structural reforms. And all of this further impairs the economy's ability to grow.

European officials may soon be tempted to celebrate their containment of the Espirito Santo mini-crisis. They should instead take to heart the bigger message: Decisive actions are needed today to avoid multiple Espiritos down the road.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mohamed Aly El-Erian at melerian@bloomberg.net

To contact the editor on this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net