European sovereign-debt crisis
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Long-term interest rates of all eurozone countries except Estonia (secondary market yields of government bonds with maturities of close to ten years) A yield of 6% or more indicates that financial markets have serious doubts about credit-worthiness.
The European sovereign debt crisis is an ongoing financial crisis that has made it difficult or impossible for some countries in the euro area to re-finance their government debt without the assistance of third parties.
From late 2009, fears of a sovereign debt crisis developed among investors as a result of the rising private and government debt levels around the world together with a wave of downgrading of government debt in some European states. Causes of the crisis varied by country. In several countries, private debts arising from a property bubble were transferred to sovereign debt as a result of banking system bailouts and government responses to slowing economies post-bubble. In Greece, unsustainable public sector wage and pension commitments drove the debt increase. The structure of the Eurozone as a monetary union (i.e., one currency) without fiscal union (e.g., different tax and public pension rules) contributed to the crisis and impacted 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 negatively reinforcing.
Concerns intensified in early 2010 and thereafter, leading Europe's finance ministers on 9 May 2010 to approve a rescue package worth €750 billion aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility (EFSF).
In October 2011 and February 2012, the eurozone leaders agreed on more measures designed to prevent the collapse of member economies. This included an agreement whereby banks would accept a 53.5% write-off of Greek debt owed to private creditors, increasing the EFSF to about €1 trillion, and requiring European banks to achieve 9% capitalisation. To restore confidence in Europe, EU leaders also agreed to create a European Fiscal Compact including the commitment of each participating country to introduce a balanced budget amendment.
While sovereign debt has risen substantially in only a few eurozone countries, it has become a perceived problem for the area as a whole. Prior to May, 2012, the European currency remained stable. As of mid-November 2011, the euro was even trading slightly higher against the bloc's major trading partners than at the beginning of the crisis. The three countries most affected, Greece, Ireland and Portugal, collectively account for 6% of the eurozone's gross domestic product (GDP).
1.1 Rising government debt levels
1.2 Trade imbalances
1.3 Structural problem of Eurozone system
1.4 Monetary policy inflexibility
1.5 Loss of confidence
2 Evolution of the crisis
2.5 Possible spread to other countries
2.5.5 United Kingdom
3 Policy reactions
3.1 EU emergency measures
3.1.1 European Financial Stability Facility (EFSF)
3.1.2 European Financial Stabilisation Mechanism (EFSM)
3.1.3 Brussels agreement and aftermath
3.2 European Central Bank
3.3 European Stability Mechanism (ESM)
3.4 European Fiscal Compact
4 Economic reforms and recovery proposals
4.1 Increase investment
4.2 Increase competitiveness
4.3 Address current account imbalances
5 Proposed long-term solutions
5.2 European Monetary Fund
5.3 Drastic debt write-off financed by wealth tax
5.4 Debt defaults and national exits from the Eurozone
6.1 EU treaty violations
6.2 Actors fueling the crisis
6.2.1 Credit rating agencies
6.3 Speculation about the breakup of the eurozone
6.4 Odious debt
6.5 National statistics
6.6 Collateral for Finland
7 Political impact
8 See also
10 External links
Public debt $ and %GDP (2010) for selected European countries
Government debt of Eurozone, Germany and crisis countries compared to Eurozone GDP
Government deficit of Eurozone compared to USA and UK
The European sovereign debt crisis resulted from a combination of complex factors, including the globalization of finance; easy credit conditions during the 2002–2008 period that encouraged high-risk lending and borrowing practices; the 2007–2012 global financial crisis; international trade imbalances; real-estate bubbles that have since burst; the 2008–2012 global recession; fiscal policy choices related to government revenues and expenses; and approaches used by nations to bail out troubled banking industries and private bondholders, assuming private debt burdens or socializing losses. 
One narrative describing the causes of the crisis begins with the significant increase in savings available for investment during the 2000–2007 period when the global 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 capital markets. Investors searching for higher yields than those offered by U.S. Treasury bonds sought alternatives globally.
The temptation offered by such readily available savings overwhelmed the policy and regulatory control mechanisms in country after country as global fixed-income investors searched for yield, generating bubble after bubble across the globe. While these bubbles have burst, causing asset prices (e.g., housing and commercial property) to decline, the liabilities owed to global investors remain at full price, generating questions regarding the solvency of governments and their banking systems.
How each European country involved in this crisis borrowed and invested the money varies. For example, Ireland's banks lent the money to property developers, generating a massive property bubble. When the bubble burst, Ireland's government and taxpayers assumed private debts. In Greece, the government increased its commitments to public workers in the form of extremely generous wage and pension benefits, with the former doubling in real terms over 10 years. Iceland's banking system grew enormously, creating debts to global investors ("external debts") several times GDP.
The interconnection in the global financial system means that if one nation defaults on its sovereign debt or enters into recession putting some of the external private debt at risk, the banking systems of creditor nations face losses. For example, in October 2011, Italian borrowers owed French banks $366 billion (net). Should Italy be unable to finance itself, the French banking system and economy could come under significant pressure, which in turn would affect France's creditors and so on. This is referred to as financial contagion. Another factor contributing to interconnection is the concept of debt protection. Institutions entered into contracts called credit default swaps (CDS) that result in payment should default occur on a particular debt instrument (including government issued bonds). But, since multiple CDSs can be purchased 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 major banks. Although some financial institutions clearly profited from the growing Greek government debt in the short run, there was a long lead-up to the crisis.
Rising government debt levels
In 1992, members of the European Union signed the Maastricht Treaty, under which they pledged to limit their deficit spending and debt levels. However, a number of EU member states, including Greece and Italy, were able to circumvent these rules and mask their deficit and debt levels through the use of complex currency and credit derivatives structures. The structures were designed by prominent U.S. investment banks, who received substantial fees in return for their services.
The adoption of the Euro led to many Eurozone countries of different credit worthiness receiving similar and very low interest rates for their bonds during years preceding the crisis, which author Michael Lewis referred to as "a sort of implicit Germany guarantee."
Public debt as a percent of GDP (2010)
A number of economists have suggested that the debt crisis was caused by excessive government spending. According to their analysis, increased debt levels were also due to the large bailout packages provided to the financial sector during the late-2000s financial crisis, and the global economic slowdown thereafter. The average fiscal deficit in the euro area in 2007 was only 0.6% before it grew to 7% during the financial crisis. In the same period, the average government debt rose from 66% to 84% of GDP. The authors also stressed that fiscal deficits in the euro area were stable or even shrinking since the early 1990s. US economist Paul Krugman named Greece as the only country where fiscal irresponsibility is at the heart of the crisis.
Either way, high debt levels alone may not explain the crisis. According to The Economist Intelligence Unit, the position of the euro area looked "no worse and in some respects, rather better than that of the US or the UK." The budget deficit for the euro area as a whole (see graph) is much lower and the euro area's government debt/GDP ratio of 86% in 2010 was about the same level as that of the US. Moreover, private-sector indebtedness across the euro area is markedly lower than in the highly leveraged Anglo-Saxon economies.
Current account balances relative to GDP (2010)
Commentator and Financial Times journalist Martin Wolf has asserted that the root of the crisis was growing trade imbalances. He notes in the run-up to the crisis, from 1999 to 2007, Germany had a considerably better public debt and fiscal deficit relative to GDP than the most affected eurozone members. In the same period, these countries (Portugal, Ireland, Italy and Spain) had far worse balance of payments positions. Whereas German trade surpluses increased as a percentage of GDP after 1999, the deficits of Italy, France and Spain all worsened.
Paul Krugman wrote in 2009 that a trade deficit by definition requires a corresponding inflow of capital to fund it, which can drive down interest rates and stimulate the creation of bubbles: "For a while, the inrush of capital created the illusion of wealth in these countries, just as it did for American homeowners: asset prices were rising, currencies were strong, and everything looked fine. But bubbles always burst sooner or later, and yesterday’s miracle economies have become today’s basket cases, nations whose assets have evaporated but whose debts remain all too real."
A trade deficit can also be affected by changes in relative labor costs, which made southern nations less competitive and increased trade imbalances. Since 2001, Italy's unit labor costs rose 32% relative to Germany's. Greek unit labor costs rose much faster than Germany's during the last decade. However, most EU nations had increases in labor costs greater than Germany's. Those nations that allowed "wages to grow faster than productivity" lost competitiveness. Germany's restrained labor costs, while a debatable factor in trade imbalances, are an important factor for its low unemployment rate. More recently, Greece's trading position has improved; in the period 2011 to 2012, imports dropped 20.9% while exports grew 16.9%, reducing the trade deficit by 42.8%.
Further, Eurozone countries with sustained trade surpluses (i.e., Germany) do not see their currency appreciate relative to the other Eurozone nations due to a common currency, keeping their exports artificially cheap. Germany's trade surplus within the Eurozone declined in 2011 as its trading partners were less able to find financing necessary to fund their trade deficits, but Germany's trade surplus outside the Eurozone has soared as the Euro declined in value relative to the dollar and other currencies.
Structural problem of Eurozone system
There is a structural contradiction within the euro system, namely that there is a monetary union (common currency) without a fiscal union (e.g., common taxation, pension, and treasury functions). In the Eurozone system, the countries are offered to follow a similar fiscal path, but they do not have common treasury to enforce it. That is, countries with same monetary system have freedom in fiscal policies in taxation and expenditure. So, even though there are some agreements on monetary policy and through European Central Bank, countries may not be able to or would simply choose not to follow it. This feature brought fiscal free riding of peripheral economies, especially represented by Greece, as it is hard to control and regulate national financial institutions. Furthermore, there is also a problem that the euro zone system has a difficult structure for quick response. Eurozone, having 17 nations as its members, require unanimous agreement for a decision making process. This would lead to failure in complete prevention of contagion of other areas, as it would be hard for the Euro zone to respond quickly to the problem.
Columnist Thomas L. Friedman wrote in June 2012: "In Europe, hyperconnectedness both exposed just how uncompetitive some of their economies were, but also how interdependent they had become. It was a deadly combination. When countries with such different cultures become this interconnected and interdependent — when they share the same currency but not the same work ethics, retirement ages or budget discipline — you end up with German savers seething at Greek workers, and vice versa."
Monetary policy inflexibility
Further information: Economic and Monetary Union of the European Union
Since membership of the Eurozone establishes a single monetary policy, individual member states can no longer act independently, preventing them from printing money in order to pay creditors and ease their risk of default. By "printing money", a country's currency is devalued relative to its (eurozone) trading partners, making its exports cheaper, in principle leading to an improved balance of trade, increased GDP and higher tax revenues in nominal terms.
In the reverse direction moreover, assets held in a currency which has devalued suffer losses on the part of those holding them. For example, by the end of 2011, following a 25 percent fall in the rate of exchange and 5 percent rise in inflation, eurozone investors in Pound Sterling, locked in to euro exchange rates, had suffered an approximate 30 percent cut in the repayment value of this debt.
Loss of confidence
Sovereign CDS prices of selected European countries (2010–2011). The left axis is in basis points; a level of 1,000 means it costs $1 million to protect $10 million of debt for five years.
Prior to development of the crisis it was assumed by both regulators and banks that sovereign debt from the eurozone was safe. Banks had substantial holdings of bonds from weaker economies such as Greece which offered a small premium and seemingly were equally sound. As the crisis developed it became obvious that Greek, and possibly other countries', bonds offered substantially more risk. Contributing to lack of information about the risk of European sovereign debt was conflict of interest by banks that were earning substantial sums underwriting the bonds. The loss of confidence is marked by rising sovereign CDS prices, indicating market expectations about countries' creditworthiness (see graph).
Furthermore, investors have doubts about the possibilities of policy makers to quickly contain the crisis. Since countries that use the euro as their currency have fewer monetary policy choices (e.g., they cannot print money in their own currencies to pay debt holders), certain solutions require multi-national cooperation. Further, the European Central Bank has an inflation control mandate but not an employment mandate, as opposed to the U.S. Federal Reserve, which has a dual mandate. According to the Economist, the crisis "is as much political as economic" and the result of the fact that the euro area is not supported by the institutional paraphernalia (and mutual bonds of solidarity) of a state. Heavy bank withdrawals have occurred in weaker Eurozone states such as Greece and Spain. Bank deposits in the Eurozone are insured, but by agencies of each member government. If banks fail, it is unlikely the government will be able to fully and promptly honor their commitment, at least not in euros, and there is the possibility that they might abandon the euro and revert to a national currency; thus, euro deposits are safer in Dutch, German, or Austrian banks than they are in Greece or Spain. In June, 2012, as the Euro hit new lows with no bottom in sight, there were reports that the wealthy were moving assets out of the Eurozone. Mario Draghi, president of the European Central Bank, has called for an integrated European system of deposit insurance which would require European political institutions craft effective solutions for problems beyond the limits of the power of the European Central Bank. As of June 6, 2012, closer integration of European banking appeared to be under consideration by political leaders.
Interest on long term sovereign debt
In June, 2012, following negotiation of the Spanish bailout line of credit interest on long-term Spanish and Italian debt continued to rise rapidly, casting doubt on the efficacy of bailout packages as anything more than a stopgap measure. The Spanish rate, over 6% before the line of credit was approved, approached 7%, a rough rule of thumb indicator of serious trouble.
Rating agency views
On 5 December 2011, S&P placed its long-term sovereign ratings on 15 members of the eurozone on "CreditWatch" with negative implications; S&P wrote this was due to "systemic stresses from five interrelated factors: 1) Tightening credit conditions across the eurozone; 2) Markedly higher risk premiums on a growing number of eurozone sovereigns including some that are currently rated 'AAA'; 3) Continuing disagreements among European policy makers on how to tackle the immediate market confidence crisis and, longer term, how to ensure greater economic, financial, and fiscal convergence among eurozone members; 4) High levels of government and household indebtedness across a large area of the eurozone; and 5) The rising risk of economic recession in the eurozone as a whole in 2012. Currently, we expect output to decline next year in countries such as Spain, Portugal and Greece, but we now assign a 40% probability of a fall in output for the eurozone as a whole."
Evolution of the crisis
See also: 2000s European sovereign debt crisis timeline
In the first few weeks of 2010, there was renewed anxiety about excessive national debt, with lenders demanding ever higher interest rates from several countries with higher debt levels, deficits and current account deficits. This in turn made it difficult for some governments to finance further budget deficits and service existing debt, particularly when economic growth rates were low, and when a high percentage of debt was in the hands of foreign creditors, as in the case of Greece and Portugal.
Some governments have focused on austerity measures (e.g., higher taxes and lower expenses) which has contributing to social unrest and significant debate among economists, many of whom advocate greater deficits when economies are struggling. Especially in countries where budget deficits and sovereign debts have increased sharply, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on CDS between these countries and other EU member states, most importantly Germany. By the end of 2011, Germany was estimated to have made more than €9 billion out of the crisis as investors flocked to safer but near zero interest rate German federal government bonds (bunds).
While Switzerland equally benefited from lower interest rates, the crisis also harmed its export sector due to a substantial influx of foreign capital and the resulting rise of the Swiss franc. In September 2011 the Swiss National Bank surprised currency traders by pledging that "it will no longer tolerate a euro-franc exchange rate below the minimum rate of 1.20 francs", effectively weakening the Swiss franc. This is the biggest Swiss intervention since 1978.
Main article: Greek government-debt crisis
Greece's debt percentage since 1999 compared to the average of the eurozone.
100,000 people protest against the harsh austerity measures in front of parliament building in Athens, 29 May 2011
In the early mid-2000s, Greece's economy was one of the fastest growing in the eurozone and was associated with a large structural deficit. As the world economy was hit by the global financial crisis in the late 2000s, Greece was hit especially hard because its main industries — shipping and tourism — were especially sensitive to changes in the business cycle. The government spent heavily to keep the economy functioning and the country's debt increased accordingly.
On 23 April 2010, the Greek government requested an initial loan of €45 billion from the EU and International Monetary Fund (IMF), to cover its financial needs for the remaining part of 2010. A few days later Standard & Poor's slashed Greece's sovereign debt rating to BB+ or "junk" status amid fears of default, in which case investors were liable to lose 30–50% of their money. Stock markets worldwide and the Euro currency declined in response to the downgrade.
On 1 May 2010, the Greek government announced a series of austerity measures to secure a three year €110 billion loan. This was met with great anger by the Greek public, leading to massive protests, riots and social unrest throughout Greece. The Troika (EU, ECB and IMF), offered Greece a second bailout loan worth €130 billion in October 2011, but with the activation being conditional on implementation of further austerity measures and a debt restructure agreement. A bit surprisingly, the Greek prime minister George Papandreou first answered that call, by announcing a December 2011 referendum on the new bailout plan, but had to back down amidst strong pressure from EU partners, who threatened to withhold an overdue €6 billion loan payment that Greece needed by mid-December. On 10 November 2011 Papandreou instead opted to resign, following an agreement with the New Democracy party and the Popular Orthodox Rally, to appoint non-MP technocrat Lucas Papademos as new prime minister of an interim national union government, with responsibility for implementing the needed austerity measures to pave the way for the second bailout loan.
All the implemented austerity measures, have so far helped Greece bring down its primary deficit before interest payments, from €24.7bn (10.6% of GDP) in 2009 to just €5.2bn (2.4% of GDP) in 2011, but as a side-effect they also contributed to a worsening of the Greek recession, which began in October 2008 and only became worse in 2010 and 2011. Overall the Greek GDP had its worst decline in 2011 with −6.9%, a year where the seasonal adjusted industrial output ended 28.4% lower than in 2005, and with 111,000 Greek companies going bankrupt (27% higher than in 2010). As a result, the seasonal adjusted unemployment rate also grew from 7.5% in September 2008 to a record high of 19.9% in November 2011, while the Youth unemployment rate during the same time rose from 22.0% to as high as 48.1%.
Overall the share of the population living at "risk of poverty or social exclusion" did not increase noteworthy during the first 2 years of the crisis. The figure was measured to 27.6% in 2009 and 27.7% in 2010 (only being slightly worse than the EU27-average at 23.4%), but for 2011 the figure was now estimated to have risen sharply above 33%. In February 2012, an IMF official negotiating Greek austerity measures admitted that excessive spending cuts were harming Greece.
Some economic experts argue that the best option for Greece and the rest of the EU, would be to engineer an “orderly default”, allowing Athens to withdraw simultaneously from the eurozone and reintroduce its national currency the drachma at a debased rate. However, if Greece were to leave the euro, the economic and political impact would be devastating. According to Japanese financial company Nomura an exit would lead to a 60% devaluation of the new drachma. Analysts at French bank BNP Paribas added that the fallout from a Greek exit would wipe 20% off Greece's GDP, increase Greece's debt-to-GDP ratio to over 200%, and send inflation soaring to 40%-50%. Also UBS warned of hyperinflation, a bank run and even "military coups and possible civil war that could afflict a departing country".
To prevent this from happening, the troika (EU, IMF and ECB) eventually agreed in February 2012 to provide a second bailout package worth €130 billion, conditional on the implementation of another harsh austerity package, reducing the Greek spendings with €3.3bn in 2012 and another €10bn in 2013 and 2014. For the first time, the bailout deal also included a debt restructure agreement with the private holders of Greek government bonds (banks, insurers and investment funds), to "voluntarily" accept a bond swap with a 53.5% nominal write-off, partly in short-term EFSF notes, partly in new Greek bonds with lower interest rates and the maturity prolonged to 11–30 years (independently of the previous maturity).
It is the world's biggest debt restructuring deal ever done, affecting some €206 billion of Greek government bonds. The debt write-off had a size of €107 billion, and caused the Greek debt level to fall from roughly €350bn to €240bn in March 2012, with the predicted debt burden now showing a more sustainable size equal to 117% of GDP, somewhat lower than the originally expected 120.5%.
On 9 March 2012 the International Swaps and Derivatives Association (ISDA) issued a communique calling the debt restructuring deal with its private sector involvement (PSI) a "Restructuring Credit Event" which will trigger payment of credit default swaps. According to Forbes magazine Greece’s restructuring represents a default.
This credit event implies that previous Greek bond holders are being given, for 1000€ of previous notional, 150€ in “PSI payment notes” issued by the EFSF and 315€ in “New Greek Bonds” issued by the Hellenic Republic, including a “GDP-linked security”. The latter represents a marginal coupon enhancement in case the Greek growth meets certain conditions. While the market price of the portfolio proposed in the exchange is of the order of 21% of the original face value (15% for the two EFSF PSI notes – 1 and 2 years – and 6% for the New Greek Bonds – 11 to 30 years), the duration of the set of New Greek Bonds is slightly below 10 years.
Mid May 2012 the crisis and impossibility to form a new government after elections led to strong speculations Greece would have to leave the Eurozone shortly due. This phenomenon became known as "Grexit" and started to govern international market behaviour.
Main article: 2008–2012 Irish financial crisis
Irish government deficit compared to other European countries and the United States (2000–2013)
The Irish sovereign debt crisis was not based on government over-spending, but from the state guaranteeing the six main Irish-based banks who had financed a property bubble. On 29 September 2008, Finance Minister Brian Lenihan, Jnr issued a one-year guarantee to the banks' depositors and bond-holders. He renewed it for another year in September 2009 soon after the launch of the National Asset Management Agency (NAMA), a body designed to remove bad loans from the six banks.
Irish banks had lost an estimated 100 billion euros, much of it related to defaulted loans to property developers and homeowners made in the midst of the property bubble, which burst around 2007. The economy collapsed during 2008. Unemployment rose from 4% in 2006 to 14% by 2010, while the federal budget went from a surplus in 2007 to a deficit of 32% GDP in 2010, the highest in the history of the eurozone, despite austerity measures.
Ireland could have guaranteed bank deposits and let private bondholders who had invested in the banks face losses, but instead borrowed money from the ECB to pay these bondholders, shifting the losses and debt to its taxpayers, with severe negative impact on Ireland's creditworthiness. As a result, the government started negotiations with the EU, the IMF and three nations: the United Kingdom, Denmark and Sweden, resulting in a €67.5 billion "bailout" agreement of 29 November 2010 Together with additional €17.5 billion coming from Ireland's own reserves and pensions, the government received €85 billion, of which €34 billion were used to support the country's ailing financial sector. In return the government agreed to reduce its budget deficit to below three percent by 2015. In April 2011, despite all the measures taken, Moody's downgraded the banks' debt to junk status.
In July 2011 European leaders agreed to cut the interest rate that Ireland was paying on its EU/IMF bailout loan from around 6% to between 3.5% and 4% and to double the loan time to 15 years. The move was expected to save the country between 600–700 million euros per year. On 14 September 2011, in a move to further ease Ireland's difficult financial situation, the European Commission announced it would cut the interest rate on its €22.5 billion loan coming from the European Financial Stability Mechanism, down to 2.59 per cent – which is the interest rate the EU itself pays to borrow from financial markets.
The Euro Plus Monitor report from November 2011 attests to Ireland's vast progress in dealing with its financial crisis, expecting the country to stand on its own feet again and finance itself without any external support from the second half of 2012 onwards. According to the Centre for Economics and Business Research Ireland's export-led recovery "will gradually pull its economy out of its trough". As a result of the improved economic outlook, the cost of 10-year government bonds, which has already fallen substantially since mid July 2011 (see the graph "Long-term Interest Rates"), is expected to fall further to 4 per cent by 2015.
In the first half of 2011, Portugal requested a €78 billion IMF-EU bailout package in a bid to stabilise its public finances. These measures were put in place as a direct result of decades-long governmental overspending and an over bureaucratised civil service. After the bailout was announced, the Portuguese government headed by Pedro Passos Coelho managed to implement measures to improve the State's financial situation and the country started to be seen as moving on the right track. However, the unemployment level rose to over 14.8 percent, taxes were increased, and civil service-related lower-wages were frozen and higher-wages were cut by 14.3%, on top of the government's spending cuts.
A report released in January 2011 by the Diário de Notícias and published in Portugal by Gradiva, had demonstrated that in the period between the Carnation Revolution in 1974 and 2010, the democratic Portuguese Republic governments encouraged over-expenditure and investment bubbles through unclear Public–private partnerships and funding of numerous ineffective and unnecessary external consultancy and advisory of committees and firms. This allowed considerable slippage in state-managed public works and inflated top management and head officer bonuses and wages. Persistent and lasting recruitment policies boosted the number of redundant public servants. Risky credit, public debt creation, and European structural and cohesion funds were mismanaged across almost four decades. Prime Minister Sócrates's cabinet was not able to forecast or prevent this in 2005, and later it was incapable of doing anything to improve the situation when the country was on the verge of bankruptcy by 2011.
Robert Fishman, in the New York Times article "Portugal's Unnecessary Bailout", points out that Portugal fell victim to successive waves of speculation by pressure from bond traders, rating agencies and speculators. In the first quarter of 2010, before pressure from the markets, Portugal had one of the best rates of economic recovery in the EU. From the perspective of Portugal's industrial orders, exports, entrepreneurial innovation and high-school achievement, the country matched or even surpassed its neighbors in Western Europe.
On 16 May 2011, the eurozone leaders officially approved a €78 billion bailout package for Portugal, which became the third eurozone country, after Ireland and Greece, to receive emergency funds. The bailout loan was equally split between the European Financial Stabilisation Mechanism, the European Financial Stability Facility, and the International Monetary Fund. According to the Portuguese finance minister, the average interest rate on the bailout loan is expected to be 5.1 percent. As part of the deal, the country agreed to cut its budget deficit from 9.8 percent of GDP in 2010 to 5.9 percent in 2011, 4.5 percent in 2012 and 3 percent in 2013.
The Portuguese government also agreed to eliminate its golden share in Portugal Telecom to pave the way for privatization. In 2012, all public servants had already seen an average wage cut of 20% relative to their 2010 baseline, with cuts reaching 25% for those earning more than 1,500 euro per month. This led to a flood of specialized technicians and top officials leaving the public service, many looking for better positions in the private sector or in other European countries.
On 6 July 2011, the ratings agency Moody's had cut Portugal's credit rating to junk status, Moody's also launched speculation that Portugal could follow Greece in requesting a second bailout.
In December 2011, it was reported that Portugal's estimated budget deficit of 4.5 percent in 2011 would be substantially lower than expected, due to a one-off transfer of pension funds. The country would therefore meet its 2012 target a year earlier than expected. Despite the fact that the economy is expected to contract by 3 percent in 2011 the IMF expects the country to be able to return to medium and long-term debt sovereign markets by late 2013. Any deficit means increasing the nation's debt. To bring down the debt to sustainable levels will require a 10% budget surplus for several years according to some estimates.
In September 2011, yields on Cyprus long-term bonds have risen above 12%, since the small island of 840,000 people was downgraded by all major credit ratings agencies following a devastating explosion at a power plant in July and slow progress with fiscal and structural reforms. Since January 2012, Cyprus is relying on a € 2.5bn emergency loan from Russia to cover its budget deficit and re-finance maturing debt. The loan has an interest rate of 4.5% and it is valid for 4.5 years though it is expected that Cyprus will be able to fund itself again by the first quarter of 2013. On June 12, 2012 financial media reported that a bailout request by Cyprus was imminent. Despite its low population and small economy Cyprus has an off-shore banking industry which is disproportional to its economy.
On 13 March 2012 Moody's has slashed Cyprus's credit rating into Junk status, warning that the Cyprus government will have to inject fresh capital into its banks to cover losses incurred through Greece's debt swap. Cyprus's banks were highly exposed to Greek debt and so are disproportionately hit by the haircut taken by creditors.
Possible spread to other countries
Total financing needs of selected countries in % of GDP (2011–2013).
Economic data from Portugal, Italy, Ireland, Greece, United Kingdom, Spain, Germany, the EU and the eurozone for 2009.
The 2010 annual budget deficit and public debt, both relative to GDP for selected European countries.
Long-term interest rates of selected European countries. Note that weak non-eurozone countries (Hungary, Romania) lack the sharp rise in interest rates characteristic of weak eurozone countries.
One of the central concerns prior to the bailout was that the crisis could spread to several other countries after reducing confidence in other European economies. According to the UK Financial Policy Committee "Market concerns remain over fiscal positions in a number of euro area countries and the potential for contagion to banking systems." Besides Ireland, with a government deficit in 2010 of 32.4% of GDP, and Portugal at 9.1%, other countries such as Spain with 9.2% are also at risk.
For 2010, the OECD forecast $16 trillion would be raised in government bonds among its 30 member countries. Financing needs for the eurozone come to a total of €1.6 trillion, while the U.S. is expected to issue US$1.7 trillion more Treasury securities in this period, and Japan has ¥213 trillion of government bonds to roll over. Greece has been the notable example of an industrialised country that has faced difficulties in the markets because of rising debt levels but even countries such as the U.S., Germany and the UK, have had fraught moments as investors shunned bond auctions due to concerns about public finances and the economy.
Italy's deficit of 4.6 percent of GDP in 2010 was similar to Germany’s at 4.3 percent and less than that of the U.K. and France. Italy even has a surplus in its primary budget, which excludes debt interest payments. However, its debt has increased to almost 120 percent of GDP (U.S. $2.4 trillion in 2010) and economic growth was lower than the EU average for over a decade. This has led investors to view Italian bonds more and more as a risky asset.
On the other hand, the public debt of Italy has a longer maturity and a substantial share of it is held domestically. Overall this makes the country more resilient to financial shocks, ranking better than France and Belgium. About 300 billion euros of Italy's 1.9 trillion euro debt matures in 2012. It will therefore have to go to the capital markets for significant refinancing in the near-term.
On 15 July and 14 September 2011, Italy's government passed austerity measures meant to save €124 billion. Nonetheless, by 8 November 2011 the Italian bond yield was 6.74 percent for 10-year bonds, climbing above the 7 percent level where the country is thought to lose access to financial markets. On 11 November 2011, Italian 10-year borrowing costs fell sharply from 7.5 to 6.7 percent after Italian legislature approved further austerity measures and the formation of an emergency government to replace that of Prime Minister Silvio Berlusconi.
The measures include a pledge to raise €15 billion from real-estate sales over the next three years, a two-year increase in the retirement age to 67 by 2026, opening up closed professions within 12 months and a gradual reduction in government ownership of local services. The interim government expected to put the new laws into practice is led by former European Union Competition Commissioner Mario Monti.
As in other countries, the social effects have been severe, with child labour even re-emerging in poorer areas.
See also: 2008–2012 Spanish financial crisis
Spain has a comparatively low debt among advanced economies. The country's public debt relative to GDP in 2010 was only 60%, more than 20 points less than Germany, France or the US, and more than 60 points less than Italy, Ireland or Greece. Like Italy, Spain has most of its debt controlled internally, and both countries are in a better fiscal situation than Greece and Portugal, making a default unlikely unless the situation gets far more severe.
As one of the largest eurozone economies, the condition of Spain's economy is of particular concern to international observers, and has faced pressure from the United States, the IMF, other European countries and the European Commission to cut its deficit more aggressively. Spain's public debt was approximately U.S. $820 billion in 2010, roughly the level of Greece, Portugal, and Ireland combined.
Rumors raised by speculators about a Spanish bail-out were dismissed by then Spanish Prime Minister José Luis Rodríguez Zapatero as "complete insanity" and "intolerable". Nevertheless, shortly after the announcement of the EU's new "emergency fund" for eurozone countries in early May 2010, Spain had to announce new austerity measures designed to further reduce the country's budget deficit, in order to signal financial markets that it was safe to invest in the country. The Spanish government had hoped to avoid such deep cuts, but weak economic growth as well as domestic and international pressure forced the government to expand on cuts already announced in January.
Spain succeeded in trimming its deficit from 11.2% of GDP in 2009 to 9.2% in 2010 and 8.5% in 2011. Due to the European crisis and over spending by regional governments the latest figure is higher than the original target of 6%. To build up additional trust in the financial markets, the government amended the Spanish Constitution in 2011 to require a balanced budget at both the national and regional level by 2020. The amendment states that public debt can not exceed 60% of GDP, though exceptions would be made in case of a natural catastrophe, economic recession or other emergencies. Under pressure from the EU the new conservative Spanish government led by Mariano Rajoy aims to cut the deficit further to 5.3 percent in 2012 and 3 percent in 2013.
As of June 6, 2012 a bailout package for Spain of between €40 and 100 billion was reported to be under consideration. The package was described as available if requested which it was on June 9, 2012 and granted for an amount up to €100 billion. The exact amount will depend on audits of the condition of Spanish banks which are in progress. The loan will be to the Spanish government but earmarked for relief of troubled banks. A larger economy than other countries which have received bailout packages, Spain had considerable bargaining power regarding the terms of a bailout. Due to reforms already instituted by Spain's conservative government less stringent austerity requirements are included then was the case with earlier bailout packages for Ireland, Portugal, and Greece.
In 2010, Belgium's public debt was 100% of its GDP—the third highest in the eurozone after Greece and Italy and there were doubts about the financial stability of the banks, following the country's major financial crisis in 2008–2009. After inconclusive elections in June 2010, by November 2011 the country still had only a caretaker government as parties from the two main language groups in the country (Flemish and Walloon) were unable to reach agreement on how to form a majority government. In November 2010 financial analysts forecast that Belgium would be the next country to be hit by the financial crisis as Belgium's borrowing costs rose.
However the government deficit of 5% was relatively modest and Belgian government 10-year bond yields in November 2010 of 3.7% were still below those of Ireland (9.2%), Portugal (7%) and Spain (5.2%). Furthermore, thanks to Belgium's high personal savings rate, the Belgian Government financed the deficit from mainly domestic savings, making it less prone to fluctuations of international credit markets. Nevertheless on 25 November 2011, Belgium's long-term sovereign credit rating was downgraded from AA+ to AA by Standard and Poor and 10-year bond yields reached 5.66%.
Shortly after, Belgian negotiating parties reached an agreement to form a new government. The deal includes spending cuts and tax rises worth about €11 billion, which should bring the budget deficit down to 2.8% of GDP by 2012, and to balance the books in 2015. Following the announcement Belgium 10-year bond yields fell sharply to 4.6%.
France's public debt in 2010 was approximately U.S. $2.1 trillion and 83% GDP, with a 2010 budget deficit of 7% GDP. By 16 November 2011, France's bond yield spreads vs. Germany had widened 450% since July, 2011. France's C.D.S. contract value rose 300% in the same period.
On 1 December 2011, France's bond yield had retreated and the country successfully auctioned €4.3 billion worth of 10 year bonds at an average yield of 3.18%, well below the perceived critical level of 7%. By early February 2012, yields on French 10 year bonds had fallen to 2.84%.
Main article: United Kingdom national debt
According to the Financial Policy Committee "Any associated disruption to bank funding markets could spill over to UK banks." The UK has the highest gross foreign debt of any European country (€7.3 trillion; €117,580 per person) due in large part to its highly leveraged financial industry, which is closely connected with both the United States and the eurozone.
In 2012 the U.K. economy was in recession, being negatively impacted by reduced economic activity in Europe, and apprehensive regarding possible future impacts of the Eurozone crisis. The Bank of England made substantial funds available at reduced interest to U.K. banks for loans to domestic enterprises. The bank is also providing liquidity by purchase of large quantities of government bonds, a program which may be expanded. Bank of England support of British banks with respect to the Eurozone crisis was backed by the British Treasury.
Bank of England governor Mervyn King stated in May 2012 that the Euro zone is "tearing itself apart" and advised British banks to pay bonuses and dividends in stock to hoard cash. He acknowledged that the Bank of England, the Financial Services Authority, and the British government were preparing contingency plans for a Greek exit from the Euro or a collapse of the currency, but refused to discuss them to avoid adding to the panic. Known contingency plans include emergency immigration controls to prevent millions of Greek and other EU residents from entering the country to seek work, and the evacuation of Britons from Greece during civil unrest.
A Euro collapse would damage London's role as a major financial centre because of the increased risk to UK banks. The pound and gilts would likely benefit, however, as investors seek safer investments. The London real estate market has similarly benefited from the crisis, with French, Greeks, and other Europeans buying property with capital moved out of their home countries, and a Greek exit from the Euro would likely increase such transfer of capital.
Switzerland was impacted by the Eurozone crisis as money was moved into Swiss assets seeking safety from the Eurozone crisis as well as by apprehension of further worsening of the crisis. This resulted in appreciation of the Swiss Franc with respect to the Euro and other currencies which drove down internal prices and raised the price of exports. Credit Suisse was required to increase its capitalization by the Swiss National Bank which also declared its intention to continue to retard rise of Swiss franc by substantial purchases of other currencies; purchases of the Euro had the effect of maintaining the value of the Euro which before Swiss intervention had fallen below the Swiss comfort level. Real estate values in Switzerland are extremely high, thus posing a possible risk.
In relationship to the total amounts involved in the Eurozone crisis the economy of Germany is relatively small and would be unable, even if it were willing, to guarantee payment of the sovereign debts of the rest of the Eurozone as Spain and even Italy and France are added to potentially defaulting nations. Thus, according to Chancellor Angela Merkel, German participation in rescue efforts are conditioned on negotiation of Eurozone reforms which have the potential to resolve the underlying imbalances which are driving the crisis.
EU emergency measures
European Financial Stability Facility (EFSF)
Main article: European Financial Stability Facility
On 9 May 2010, the 27 EU member states agreed to create the European Financial Stability Facility, a legal instrument aiming at preserving financial stability in Europe by providing financial assistance to eurozone states in difficulty. The EFSF can issue bonds or other debt instruments on the market with the support of the German Debt Management Office to raise the funds needed to provide loans to eurozone countries in financial troubles, recapitalize banks or buy sovereign debt.
Emissions of bonds are backed by guarantees given by the euro area member states in proportion to their share in the paid-up capital of the European Central Bank. The €440 billion lending capacity of the facility is jointly and severally guaranteed by the eurozone countries' governments and may be combined with loans up to €60 billion from the European Financial Stabilisation Mechanism (reliant on funds raised by the European Commission using the EU budget as collateral) and up to €250 billion from the International Monetary Fund (IMF) to obtain a financial safety net up to €750 billion.
The EFSF issued €5 billion of five-year bonds in its inaugural benchmark issue 25 January 2011, attracting an order book of €44.5 billion. This amount is a record for any sovereign bond in Europe, and €24.5 billion more than the European Financial Stabilisation Mechanism(EFSM), a separate European Union funding vehicle, with a €5 billion issue in the first week of January 2011.
On 29 November 2011, the member state finance ministers agreed to expand the EFSF by creating certificates that could guarantee up to 30% of new issues from troubled euro-area governments, and to create investment vehicles that would boost the EFSF’s firepower to intervene in primary and secondary bond markets.
Reception by financial markets
Stocks surged worldwide after the EU announced the EFSF's creation. The facility eased fears that the Greek debt crisis would spread, and this led to some stocks rising to the highest level in a year or more. The euro made its biggest gain in 18 months, before falling to a new four-year low a week later. Shortly after the euro rose again as hedge funds and other short-term traders unwound short positions and carry trades in the currency. Commodity prices also rose following the announcement.
The dollar Libor held at a nine-month high. Default swaps also fell. The VIX closed down a record almost 30%, after a record weekly rise the preceding week that prompted the bailout. The agreement is interpreted as allowing the ECB to start buying government debt from the secondary market which is expected to reduce bond yields. As a result Greek bond yields fell sharply from over 10% to just over 5%. Asian bonds yields also fell with the EU bailout.)
Usage of EFSF funds
Debt profile of Eurozone countries
The EFSF only raises funds after an aid request is made by a country. As of the end of December 2011, it has been activated two times. In November 2010, it financed €17.7 billion of the total €67.5 billion rescue package for Ireland (the rest was loaned from individual European countries, the European Commission and the IMF). In May 2011 it contributed one third of the €78 billion package for Portugal. As part of the second bailout for Greece, the loan was shifted to the EFSF, amounting to €164 billion (130bn new package plus 34.4bn remaining from Greek Loan Facility) throughout 2014. This leaves the EFSF with €250 billion or an equivalent of €750 billion in leveraged firepower. According to German newspaper Sueddeutsche, this is more than enough to finance the debt rollovers of all flagging European countries until end of 2012, in case necessary.
The EFSF is set to expire in 2013, running one year parallel to the permanent €500 billion rescue funding program called the European Stability Mechanism (ESM), which will start operating as soon as member states representing 90% of the capital commitments have ratified it. This is expected to be in July 2012.
On 13 January 2012, Standard & Poor’s downgraded France and Austria from AAA rating, lowered Spain, Italy (and five other) euro members further, and maintained the top credit rating for Finland, Germany, Luxembourg, and the Netherlands; shortly after, S&P also downgraded the EFSF from AAA to AA+.
European Financial Stabilisation Mechanism (EFSM)
Main article: European Financial Stabilisation Mechanism
On 5 January 2011, the European Union created the European Financial Stabilisation Mechanism (EFSM), an emergency funding programme reliant upon funds raised on the financial markets and guaranteed by the European Commission using the budget of the European Union as collateral. It runs under the supervision of the Commission and aims at preserving financial stability in Europe by providing financial assistance to EU member states in economic difficulty. The Commission fund, backed by all 27 European Union members, has the authority to raise up to €60 billion and is rated AAA by Fitch, Moody's and Standard & Poor's.
Under the EFSM, the EU successfully placed in the capital markets a €5 billion issue of bonds as part of the financial support package agreed for Ireland, at a borrowing cost for the EFSM of 2.59%.
Like the EFSF, the EFSM will also be replaced by the permanent rescue funding programme ESM, which is due to be launched in July 2012.
Brussels agreement and aftermath
On 26 October 2011, leaders of the 17 eurozone countries met in Brussels and agreed on a 50% write-off of Greek sovereign debt held by banks, a fourfold increase (to about €1 trillion) in bail-out funds held under the European Financial Stability Facility, an increased mandatory level of 9% for bank capitalisation within the EU and a set of commitments from Italy to take measures to reduce its national debt. Also pledged was €35 billion in "credit enhancement" to mitigate losses likely to be suffered by European banks. José Manuel Barroso characterised the package as a set of "exceptional measures for exceptional times".
The package's acceptance was put into doubt on 31 October when Greek Prime Minister George Papandreou announced that a referendum would be held so that the Greek people would have the final say on the bailout, upsetting financial markets. On 3 November 2011 the promised Greek referendum on the bailout package was withdrawn by Prime Minister Papandreou.
In late 2011, Landon Thomas in the New York Times noted that some, at least, European banks were maintaining high dividend payout rates and none were getting capital injections from their governments even while being required to improve capital ratios. Thomas quoted Richard Koo, an economist based in Japan, an expert on that country's banking crisis, and specialist in balance sheet recessions, as saying:
I do not think Europeans understand the implications of a systemic banking crisis.... When all banks are forced to raise capital at the same time, the result is going to be even weaker banks and an even longer recession – if not depression.... Government intervention should be the first resort, not the last resort.
Beyond equity issuance and debt-to-equity conversion, then, one analyst "said that as banks find it more difficult to raise funds, they will move faster to cut down on loans and unload lagging assets" as they work to improve capital ratios. This latter contraction of balance sheets "could lead to a depression”, the analyst said. Reduced lending was a circumstance already at the time being seen in a "deepen[ing] crisis" in commodities trade finance in western Europe.
Final agreement on the second bailout package
In a marathon meeting on 20/21 February 2012 the Eurogroup agreed with the IMF and the Institute of International Finance on the final conditions of the second bailout package worth €130 billion. The lenders agreed to increase the nominal haircut from 50% to 53.5%. EU Member States agreed to an additional retroactive lowering of the interest rates of the Greek Loan Facility to a level of just 150 basis points above the Euribor. Furthermore, governments of Member States where central banks currently hold Greek government bonds in their investment portfolio commit to pass on to Greece an amount equal to any future income until 2020. Altogether this should bring down Greece's debt to between 117% and 120.5% of GDP by 2020.
European Central Bank
ECB Securities Markets Program (SMP) covering bond purchases from May 2010 till May 2012.
The European Central Bank (ECB) has taken a series of measures aimed at reducing volatility in the financial markets and at improving liquidity.
In May 2010 it took the following actions:
It began open market operations buying government and private debt securities, reaching €219.5 billion by February 2012, though it simultaneously absorbed the same amount of liquidity to prevent a rise in inflation. According to Rabobank economist Elwin de Groot, there is a “natural limit” of €300 billion the ECB can sterilize.
It reactivated the dollar swap lines with Federal Reserve support.
It changed its policy regarding the necessary credit rating for loan deposits, accepting as collateral all outstanding and new debt instruments issued or guaranteed by the Greek government, regardless of the nation's credit rating.
The move took some pressure off Greek government bonds, which had just been downgraded to junk status, making it difficult for the government to raise money on capital markets.
On 30 November 2011, the ECB, the U.S. Federal Reserve, the central banks of Canada, Japan, Britain and the Swiss National Bank provided global financial markets with additional liquidity to ward off the debt crisis and to support the real economy. The central banks agreed to lower the cost of dollar currency swaps by 50 basis points to come into effect on 5 December 2011. They also agreed to provide each other with abundant liquidity to make sure that commercial banks stay liquid in other currencies.
Long Term Refinancing Operation (LTRO)
On 22 December 2011, the ECB started the biggest infusion of credit into the European banking system in the euro's 13 year history. Under its Long Term Refinancing Operations (LTROs) it loaned €489 billion to 523 banks for an exceptionally long period of three years at a rate of just one percent. Previous refinancing operations matured after three, six and twelve months. The by far biggest amount of €325 billion was tapped by banks in Greece, Ireland, Italy and Spain.
This way the ECB tried to make sure that banks have enough cash to pay off €200 billion of their own maturing debts in the first three months of 2012, and at the same time keep operating and loaning to businesses so that a credit crunch does not choke off economic growth. It also hoped that banks would use some of the money to buy government bonds, effectively easing the debt crisis. On 29 February 2012, the ECB held a second auction, LTRO2, providing 800 Eurozone banks with further €529.5 billion in cheap loans. Net new borrowing under the €529.5 billion February auction was around €313 billion; out of a total of €256 billion existing ECB lending (MRO + 3m&6m LTROs), €215 billion was rolled into LTRO2.
In September 2011, Jürgen Stark became the second German after Axel A. Weber to resign from the ECB Governing Council in 2011. Weber, the former Deutsche Bundesbank president, was once thought to be a likely successor to Jean-Claude Trichet as bank president. He and Stark were both thought to have resigned due to "unhappiness with the ECB’s bond purchases, which critics say erode the bank’s independence". Stark was "probably the most hawkish" member of the council when he resigned. Weber was replaced by his Bundesbank successor Jens Weidmann, while Belgium's Peter Praet took Stark's original position, heading the ECB's economics department.
Money supply growth
In April, 2012, statistics showed a growth trend in the M1 "core" money supply. Having fallen from an over 9% growth rate in mid-2008 to negative 1% +/- for several months in 2011, M1 core has built to a 2-3% range in early 2012. "'It is still early days but a further recovery in peripheral real M1 would suggest an end to recessions by late 2012,' said Simon Ward from Henderson Global Investors who collects the data." While attributing the money supply growth to ECB's LTRO policies, an analysis in The Telegraph said lending "continued to fall across the eurozone in March [and] ... [t]he jury is out on the ... three-year lending adventure (LTRO)".
Reorganization of the European banking system
On June 16, 2012 the European Central Bank together with other European leaders hammered out plans for the ECB to become a bank regulator and to form a deposit insurance program to augment national programs. Other economic reforms promoting European growth and employment were also proposed.
European Stability Mechanism (ESM)
Main article: European Stability Mechanism
The European Stability Mechanism (ESM) is a permanent rescue funding programme to succeed the temporary European Financial Stability Facility and European Financial Stabilisation Mechanism in July 2012.
On 16 December 2010 the European Council agreed a two line amendment to the EU Lisbon Treaty to allow for a permanent bail-out mechanism to be established including stronger sanctions. In March 2011, the European Parliament approved the treaty amendment after receiving assurances that the European Commission, rather than EU states, would play 'a central role' in running the ESM. According to this treaty, the ESM will be an intergovernmental organisation under public international law and will be located in Luxembourg.
Such a mechanism serves as a "financial firewall." Instead of a default by one country rippling through the entire interconnected financial system, the firewall mechanism can ensure that downstream nations and banking systems are protected by guaranteeing some or all of their obligations. Then the single default can be managed while limiting financial contagion.
European Fiscal Compact
Main article: European Fiscal Compact
In March 2011 a new reform of the Stability and Growth Pact was initiated, aiming at straightening the rules by adopting an automatic procedure for imposing of penalties in case of breaches of either the deficit or the debt rules. By the end of the year, Germany, France and some other smaller EU countries went a step further and vowed to create a fiscal union across the eurozone with strict and enforceable fiscal rules and automatic penalties embedded in the EU treaties. On 9 December 2011 at the European Council meeting, all 17 members of the eurozone and six countries that aspire to join agreed on a new intergovernmental treaty to put strict caps on government spending and borrowing, with penalties for those countries who
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