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European Debt Crisis

The European Debt Crisis refers to the ongoing European sovereign government struggle to repay various national debts the countries ran up over the past several decades. There were five of the peripheral EU states in particular that were unable to create sufficient economic growth in order to make possible their repaying of the national bondholders as they promised to originally.

These countries included especially Greece, Portugal, and Ireland, but also enmeshed were Spain and Italy to one degree or another. Though only these five nations showed signs of potential default during the crisis peak in the years 2010 to 2011, the crisis had broad and dangerous consequences that impacted not only the rest of the European Union, but also the world in general. The governor of the Bank of England called this the “most serious financial crisis at least since the 1930s, if not ever,” back in October of 2011.

The European Debt Crisis did not suddenly appear overnight, but was years and even decades in the making. Slower growth from the time of the American based financial crisis and Great Recession from 2007 to 2009 demonstrated that many spending policies in Europe and the world at large were truly unsustainable any more. Greece became the poster child for the effects of reckless overspending in the following years. The Greeks had spent with great largesse for seemingly endless years and avoided painful but urgently needed financial and fiscal reforms. They were the first to feel the negative effects of weaker ongoing growth as it so happened.

As growth slows down, tax revenues also decrease apace. This means that greater budget deficits become impossible to sustain. The Greeks had been hiding the amounts of their large and increasing national deficits for years, but by the end of 2009, it was no longer possible to keep them from world markets and the enraged Greek populace any longer. The Greek debts had become so vast that they substantially exceeded the entire economy of the smaller nation.

Investors in their sovereign debt naturally retaliated by insisting on larger yields on their Greek national bonds. The unfortunate side effect of this action was that the interest payments on the Greek debt also skyrocketed, causing their debt burden to become so onerous that they could not manage it any longer. The EU and European Central Bank had to come riding to the rescue of the Greek government and economy in consequence. This did not stop investors and markets from pushing up the yields of bonds in other similarly indebted nations throughout Europe, where they expected similar crises and potential collapse as had already tragically occurred in Greece.

The vicious cycle of higher demand yields leading to greater borrowing costs for the nations in crisis led to greater fiscal strain which caused investors to require still higher interest yields on the troubled European sovereign bonds. This gradual erosion of investor confidence did not stay focused on Greece, but impacted the other shaky economies of Portugal, Ireland, Cyprus, Spain, and even G7 trillion-plus dollar economy Italy. This became known as financial crisis contagion. Portugal, Ireland, Cyprus, and Spain were forced to seek out bailouts either for their embattled sovereign government finances, their national primary banks, or in the cases of Portugal and Ireland, both.

The problems were exacerbated by the fact that the European Union moved so slowly to address the severe problems. This is because their actions required the approval of all 28 countries in the economic and political union. Bailouts were offered to the troubled governments via the European Stabilization Mechanism or ESM. The European Central Bank acted in a substitute capacity by cutting interest rates and providing unlimited loans to European national banks which were in trouble in exchange for assets (which were highly questionable at best) as collateral.

The problems of the European Debt Crisis are far from over fully five long years later. Italy’s banks have not yet addressed their over $360 billion in bad loans to this day. Their third largest and oldest bank Monte Dei Paschi Di Sienna has 28 billion Euros in bad debts it has been trying unsuccessfully to offload as it sought out 5 billion Euros in fresh capital from skeptical investors. Greece is on its third consecutive bailout program from the EU so far in only five years. Portugal, Ireland, and Cyprus have all emerged successfully from their bailout and bank recapitalization programs, while Spain is on the right track and making measurable and material progress in escaping from theirs.

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