European Financial Crisis

Sai Kumar Swamy

Course Director, T.I.M.E.
PGPM IIM Bangalore

Agenda
Genesis
Sub-Prime Crisis
Contagion Effect

European Financial Crisis

Iceland

Principal Actors
PIIGS

Portugal
Ireland
Italy
Greece
Spain

Current Status
Future Scenario

Genesis
EU
Economic & Political Union of 27 member states

500 Mn citizens
GDP - $18Tn and 20% of total world output
Free movement of people, goods, services & capital
Schengen Free movement Abolition of passport controls

Treaty of Maastricht 1st Nov 1993

Salient Features
Common Currency - Euro
EMU

SGP - Stability & Growth Pact

Convergence Criteria Article 121
Inflation; Deficit & Debt; Interest rates

Fiscal Monitoring of members

Article 122
EC can take measures to help an ailing country

Sub-Prime Crisis
Sub-Prime loans
Housing Bubble
Fuelled by Low interest rates
Supply Glut
Foreclosures

MBS
CDS
Failure of Banks
Credit Crunch
Reduced Output Unemployment

Government Bail-outs
Stimulus Packages
Fannie Mae and Freddie Mac

Keynesian model adopted Deficit Spending

Contagion effect Global linkages

European Financial Crisis

Principal Actors - Iceland

Pre 1990s
Natural resources
Tourism Fiords, Glaciers and Geysers
Fishing Salted Cod

David Oddsson
Mayor of Reykjavik
Prime Minister in 1991
Promised to end the boom and bust cycles based on Fish catch
Privatization - $2Bn
Privatized banking industry
Thrust on
Biotechnology
Software

Principal Actors - Iceland

Banking
Tapped Overseas markets
Landbanski Icesave Scheme

High interest rates

Banking accounted for 75% of stock market
Kaupthing Bank
Assets 208Bn Krn in 2000 6600Bn Krn in 2008

Loans & Assets were 10 times Iceland GDP

High inflows Strong kronor
Consumption led economy
Global Financial Crisis large scale outflow of funds
Central bank had 2Bn Loans were 70Bn
Defaults by Glitner bank 600Mn
Govt. bailout for Glitner Landsbanski Kaupthing

Misuse of banks by promoters

Too big to fail hypothesis negated by Iceland

Principal Actors - Ireland

Economic Transformation in the 90s
Low Taxes Educated workforce Entry of MNCs
Bridge between US and Europe
GDP Growth rate of 6.5%
Celtic Tiger

Housing Boom
Cheap Loans Tax Incentives
House prices increased 3 fold in a decade
40% of houses built in 1996-2006

Housing Bubble
Over Supply
Speculative nature of demand
Sub-prime echoes of the US
Multi unit loans to property developers with sub-prime characteristics

Principal Actors - Greece

Cause
Economic downturn post 2008
Tourism & Shipping badly hit
Govt. revenues decreased significantly
Govt. expenditure increased worsened debt situation

Huge spending Deficit Budgets

Cheap lending
Lack of financial reform
Government cooking the accounts

Effect
300 billion Debt
Budget Deficit 12.7%
Violation of Growth & Stability Pact
Accumulated debt Estd. at 160% in 2011

Credit Rating downgraded

Bond Yield 34%

Principal Actors - Greece

Bailouts 45Bn (2010) 130Bn (2011)
Troika EC, ECB, IMF

Steps Taken
Debt Restructuring
Cut in spending Austerity measures
Increase in Taxes Better Tax collection
Public Sector Pay cuts Inc in retirement age by 2 yrs Later by 4
Denationalization to raise money

Fears
Civil Unrest
Anti austerity parties winning 2012 elections - GREXIT
Sovereign Debt default
Orderly Default Debt write off - 50%

Euro under pressure

Light at the end of the tunnel Bond yields below 10%

Principal Actors - Spain

GDP contracted in 2008
Construction Sector 10% of GDP

Housing Bubble

Price increases of more than 200%

Bubble started in 1995 and sustained till 2007
28% of houses vacant
Fuelled by tax incentives similar to India

High indebtedness
High Inflation
High Oil prices

High Interest Rates pricks the bubble

Large scale unemployment ~ 25-30%

Severe pressure on Banking system

Bond Yield 5%

Principal Actors - Portugal

GDP $220Bn
Tourism, Cork, Fishing, Wine

High Debt to GDP Ratio 113%

Mostly external debt
Socialist Govt. with excess spending
Very low GDP growth rates
Debt Servicing Issues
Unable to generate new loans
Required a bailout from EU
Bond Yield 12-15%

Severe unemployment 12.4% in 2011

Emigration
Austerity measures
Social Unrest

Italy
7th largest economy
GDP - $2 Tn
Manufacturing & Services led economy
Big brands Quality products

Current Issue
Huge Debt to GDP ratio roughly 120% in 2010
Similar to Greece
Key difference is that most of it is internal
Recession
Contraction of almost 7% in GDP
Political Weakness
High Govt. Spending Profligacy
Black market economy
Organized crime 7% of GDP
Protection money

Bond Yield 5-6%

Current Status
Greece
Austerity measures
Looking for a bail-out
Germany against such a bailout France in favour

Portugal
Govt. trying to raise money to prop up banking system
Failed Bond Auction to raise 500Mn
Bailout required

Spain & Ireland

Reduce fiscal deficit
Rollback Keynesian debt fuelled monetary policies

Future Scenario
Sovereign Debt Crisis looms
Euro under threat
The concept of United States of Europe in grave danger
Political Union of Europe unlikely

Issues of Solidarity & Responsibility

Return to Non-Keynesian policies can further deflate
the economies
Double Dip recession possible

Common Fiscal Policy for the EU

Two Solutions
EMF Fund for Bailouts - EFSF
European Treasury Single authority for
Tax policy
Govt. Spending

Annexures

Long Term Interest Rates

Deficit & Public Debt - 2009

Deficit & Public Debt - 2012

Debt of Eurozone Countries

Public Debt and Debt as % of GDP

Public Debt as % of GDP - World

S&P Ratings

Belief in God

Cartoons

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PIIGS

Foreclosures

Sub-Prime Vicious Cycle

Geyser Economy

Greek Debt vs. Eurozone average

US vs. the Eurozone

Housing Prices - Ireland

100% Loans

Portugal Sick Man of Europe