The euro area crisis, often also referred to as the eurozone crisis or the European sovereign debt crisis, was a multi-year debt crisis that took place in the European Union (EU) from 2009 until the mid to late 2010s. Several eurozone member states (Greece, Portugal, Ireland and Cyprus) were unable to repay or refinance their government debt or to bail out over-indebted banks under their national supervision without the assistance of other eurozone countries, the European Central Bank (ECB), or the International Monetary Fund (IMF).
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 2008 financial crisis; international trade imbalances; real-estate bubbles that have since burst; the Great 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 lenders and borrowers put these savings to use, 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 three crucial problems of the European economic governance emerged during the crisis are the asymmetry in the policy-making process for centralized policies and decentralized ones, ambiguities related to the coherent functioning of the euro area and the EU as well as of distribution of powers between national institutions and supranational ones, which implies the dilemma of legitimacy of the European economic governance and its rules.
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.
EU emergency measures
European Financial Stability Facility (EFSF)
On 9 May 2010, the 27 EU member states agreed to create the European Financial Stability Facility, a legal instrument The EFSF, "a legal instrument agreed by finance ministers earlier this month following the risk of Greece's debt crisis spreading to other weak economies." 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.Europeanvoice.com "Media reports said that Spain would ask for support from two EU funds for eurozone governments in financial difficulty: a €60bn 'European financial stabilisation mechanism', which is reliant on guarantees from the EU budget."
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 The EFSF only raises funds after an aid request is made by a country. As of the end of July 2012, it has been activated various times. In November 2010, it financed of the total 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 (130bn new package plus 34.4bn remaining from Greek Loan Facility) throughout 2014. On 20 July 2012, European finance ministers sanctioned the first tranche of a partial bail-out worth up to €100 billion for Spanish banks. This leaves the EFSF with or an equivalent of in leveraged firepower.
The EFSF is set to expire in 2013, running some months parallel to the permanent 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. (see section: ESM)
On 13 January 2012, Standard & Poor’s downgraded France and Austria from AAA rating, lowered Spain, Italy (and five otherGibson, Kate, "S&P takes Europe's rescue fund down a notch" , MarketWatch, 16 January 2012 2:37 pm EST. Retrieved 16 January 2012.) 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+.Standard & Poor's Ratings Services quoted at
European Financial Stabilisation Mechanism (EFSM)
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 and is rated AAA by Fitch, Moody's and Standard & Poor's.
Under the EFSM, the EU successfully placed in the capital markets a 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 was replaced by the permanent rescue funding programme ESM, which was launched in September 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 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.