European debt crisis FIN534
What is the Eurozone Debt Crisis? • This is also known as Eurozone sovereign debt crisis • The term indicates the financial woes caused due to overspending by come European countries • When a nation lives beyond its means by borrowing heavily and spending freely, there comes a point when it cannot manage its financial situation. • When that country faces insolvency. (Insolvency: when it is unable to repay its debts and lenders start demanding higher interest rates, the cornered nation begins to get swallowed up by what is known as the Sovereign Debt Crisis
What are the causes of a debt crisis? • What causes a debt crisis to occur are a stopped or slowed economic growth, declined tax revenues, increased government spending, or a combination of the factors.
Brief History • The Eurozone debt crisis seems to surround Greece the most. • The actual beginning is how the European Union (EU) began in 1993 where 27 European nations "agreed to form an alliance that could compete economically with larger nations such as the US". This is what created the currency of the euro. • The euro's value has decreased over the past few years due to the European Debt Crisis.
Brief History • The EDC began in 2008 with the crash of Iceland’s banking system, which spread to Greece. • Greece had experienced corruption and spending as its government continued borrowing money despite not being able to produce sufficient income through work and goods. • It was admitted that Greece's debts had reached 300bn euros, the highest in modern history • Spain, Portugal, and the other nations later followed Greece.
Data Collection The main European countries affected in the European Debt Crisis are as follows:
Timeline – Year 1999 • The euro is introduced with 11 founding countries • Those countries were Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. Greece joined in 2001. • Since 2007, five other countries have joined the euro area, including Slovenia, Cyprus, Malta, Slovakia and Estonia.
Timeline – Year 2008 • Lehman Brothers collapses; financial crisis spreads • Lehman Brothers filed for bankruptcy Sept. 15, 2008. • Over the ensuing months, the S&P 500 index would lose nearly half its value, bottoming out March 9, closing at 676.53. • Within days, the crisis spread to Europe, where economies in Russia and Pakistan contracted and governments from England to Germany stepped in to bail out banks. Iceland went bankrupt.
Timeline – Year 2009 • Greece's budget deficit higher than previously thought • Greece's budget deficit was revealed to be 12.7 percent of gross domestic product, or GDP, nearly twice what it was thought to be and four times higher than it was supposed to be. In addition, its debt-to-GDP ratio was twice the limit allowed in the treaty, which established the common currency. • Greek prime minister at the time, George Papandreou, declared that Greece's budget deficit was 12.7 percent of GDP
Timeline – Year 2010 • Spain and Portugal launch austerity measures • In 2009, Spain's budget deficit totaled 11.2 percent of GDP. • By May 2010, Spain's Prime Minister Jose Luis Rodriguez Zapatero announced cuts to the salaries of public employees and slashed pension and government funding. • Portugal government announced plans to cut the budget deficit and passed an austerity budget that cut public spending and raised taxes.
Timeline – Year 2010 • Greece asks for a loan • On April 23, 2010, then Greek Prime Minister George Papandreou announced that Greece would take a 45 billion euro loan from eurozone countries and the International Monetary Fund to avoid default. • The fiscal austerity measures included a plan to raise taxes and cut spending. State pensions were frozen, civil service bonuses were cut and public sector payrolls were slashed.
Timeline – Year 2010 • The ECB begins buying bonds under the Securities Markets Program • On May 10, 2010, the ECB announced the beginning of the Securities Markets Program. The plan was that the central bank would buy sovereign debt to "ensure depth and liquidity in those market segments which are dysfunctional." For instance, when Italian bond yields would spike beyond sustainability and no investors would buy them, the ECB would step in. The bond purchases were also sterilized, which means that for every investment purchased by the central bank, an equivalent amount of money would be taken out of circulation.
Timeline – Year 2010 • EU takes action and creates special funds to preserve financial stability • In May 2010, the European Financial Stability Facility, or EFSF, was created to provide loans to cash-strapped countries. The EFSF issues bonds that are guaranteed by the euro-area countries. • The EFSF is considered a special-purpose vehicle for lending money to struggling countries. • Established at the same time, the European Financial Stabilisation Mechanism, or EFSM, would also lend to struggling countries.
Timeline – Year 2010 • European banks perform poorly in stress tests, revealing major weaknesses • Ireland applies for and receives a bailout • In November 2010, Ireland reluctantly took a bailout of 85 billion euros from the IMF, the European Commission and the bailout fund, the EFSF.
Timeline – Year 2011 • Portugal requests and receives bailout • On April 7, 2011, Portugal requested a bailout and reached a deal on the bailout package in mid-May. The deal gave them a three-year loan of up to 78 billion euros from the European Financial Stabilisation Mechanism, the European Financial Stability Facility and the IMF. • European Central Bank raises interest rates in April and July • To fight inflation, the European Central Bank raised interest rates April 7 to 1.25% and again in July to 1.5%. • In March 2011, inflation in the eurozone was 2.6 percent, Eurostat estimated. The ECB has a target inflation rate of below 2 percent.
Timeline – Year 2011 • Plans for the permanent rescue fund, the European Stability Mechanism, are launched • July 11, 2011, brought the first signing of the treaty establishing the European Stability Mechanism, or the permanent bailout fund designed to replace the European Financial Stability Facility and the European Financial Stabilisation Mechanism. The new bailout fund would be able to lend up to 500 billion euros and would be funded by euro-area countries. The original launch date was July 2013 , but that was later moved to summer 2012 and then pushed back to launch in late 2012. • EU countries ask Greek bond holders to take a 50 percent haircut. European banks are shored up and lending capacity of the EFSF is jacked up to 1 trillion euros • On Oct. 27, leaders from the 17 euro-area countries met in Brussels and agreed to write down Greek debt by 50 percent.
Timeline – Year 2011 • Hungary requests bailout • In November, Hungary made an official request for assistance from the IMF. Hungary is one of the countries that is a noneuro-area member. • U.S. Federal Reserve adjusts dollar liquidity swap arrangement • During the financial crisis, the Federal Reserve authorized swaps with central banks around the world. The swaps make it easier for central banks to provide U.S. dollars to financial institutions in their countries when they can't get loans from anyone else.
Timeline – Year 2011 • ECB cuts interest rates in November and December to 1 percent • On Nov. 1, 2011, Mario Draghi took over for Jean-Claude Trichet as the president of the European Central Bank. • In December the central bank embarked on two longer-term refinancing operations, or LTROs, in order to keep banks flush with cash. The terms of the LTROs allowed the ECB to make low-interest loans to banks, maturing in three years, for which the banks could use their country's sovereign bonds as collateral. Before the debt crisis the maturity of LTROs was three months. • The first LTRO in late December gave 489 billion euros to 523 banks. In March 2012, the second 36-month LTRO allotted 530 billion euros to 800 banks.
Timeline – Year 2012 • ECB buys Italian and Spanish bonds after Italian bond yields rise precipitously • On Jan. 6, 2012, the ECB stepped in to purchase Italian and Spanish bonds after yields jumped as high as 7.12 percent on 10-year Italian bonds. • Greek debt deal is reached; S&P considers it a default • On Feb. 27, 2012, ratings agency Standard & Poor's dropped the Greek credit rating to Selective Default. In May, the rating was upgraded to CCC, three notches up from default. • On March 9, 2012, Greek's creditors had to agree to the loss: 85.8 percent agreed to the haircut of 53.5 percent, a real loss of 74 percent when the loss in future interest payments is taken into account.
Timeline – Year 2012 • Spain requests bailout for banks only, to avoid all the strings that came with bailouts to other countries • On June 9, 2012, Spain announced that it would take a bailout in order to help the flailing financial sector. As the funds would only go to banks, there would be no austerity requirements attached to the 100 billion euro loan. • Cyprus requests bailout • On June 25, 2012, due to exposure to Greek debt, Cyprus became the fifth eurozone country to request a bailout following Spain's bank bailout request. Cyprus would need a loan of up to 10 billion euros, which represents more than half of its 17 billion euro economy. • ECB cuts interest rates to 0.75 percent • On July 5, 2012, the European Central Bank met and dropped a key interest rate to 0.75 percent.
Timeline – Year 2012 • ECB announces new sterilized bond-buying program • On Sept. 6, 2012, following an August meeting that hinted at the plan, the ECB announced that it would launch an unlimited but sterilized bond-buying program. Sterilizing the purchases means that the central bank would offset bond purchases by taking money out of circulation to avoid increasing the money supply. The new program known as Outright Monetary Transactions will replace the Securities Markets Program. • Under the new plan, the ECB will buy sovereign debt from countries that formally request bailouts. Continued aid will be conditional on adherence to strict budget requirements.
Timeline – Year 2012 • German court OKs participation in the permanent bailout fund, the ESM • On Sept. 12, 2012, the permanent bailout fund, the European Stability Mechanism, got the go-ahead from a German court. As the primary contributor to the 500 billion euro fund, Germany is slated to kick in 190 billion euros. In March, finance ministers voted to combine the bailout funds committed to by the EFSF with the ESM for a combined capital base of 700 billion euros. • Following a summit of European Union leaders Oct. 18, 2012, it was announced the European Central Bank would lead supervision of the eurozone's 6,000 banks • With that decision in the bag, the European Stability Mechanism can move ahead with plans to directly recapitalize banks, rather than lending money to sovereigns that would then lend to financial institutions.
Greece’s Debt Dynamics Source: Economist.com
Impact on the local economy • The Eurozone debt crisis impacted market sentiment. • The country’s economic condition will remain sound—able to withstand the effects of the lingering debt crisis in Europe and uncertainties in the United States • “2013 will be a tough one, with reduced global growth outlook due to global uncertainties.” • Trouble abroad curbed the country’s economic growth last year and dampened the market. The debt crisis in the euro zone rattled investors and heightened demand for safe haven and assets such as US dollars and bonds.
Remedial Measures • Emergency loans have been extended as bailouts mainly by stronger economies like France and Germany, as also by the IMF. • The EU member states have also created the European Financial Stability Facility (EFSF) to provide emergency loans. • Restructuring of the debt • Austerity measures have been enforced.
Opinions • One of the reasons for the debt crisis is because of the corrupt government. • Another reason is the trade imbalance. • Proposed solutions: • First, citizens must elect uncorrupt government officials who care for the economic and political growth of the country. • The government must give lower wages given the economic situation the country is faced with. • They should reduce the trade imbalances.