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European Sovereign-Debt Crisis 2007-2012

European Sovereign-Debt Crisis 2007-2012

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Published by Aarón Altamirano
European Sovereign-Debt Crisis 2007-2012
European Sovereign-Debt Crisis 2007-2012

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Published by: Aarón Altamirano on Oct 08, 2012
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European sovereign-debt crisis1
European sovereign-debt crisis
Long-term interest rates (secondary market yields of government bonds with maturitiesof close to ten years) of all eurozone countries except Estonia[1]A yield of 6% or moreindicates that financial markets have serious doubts about credit-worthiness.[2]
European sovereign debt crisis
(often referred to as the
Eurozone crisis
)is an ongoing financial crisis that hasmade it difficult or impossible for somecountries in the euro area to repay orre-finance their government debt withoutthe assistance of third parties.
From late 2009, fears of a sovereign debtcrisis developed among investors as aresult of the rising private andgovernment debt levels around the worldtogether with a wave of downgrading of government debt in some Europeanstates. Causes of the crisis varied bycountry. In several countries, privatedebts arising from a property bubblewere transferred to sovereign debt as aresult of banking system bailouts andgovernment responses to slowingeconomies post-bubble. In Greece,unsustainable public sector wage andpension commitments drove the debtincrease. The structure of the Eurozoneas a monetary union (i.e., one currency)without fiscal union (e.g., different taxand public pension rules) contributed tothe crisis and harmed the ability of European leaders to respond.
European banks own a significant amount of sovereign debt, such that concerns regarding the solvency of banking systems or sovereigns are negativelyreinforcing.
Concerns intensified in early 2010 and thereafter,
leading Europe's finance ministers on 9 May 2010 to approvea rescue package worth
750 billion aimed at ensuring financial stability across Europe by creating the EuropeanFinancial Stability Facility (EFSF).
In October 2011 and February 2012, the eurozone leaders agreed on moremeasures designed to prevent the collapse of member economies. This included an agreement whereby banks wouldaccept a 53.5% write-off of Greek debt owed to private creditors,
increasing the EFSF to about
1 trillion, andrequiring European banks to achieve 9% capitalisation.
To restore confidence in Europe, EU leaders also agreedto create a European Fiscal Compact including the commitment of each participating country to introduce a balancedbudget amendment.
European policy makers have also proposed greater integration of EU bankingmanagement with euro-wide deposit insurance, bank oversight and joint means for the recapitalization or resolutionof failing banks.
The European Central Bank has taken measures to maintain money flows between Europeanbanks by lowering interest rates and providing weaker banks (mostly from crisis countries) with cheap loans of morethan one trillion Euros.While sovereign debt has risen substantially in only a few eurozone countries, it has become a perceived problem forthe area as a whole,
leading to continuous speculation of a possible breakup of the Eurozone. However, as of 
European sovereign-debt crisis2mid-November 2011, the Euro was even trading slightly higher against the bloc's major trading partners than at thebeginning of the crisis,
before losing some ground in the following months.
Three countriessignificantly affected, Greece, Ireland and Portugal, collectively accounted for 6% of the eurozone's gross domesticproduct (GDP).
In June 2012, also Spain became a matter of concern,
when rising interest rates began to affectits ability to access capital markets, leading to a bailout of its banks and other measures.
To address the deeper roots of economic imbalances most EU countries agreed on adopting the Euro Plus Pact,consisting of political reforms to improve fiscal strength and competitiveness. This has forced weaker countries todraw up ever more austerity measures to bring down national deficits and debt levels. Such non-Keynesian policieshave been criticized by various economists, many of which called for a new growth strategy based on additionalpublic investments, financed by growth-friendly taxes on property, land, wealth, and financial institutions, mostprominently a new EU financial transaction tax. EU leaders have agreed to moderately increase the funds of theEuropean Investment Bank to kick-start infrastructure projects and increase loans to the private sector. Furthermore,weaker EU economies were asked to restore competitiveness through internal devaluation, i.e. lowering their relativeproduction costs.
It is hoped that these measures will decrease current account imbalances among Euro-zonemember states and gradually lead to an end of the crisis.The crisis has had a major impact on EU politics, leading to power shifts in several European countries, most notablyin Greece, Ireland, Italy, Portugal, Spain, and France.
Public debt $ and %GDP (2010) for selected European countries
The European sovereign debt crisis resultedfrom a combination of complex factors,including the globalization of finance; easycredit conditions during the 2002
2008period that encouraged high-risk lendingand borrowing practices; the 2007
2012global financial crisis; international tradeimbalances; real-estate bubbles that havesince burst; the 2008
2012 global recession;fiscal policy choices related to governmentrevenues and expenses; and approaches usedby nations to bail out troubled bankingindustries and private bondholders,assuming private debt burdens or socializinglosses.
One narrative describing the causes of thecrisis begins with the significant increase in savings available for investment during the 2000
2007 period when theglobal pool of fixed-income securities increased from approximately $36 trillion in 2000 to $70 trillion by 2007.This "Giant Pool of Money" increased as savings from high-growth developing nations entered global capitalmarkets. Investors searching
European sovereign-debt crisis3
Government debt of Eurozone, Germany and crisis countries compared toEurozone GDPGovernment deficit of Eurozone compared to USA and UK
for higher yields than those offered by U.S.Treasury bonds sought alternativesglobally.
The temptation offered by such readilyavailable savings overwhelmed the policyand regulatory control mechanisms incountry after country, as lenders andborrowers put these savings to use,generating bubble after bubble across theglobe. While these bubbles have burst,causing asset prices (e.g., housing andcommercial property) to decline, theliabilities owed to global investors remain atfull price, generating questions regarding thesolvency of governments and their bankingsystems.
How each European country involved in thiscrisis borrowed and invested the moneyvaries. For example, Ireland's banks lent themoney to property developers, generating amassive property bubble. When the bubbleburst, Ireland's government and taxpayersassumed private debts. In Greece, thegovernment increased its commitments topublic workers in the form of extremelygenerous wage and pension benefits, withthe former doubling in real terms over 10years.
Iceland's banking system grewenormously, creating debts to globalinvestors (external debts) several timesGDP.
The interconnection in the global financialsystem means that if one nation defaults on its sovereign debt or enters into recession putting some of the externalprivate debt at risk, the banking systems of creditor nations face losses. For example, in October 2011, Italianborrowers owed French banks $366 billion (net). Should Italy be unable to finance itself, the French banking systemand economy could come under significant pressure, which in turn would affect France's creditors and so on. This isreferred to as financial contagion.
Another factor contributing to interconnection is the concept of debtprotection. Institutions entered into contracts called credit default swaps (CDS) that result in payment should defaultoccur on a particular debt instrument (including government issued bonds). But, since multiple CDSs can bepurchased on the same security, it is unclear what exposure each country's banking system now has to CDS.
Greece hid its growing debt and deceived EU officials with the help of derivatives designed by majorbanks.
Although some financial institutions clearly profited from the growing Greek governmentdebt in the short run,
there was a long lead-up to the crisis.

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