Democracies are supposed to strive to deliver outcomes that advance the greater good of society.

In a number of posts here on I have been making the case that reining in public sector deficits (the fiscal austerity) and curing the persistent imbalances in the external accounts of Eurozone countries (Northern Euro / Southern Euro) are necessary but not sufficient prerequisites for the return of growth.

The third essential prerequisite is that the great losses caused by the past debt-financed excesses will have to be written off and banking systems restructured or forcibly recapitalized as necessary.

This is also the central argument of blogger London Banker in his latest post Why I Oppose Financial Stability, which I recommend to readers. Here is the gist of his post on the subject:

Quoting from London Banker’s post:

One strength of the US banking system from the 1930s to the 1980s was that failures were dealt with quickly and certainly. Foreclosed properties had to be sold by banks within two years of repossession, leading to a quick and certain reallocation of assets from failed borrowers to new owners. The FDIC swiftly and mercilessly shut down failed banks. New owners – often buying at distressed prices – were encouraged to invest in making the assets productive and profitable. It was this simple recycling from failed managers to better managers that was largely behind the short recessions and strong recoveries during this period of American economic history. With forbearance now institutionalised at all levels of the US economy, we are seeing Japanification instead of recovery. And it is even worse just about everywhere else where dominant banks are much more influential.

As with so many other things, from the equations explaining the movements of the planets (hat tip Newton) to an elegant explanation of the origins of biodiversity (hat tip Darwin), it is the simple explanations — simple but powerful mechanisms — which are behind almost everything that is important in our lives.

And so it is with the never ending economic and financial crisis. A big part of this crisis is the collapse in confidence in the sustainability of the global debt mountain. It is no longer any use trying to put out the fire of this crisis of confidence (with “forbearance” as London Banker so aptly put it), because with the endgame now clearly within sight by all market actors, the run on sovereign debt is extremely hard to stop and reverse. Instead, fire must be allowed to claim the dead wood, to free up room and resources for new trees to grow.

Unfortunately, forbearance is the only choice on the official menu. The solution package that the EU will likely adopt at today’s critical meeting is headed towards even less PSI (private sector involvement), and even more promises to try to agree more fiscal coordination without violating subsidiarity on fiscal policy. Basically, Europe is fighting the last war that it already lost: bond market confidence is already shattered.

Europe today, at this historic summit, will once again promise to do too little, too late on all three fronts of external account imbalances, fiscal imbalances and its zombified banking system.

In exchange, the ECB is jumping in with increased buying of sovereign bonds and the raft of other measures it announced yesterday. Yields may come down for a while, but so will GDP as the zombie banks frantically deleverage to save themselves. The question mark over the debt mountain will remain.

A little bit of everything, in a desperate effort to avoid doing the right thing, will amount to a whole lot of nothing in the end. Too bad for all us Europeans.