European sovereign-debt crisis 1

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 more

indicates that financial markets have serious doubts about credit-worthiness.[2]

The 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.[3]

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 ofgovernment 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.[4][5] European banks own a significant amount ofsovereign debt, such that concerns regarding the solvency of banking systems or sovereigns are negativelyreinforcing.[6]

Concerns intensified in early 2010 and thereafter,[7][8] 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).[9] 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,[10] increasing the EFSF to about €1 trillion, andrequiring European banks to achieve 9% capitalisation.[11] 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.[12][13] 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.[14] 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 for the area as a whole,[15] leading to continuous speculation of a possible breakup of the Eurozone. However, as of

European sovereign-debt crisis 2

mid-November 2011, the Euro was even trading slightly higher against the bloc's major trading partners than at thebeginning of the crisis,[16][17] before losing some ground in the following months.[18][19] Three countriessignificantly affected, Greece, Ireland and Portugal, collectively accounted for 6% of the eurozone's gross domesticproduct (GDP).[20] In June 2012, also Spain became a matter of concern,[21] when rising interest rates began to affectits ability to access capital markets, leading to a bailout of its banks and other measures.[22]

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.[23] 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.

Causes

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. [24][25]

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 crisis 3

Government debt of Eurozone, Germany and crisis countries compared toEurozone GDP

Government deficit of Eurozone compared to USA and UK

for higher yields than those offered by U.S.Treasury bonds sought alternativesglobally.[26]

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.[25]

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.[4] Iceland's banking system grewenormously, creating debts to globalinvestors (external debts) several timesGDP.[25][27]

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.[6][28] 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.[29]

Greece hid its growing debt and deceived EU officials with the help of derivatives designed by majorbanks.[30][31][32][33][34][35] Although some financial institutions clearly profited from the growing Greek governmentdebt in the short run,[30] there was a long lead-up to the crisis.

European sovereign-debt crisis 4

Rising household and government debt levelsIn 1992, members of the European Union signed the Maastricht Treaty, under which they pledged to limit theirdeficit spending and debt levels. However, a number of EU member states, including Greece and Italy, were able tocircumvent these rules, failing to abide by their own internal guidelines, sidestepping best practice and ignoringinternationally agreed standards.[36] This allowed the sovereigns to mask their deficit and debt levels through acombination of techniques, including inconsistent accounting, off-balance-sheet transactions [36] as well as the use ofcomplex currency and credit derivatives structures.[37][38] The complex structures were designed by prominent U.S.investment banks, who received substantial fees in return for their services.[30]

The adoption of the euro led to many Eurozone countries of different credit worthiness receiving similar and verylow interest rates for their bonds during years preceding the crisis, which author Michael Lewis referred to as "a sortof implicit Germany guarantee."[4]

Public debt as a percent of GDP (2010)

A number of economists have dismissed thepopular belief that the debt crisis was causedby excessive social welfare spending.According to their analysis, increased debtlevels were mostly due to the large bailoutpackages provided to the financial sectorduring the late-2000s financial crisis, andthe global economic slowdown thereafter.The average fiscal deficit in the euro area in2007 was only 0.6% before it grew to 7%during the financial crisis. In the sameperiod, the average government debt rosefrom 66% to 84% of GDP. The authors also stressed that fiscal deficits in the euro area were stable or even shrinkingsince the early 1990s.[39] US economist Paul Krugman named Greece as the only country where fiscalirresponsibility is at the heart of the crisis.[40]

Unprecedented household debt levels were another cause. The International Monetary Fund (IMF) reported in April2012 that in advanced economies, during the five years preceding 2007, the ratio of household debt to income roseby an average of 39 percentage points, to 138 percent. In Denmark, Iceland, Ireland, the Netherlands, and Norway,debt peaked at more than 200 percent of household income. A surge in household debt to historic highs also occurredin emerging economies such as Estonia, Hungary, Latvia, and Lithuania. When house prices declined, manyhouseholds saw their wealth shrink relative to their debt. By the end of 2011, real house prices had fallen from theirpeak by about 41% in Ireland, 29% in Iceland, 23% in Spain and the United States, and 21% in Denmark. Householddefaults, underwater mortgages (where the loan balance exceeds the house value), foreclosures, and fire sales wereendemic to a number of economies as of 2012. Household deleveraging by paying off debts or defaulting on themhas begun in some countries, which slows economic growth.[41][42]

Either way, high debt levels alone may not explain the crisis. According to The Economist Intelligence Unit, theposition of the euro area looked "no worse and in some respects, rather better than that of the US or the UK." Thebudget deficit for the euro area as a whole (see graph) is much lower and the euro area's government debt/GDP ratioof 86% in 2010 was about the same level as that of the US. Moreover, private-sector indebtedness across the euroarea is markedly lower than in the highly leveraged Anglo-Saxon economies.[43]

European sovereign-debt crisis 5

Trade imbalances

Current account balances relative to GDP (2010)

Commentator and Financial Timesjournalist Martin Wolf has asserted that theroot of the crisis was growing tradeimbalances. He notes in the run-up to thecrisis, from 1999 to 2007, Germany had aconsiderably better public debt and fiscaldeficit relative to GDP than the mostaffected eurozone members. In the sameperiod, these countries (Portugal, Ireland,Italy and Spain) had far worse balance ofpayments positions.[44][45] Whereas Germantrade surpluses increased as a percentage ofGDP after 1999, the deficits of Italy, Franceand Spain all worsened.

Paul Krugman wrote in 2009 that a tradedeficit by definition requires acorresponding 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 Americanhomeowners: asset prices were rising, currencies were strong, and everything looked fine. But bubbles always burstsooner or later, and yesterday’s miracle economies have become today’s basket cases, nations whose assets haveevaporated but whose debts remain all too real."[46]

A trade deficit can also be affected by changes in relative labor costs, which made southern nations less competitiveand increased trade imbalances. Since 2001, Italy's unit labor costs rose 32% relative to Germany's.[47][48] Greek unitlabor costs rose much faster than Germany's during the last decade.[49] However, most EU nations had increases inlabor costs greater than Germany's.[50] Those nations that allowed "wages to grow faster than productivity" lostcompetitiveness.[45] Germany's restrained labor costs, while a debatable factor in trade imbalances,[50] are animportant factor for its low unemployment rate.[51] More recently, Greece's trading position has improved;[52] in theperiod 2011 to 2012, imports dropped 20.9% while exports grew 16.9%, reducing the trade deficit by 42.8%.[52]

Simon Johnson explains the hope for convergence in the Euro-zone and what went wrong. The euro locks countriesinto an exchange rate amounting to “very big bet that their economies would converge in productivity.” If not,workers would move to countries with greater productivity. Instead the opposite happened: the gap between Germanand Greek productivity increased resulting in a large current account surplus financed by capital flows. The capitalflows could have been invested to increase productivity in the peripheral nations. Instead capital flows weresquandered in consumption and consumptive investments.[53]

Further, Eurozone countries with sustained trade surpluses (i.e., Germany) do not see their currency appreciaterelative to the other Eurozone nations due to a common currency, keeping their exports artificially cheap. Germany'strade surplus within the Eurozone declined in 2011 as its trading partners were less able to find financing necessaryto fund their trade deficits, but Germany's trade surplus outside the Eurozone has soared as the euro declined in valuerelative to the dollar and other currencies.[54]

European sovereign-debt crisis 6

Structural problem of Eurozone systemThere 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).[55] In the Eurozone system, thecountries are required to follow a similar fiscal path, but they do not have common treasury to enforce it. That is,countries with the same monetary system have freedom in fiscal policies in taxation and expenditure. So, eventhough there are some agreements on monetary policy and through European Central Bank, countries may not beable 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 17nations as its members, require unanimous agreement for a decision making process. This would lead to failure incomplete prevention of contagion of other areas, as it would be hard for the Eurozone to respond quickly to theproblem.[56]

In addition, as of June 2012 there was no "banking union" meaning that there was no Europe-wide approach to bankdeposit insurance, bank oversight, or a joint means of recapitalization or resolution (wind-down) of failing banks.[14]

Bank deposit insurance helps avoid bank runs. Recapitalization refers to injecting money into banks so that they canmeet their immediate obligations and resume lending, as was done in 2008 in the U.S. via the Troubled Asset ReliefProgram.[57]

Columnist Thomas L. Friedman wrote in June 2012: "In Europe, hyperconnectedness both exposed just howuncompetitive some of their economies were, but also how interdependent they had become. It was a deadlycombination. When countries with such different cultures become this interconnected and interdependent — whenthey share the same currency but not the same work ethics, retirement ages or budget discipline — you end up withGerman savers seething at Greek workers, and vice versa."[58]

Monetary policy inflexibilityFurther information: Economic and Monetary Union of the European UnionSince membership of the Eurozone establishes a single monetary policy, individual member states can no longer actindependently, 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 exportscheaper, in principle leading to an improved balance of trade, increased GDP and higher tax revenues in nominalterms.[59]

In the reverse direction moreover, assets held in a currency which has devalued suffer losses on the part of thoseholding them. For example, by the end of 2011, following a 25 percent fall in the rate of exchange and 5 percent risein inflation, eurozone investors in Pound Sterling, locked in to euro exchange rates, had suffered an approximate 30percent cut in the repayment value of this debt.[60]

European sovereign-debt crisis 7

Loss of confidence

Sovereign CDS prices of selected European countries(2010–2012). The left axis is in basis points; a level of

1,000 means it costs $1 million to protect $10 million ofdebt for five years.

Prior to development of the crisis it was assumed by bothregulators and banks that sovereign debt from the eurozonewas safe. Banks had substantial holdings of bonds fromweaker economies such as Greece which offered a smallpremium and seemingly were equally sound. As the crisisdeveloped it became obvious that Greek, and possibly othercountries', bonds offered substantially more risk. Contributingto lack of information about the risk of European sovereigndebt was conflict of interest by banks that were earningsubstantial sums underwriting the bonds.[61] The loss ofconfidence is marked by rising sovereign CDS prices,indicating market expectations about countries'creditworthiness (see graph).

Furthermore, investors have doubts about the possibilities ofpolicy makers to quickly contain the crisis. Since countries thatuse the euro as their currency have fewer monetary policychoices (e.g., they cannot print money in their own currenciesto pay debt holders), certain solutions require multi-nationalcooperation. Further, the European Central Bank has aninflation control mandate but not an employment mandate, asopposed to the U.S. Federal Reserve, which has a dualmandate.

According to The Economist, the crisis "is as much political aseconomic" and the result of the fact that the euro area is notsupported by the institutional paraphernalia (and mutual bondsof solidarity) of a state.[43] Heavy bank withdrawals haveoccurred in weaker Eurozone states such as Greece and Spain.[62] Bank deposits in the Eurozone are insured, but byagencies of each member government. If banks fail, it is unlikely the government will be able to fully and promptlyhonor their commitment, at least not in euros, and there is the possibility that they might abandon the euro and revertto a national currency; thus, euro deposits are safer in Dutch, German, or Austrian banks than they are in Greece orSpain.[63]

As of June, 2012, many European banking systems were under significant stress, particularly Spain. A series of"capital calls" or notices that banks required capital contributed to a freeze in funding markets and interbank lending,as investors worried that banks might be hiding losses or were losing trust in one another.[64][65]

In June 2012, as the euro hit new lows with no bottom in sight, there were reports that the wealthy were movingassets out of the Eurozone.[66] Mario Draghi, president of the European Central Bank, has called for an integratedEuropean system of deposit insurance which would require European political institutions craft effective solutionsfor problems beyond the limits of the power of the European Central Bank.[67] As of June 6, 2012, closer integrationof European banking appeared to be under consideration by political leaders.[68]

Interest on long term sovereign debtIn June, 2012, following negotiation of the Spanish bailout line of credit interest on long-term Spanish and Italiandebt continued to rise rapidly, casting doubt on the efficacy of bailout packages as anything more than a stopgapmeasure. The Spanish rate, over 6% before the line of credit was approved, approached 7%, a rough rule of thumbindicator of serious trouble.[69]

European sovereign-debt crisis 8

Rating agency viewsOn 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 ofeurozone sovereigns including some that are currently rated 'AAA'; 3) Continuing disagreements among Europeanpolicy makers on how to tackle the immediate market confidence crisis and, longer term, how to ensure greatereconomic, financial, and fiscal convergence among eurozone members; 4) High levels of government and householdindebtedness across a large area of the eurozone; and 5) The rising risk of economic recession in the eurozone as awhole in 2012. Currently, we expect output to decline next year in countries such as Spain, Portugal and Greece, butwe now assign a 40% probability of a fall in output for the eurozone as a whole."[70]

Evolution of the crisisIn the first few weeks of 2010, there was renewed anxiety about excessive national debt, with lenders demandingever higher interest rates from several countries with higher debt levels, deficits and current account deficits. This inturn made it difficult for some governments to finance further budget deficits and service existing debt, particularlywhen economic growth rates were low, and when a high percentage of debt was in the hands of foreign creditors, asin the case of Greece and Portugal.[71]

Some governments have focused on austerity measures (e.g., higher taxes and lower expenses) which hascontributed to social unrest and significant debate among economists, many of whom advocate greater deficits wheneconomies 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 thesecountries and other EU member states, most importantly Germany.[72] By the end of 2011, Germany was estimatedto have made more than €9 billion out of the crisis as investors flocked to safer but near zero interest rate Germanfederal government bonds (bunds).[73] By July 2012 also the Netherlands, Austria and Finland benefited from zero ornegative interest rates. Looking at short-term government bonds with a maturity of less than one year the list ofbeneficiaries also includes Belgium and France.[74]

While Switzerland (and Denmark)[74] equally benefited from lower interest rates, the crisis also harmed its exportsector due to a substantial influx of foreign capital and the resulting rise of the Swiss franc. In September 2011 theSwiss National Bank surprised currency traders by pledging that "it will no longer tolerate a euro-franc exchange ratebelow the minimum rate of 1.20 francs", effectively weakening the Swiss franc. This is the biggest Swissintervention since 1978.[75]

European sovereign-debt crisis 9

Greece

Greece's debt percentage since 1999 compared to the average of the eurozone.

100,000 people protest against the harsh austeritymeasures in front of parliament building in

Athens, 29 May 2011

In the early mid-2000s, Greece'seconomy was one of the fastestgrowing in the eurozone and wasassociated with a large structuraldeficit.[76] As the world economy washit by the global financial crisis in thelate 2000s, Greece was hit especiallyhard because its main industries —shipping and tourism — wereespecially sensitive to changes in thebusiness cycle. The government spentheavily to keep the economyfunctioning and the country's debtincreased accordingly.

On 23 April 2010, the Greekgovernment requested an initial loan of€45 billion from the EU andInternational Monetary Fund (IMF), tocover its financial needs for theremaining part of 2010.[77][78] A fewdays later Standard & Poor's slashedGreece's sovereign debt rating to BB+or "junk" status amid fears ofdefault,[79] in which case investorswere liable to lose 30–50% of theirmoney.[79] Stock markets worldwideand the euro currency declined inresponse to the downgrade.[80]

On 1 May 2010, the Greek governmentannounced a series of austeritymeasures[81] to secure a three year€110 billion loan.[82] This was metwith great anger by the Greek public,leading to massive protests, riots andsocial unrest throughout Greece.[83] 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 austeritymeasures and a debt restructure agreement. A bit surprisingly, the Greek prime minister George Papandreou firstanswered that call, by announcing a December 2011 referendum on the new bailout plan,[84][85] but had to backdown amidst strong pressure from EU partners, who threatened to withhold an overdue €6 billion loan payment thatGreece needed by mid-December.[84][86] On 10 November 2011 Papandreou instead opted to resign, following anagreement with the New Democracy party and the Popular Orthodox Rally, to appoint non-MP technocrat LucasPapademos as new prime minister of an interim national union government, with responsibility for implementing theneeded austerity measures to pave the way for the second bailout loan.[87][88]

European sovereign-debt crisis 10

All the implemented austerity measures, have so far helped Greece bring down its primary deficit - i.e. fiscal deficitbefore interest payments - from €24.7bn (10.6% of GDP) in 2009 to just €5.2bn (2.4% of GDP) in 2011,[89][90] butas a side-effect they also contributed to a worsening of the Greek recession, which began in October 2008 and onlybecame worse in 2010 and 2011.[91] The austerity relies primarily on tax increases which harms the private sectorand economy.[92] Overall the Greek GDP had its worst decline in 2011 with −6.9%,[93] a year where the seasonaladjusted industrial output ended 28.4% lower than in 2005,[94][95] and with 111,000 Greek companies goingbankrupt (27% higher than in 2010).[96][97] As a result, the seasonal adjusted unemployment rate also grew from7.5% in September 2008 to a record high of 19.9% in November 2011, while the Youth unemployment rate duringthe same time rose from 22.0% to as high as 48.1%.[98][99] Youth unemployment ratio hit 13 percent in2011.[100][101]

Overall the share of the population living at "risk of poverty or social exclusion" did not increase noteworthily duringthe first 2 years of the crisis. The figure was measured to 27.6% in 2009 and 27.7% in 2010 (only being slightlyworse than the EU27-average at 23.4%),[102] but for 2011 the figure was now estimated to have risen sharply above33%.[103] In February 2012, an IMF official negotiating Greek austerity measures admitted that excessive spendingcuts were harming Greece.[89]

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 nationalcurrency the drachma at a debased rate.[104][105] However, if Greece were to leave the euro, the economic andpolitical consequences would be devastating. According to Japanese financial company Nomura an exit would leadto a 60% devaluation of the new drachma. Analysts at French bank BNP Paribas added that the fallout from a Greekexit would wipe 20% off Greece's GDP, increase Greece's debt-to-GDP ratio to over 200%, and send inflationsoaring to 40%-50%.[106] Also UBS warned of hyperinflation, a bank run and even "military coups and possible civilwar that could afflict a departing country".[107][108] Eurozone National Central Banks (NCBs) may lose up to€100bn in debt claims against the Greek national bank through the ECB's TARGET2 system. The DeutscheBundesbank alone may have to write off €27bn.[109]

To prevent all this from happening, the troika (EU, IMF and ECB) eventually agreed in February 2012 to provide asecond bailout package worth €130 billion,[110] conditional on the implementation of another harsh austeritypackage, reducing the Greek spendings with €3.3bn in 2012 and another €10bn in 2013 and 2014.[90] For the firsttime, 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, partlyin short-term EFSF notes, partly in new Greek bonds with lower interest rates and the maturity prolonged to 11–30years (independently of the previous maturity).[10] The deal implies that previous Greek bond holders are beinggiven, for 1000€ of previous notional, 150€ in “PSI payment notes” issued by the EFSF and 315€ in “New GreekBonds” issued by the Hellenic Republic, including a “GDP-linked security”. The latter represents a marginal couponenhancement in case the Greek growth meets certain conditions. While the market price of the portfolio proposed inthe 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 10years.[111]

On 9 March 2012 the International Swaps and Derivatives Association (ISDA) issued a communique calling the debtrestructuring deal with its private sector involvement (PSI) a "Restructuring Credit Event" which will triggerpayment of credit default swaps. According to Forbes magazine Greece’s restructuring represents a default.[112][113]

It is the world's biggest debt restructuring deal ever done, affecting some €206 billion of Greek governmentbonds.[114] 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 to117% of GDP by 2020,[115] somewhat lower than the target of 120.5% initially outlined in the signed Memorandumwith the Troika.[90][116][117]

European sovereign-debt crisis 11

Critics such as the director of LSE's Hellenic Observatory [118] argue that the billions of taxpayer euros are notsaving Greece but financial institutions,[119] as "more than 80 percent of the rescue package is going tocreditors—that is to say, to banks outside of Greece and to the ECB."[120] The shift in liabilities from Europeanbanks to European taxpayers has been staggering. One study found that the public debt of Greece to foreigngovernments, including debt to the EU/IMF loan facility and debt through the eurosystem, increased from €47.8bnto €180.5bn (+132,7bn) between January 2010 and September 2011,[121] while the combined exposure of foreignbanks to (public and private) Greek entities was reduced from well over €200bn in 2009 to around €80bn (-120bn)by mid-February 2012.[122]

Mid May 2012 the crisis and impossibility to form a new government after elections led to strong speculationsGreece would have to leave the Eurozone shortly due. This phenomenon became known as "Grexit" and started togovern international market behaviour.[123][124] The center-right's narrow victory in the June 17th election giveshope that a coalition will enable Greece to stay in the Euro-zone.[125] A victory by the anti-austerity axis could havebeen "an excuse to cut Greece out of the euro zone" according to the Wall Street Journal.[126]

Ireland

Irish government deficit compared to other European countries and theUnited States (2000–2013)

The Irish sovereign debt crisis was not based ongovernment over-spending, but from the stateguaranteeing the six main Irish-based banks who hadfinanced a property bubble. On 29 September 2008,Finance Minister Brian Lenihan, Jnr issued a two-yearguarantee to the banks' depositors andbond-holders.[127] The guarantees were subsequentlyrenewed for new deposits and bonds in a slightlydifferent manner. In 2009, an National AssetManagement Agency (NAMA), was created toacquire large property-related loans from the sixbanks at a market-related "long-term economicvalue".[128]

Irish banks had lost an estimated 100 billion euros,much of it related to defaulted loans to propertydevelopers and homeowners made in the midst of theproperty bubble, which burst around 2007. Theeconomy collapsed during 2008. Unemployment rosefrom 4% in 2006 to 14% by 2010, while the nationalbudget went from a surplus in 2007 to a deficit of32% GDP in 2010, the highest in the history of theeurozone, despite austerity measures.[25][129]

With Ireland's credit rating falling rapidly in the faceof mounting estimates of the banking losses,guaranteed depositors and bondholders cashed in during 2009-10, and especially after August 2010. (The necessaryfunds were borrowed from the central bank.) With yields on Irish Government debt rising rapidly it was clear thatthe Government would have to seek assistance from the EU and IMF, resulting in a €67.5 billion "bailout"agreement of 29 November 2010[130][131] Together with additional €17.5 billion coming from Ireland's own reservesand pensions, the government received €85 billion,[132] of which up to €34 billion was to be used to support the

European sovereign-debt crisis 12

country's ailing financial sector (only about half of this was used in that way following stress tests conducted in2011.[133] In return the government agreed to reduce its budget deficit to below three percent by 2015.[133] In April2011, despite all the measures taken, Moody's downgraded the banks' debt to junk status.[134]

In July 2011 European leaders agreed to cut the interest rate that Ireland was paying on its EU/IMF bailout loan fromaround 6% to between 3.5% and 4% and to double the loan time to 15 years. The move was expected to save thecountry between 600–700 million euros per year.[135] On 14 September 2011, in a move to further ease Ireland'sdifficult financial situation, the European Commission announced it would cut the interest rate on its €22.5 billionloan coming from the European Financial Stability Mechanism, down to 2.59 per cent – which is the interest rate theEU itself pays to borrow from financial markets.[136]

The Euro Plus Monitor report from November 2011 attests to Ireland's vast progress in dealing with its financialcrisis, expecting the country to stand on its own feet again and finance itself without any external support from thesecond half of 2012 onwards.[137] According to the Centre for Economics and Business Research Ireland's export-ledrecovery "will gradually pull its economy out of its trough". As a result of the improved economic outlook, the costof 10-year government bonds, has already fallen substantially since its record high at 12% in mid July 2011 (see thegraph "Long-term Interest Rates"). At 24 July 2012 it was down at a sustainable 6.3%,[138] and it is expected to falleven further to a level of only 4% by 2015.[139]

On 26 July 2012, for the first time since September 2010, Ireland was able to return to the financial markets sellingover €5 billion in long-term government debt, with an interest rate of 5.9% for the 5-year bonds and 6.1% for the8-year bonds at sale.[140]

PortugalIn the first half of 2011, Portugal requested a €78 billion IMF-EU bailout package in a bid to stabilise its publicfinances.[141] These measures were put in place as a direct result of decades-long governmental overspending and anover bureaucratised civil service. After the bailout was announced, the Portuguese government headed by PedroPassos Coelho managed to implement measures to improve the State's financial situation and the country started tobe seen as moving on the right track. However, the unemployment level rose to over 14.8 percent, taxes wereincreased, and civil service-related lower-wages were frozen and higher-wages were cut by 14.3%, on top of thegovernment's spending cuts.A report released in January 2011 by the Diário de Notícias[142] and published in Portugal by Gradiva, haddemonstrated that in the period between the Carnation Revolution in 1974 and 2010, the democratic PortugueseRepublic governments encouraged over-expenditure and investment bubbles through unclear Public–privatepartnerships and funding of numerous ineffective and unnecessary external consultancy and advisory of committeesand firms. This allowed considerable slippage in state-managed public works and inflated top management and headofficer bonuses and wages. Persistent and lasting recruitment policies boosted the number of redundant publicservants. Risky credit, public debt creation, and European structural and cohesion funds were mismanaged acrossalmost four decades. Prime Minister Sócrates's cabinet was not able to forecast or prevent this in 2005, and later itwas incapable of doing anything to improve the situation when the country was on the verge of bankruptcy by2011.[143]

Robert Fishman, in the New York Times article "Portugal's Unnecessary Bailout", points out that Portugal fell victimto successive waves of speculation by pressure from bond traders, rating agencies and speculators.[144] In the firstquarter of 2010, before pressure from the markets, Portugal had one of the best rates of economic recovery in theEU. From the perspective of Portugal's industrial orders, exports, entrepreneurial innovation and high-schoolachievement, the country matched or even surpassed its neighbors in Western Europe.[144]

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

European sovereign-debt crisis 13

International Monetary Fund.[145] According to the Portuguese finance minister, the average interest rate on thebailout loan is expected to be 5.1 percent.[146] As part of the deal, the country agreed to cut its budget deficit from9.8 percent of GDP in 2010 to 5.9 percent in 2011, 4.5 percent in 2012 and 3 percent in 2013.[147]

The Portuguese government also agreed to eliminate its golden share in Portugal Telecom which gave it veto powerover vital decisions.[148][149] In 2012, all public servants had already seen an average wage cut of 20% relative totheir 2010 baseline, with cuts reaching 25% for those earning more than 1,500 euro per month. This led to a flood ofspecialized technicians and top officials leaving the public service, many looking for better positions in the privatesector or in other European countries.[150]

On 6 July 2011, the ratings agency Moody's had cut Portugal's credit rating to junk status, Moody's also launchedspeculation that Portugal could follow Greece in requesting a second bailout.[151]

In December 2011, it was reported that Portugal's estimated budget deficit of 4.5 percent in 2011 would besubstantially lower than expected, due to a one-off transfer of pension funds. The country would therefore meet its2012 target a year earlier than expected.[147] Despite the fact that the economy is expected to contract by 3 percent in2011 the IMF expects the country to be able to return to medium and long-term debt sovereign markets by late2013.[152] Any deficit means increasing the nation's debt. To bring down the debt to sustainable levels will require a10% budget surplus for several years according to some estimates.[153]

SpainSpain had a comparatively low debt level among advanced economies prior to the crisis.[154] The country's publicdebt relative to GDP in 2010 was only 60%, more than 20 points less than Germany, France or the US, and morethan 60 points less than Italy, Ireland or Greece.[155][156] Debt was largely avoided by the ballooning tax revenuefrom the housing bubble, which helped accommodate a decade of increased government spending without debtaccumulation.[157] Like Italy, Spain has most of its debt controlled internally, and both countries were in a betterfiscal situation than Greece and Portugal at the outset of the financial crisis.[158] However, debt relative to GDP isexpected to reach 90.5% GDP during 2013.[159]

As one of the largest eurozone economies, the condition of Spain's economy is of particular concern to internationalobservers, and has faced pressure from the United States, the IMF, other European countries and the EuropeanCommission to cut its deficit more aggressively.[160][161] Spain's public debt was approximately U.S. $820 billion in2010, roughly the level of Greece, Portugal, and Ireland combined.[162]

Rumors raised by speculators about a Spanish bail-out were dismissed by then Spanish Prime Minister José LuisRodríguez Zapatero as "complete insanity" and "intolerable".[163] Nevertheless, shortly after the announcement ofthe EU's new "emergency fund" for eurozone countries in early May 2010, Spain had to announce new austeritymeasures designed to further reduce the country's budget deficit, in order to signal financial markets that it was safeto invest in the country.[164] The Spanish government had hoped to avoid such deep cuts, but weak economic growthas well as domestic and international pressure forced the government to expand on cuts already announced inJanuary.Spain succeeded in trimming its deficit from 11.2% of GDP in 2009 to 9.2% in 2010[165] and 8.5% in 2011.[166] Dueto the European crisis and over spending by regional governments the latest figure is higher than the original targetof 6%.[167][168] To build up additional trust in the financial markets, the government amended the SpanishConstitution in 2011 to require a balanced budget at both the national and regional level by 2020. The amendmentstates that public debt can not exceed 60% of GDP, though exceptions would be made in case of a naturalcatastrophe, economic recession or other emergencies.[169][170] Under pressure from the EU the new conservativeSpanish government led by Mariano Rajoy aims to cut the deficit further to 5.3 percent in 2012 and 3 percent in2013.[171]

While public debt was restrained prior to the crisis, private mortgage debt fueled a housing bubble.[45][172] The subsequent burst weakened private banks leading to government bailouts. In May 2012, Bankia received a 19 billion

European sovereign-debt crisis 14

euro bailout,[173] on top of the previous 4.5 billion euros to prop up Bankia.[174] Questionable accounting methodsdisguised bank losses.[175] During September 2012, regulators indicated that Spanish banks required €59 billion(USD $77 billion) in additional capital to offset losses from real estate investments.[176]

As of June 6, 2012 a bailout package for Spain of between €40 and 100 billion was reported to be underconsideration. The package was described as available if requested which it was on June 9, 2012 and granted for anamount up to €100 billion. The exact amount will depend on audits of the condition of Spanish banks which are inprogress. The funds will go directly to the Spanish banks to hopefully avoid adding to Spain's sovereigndebt.[172][177][178][179][180] A larger economy than other countries which have received bailout packages, Spain hadconsiderable bargaining power regarding the terms of a bailout.[181] Due to reforms already instituted by Spain'sconservative government less stringent austerity requirements are included then was the case with earlier bailoutpackages for Ireland, Portugal, and Greece.[182][183]

During June 2012, Spain also became a prime concern for the Euro-zone.[21] Interest on Spain’s 10-year bondsreached the 7% level and it faced difficulty in accessing bond markets. Spain accepted a €100 billion aid package forits banks. “Spanish banks have propped up the government, which is now forced to turn to Europe for help proppingup the weaker banks. Stronger banks are shying away from buying government bonds.” The aid package (countedtowards Spain’s gross debt but it is not considered a sovereign debt bailout) brings Spain’s debt close to the 90%level, the Euro-zone average. It is expected to increase given a negative growth rate of 1.7%, 25% unemployment,falling housing prices, and a deficit of 5.4%. Spain is the EU’s fourth-largest economy, larger than Greece, Portugaland Ireland combined.[22]

As Spanish CDS hits a record high of 633 basis points and the 10yr bond yield at 7.7% (25 July 2012)[184] Spain'seconomic minister travels to Germany to request that the ECB facilitate government bond purchases to "avoid animminent financial collapse".[185] A few days later ECB president Mario Draghi reassured investors: "Within ourmandate, the ECB is ready to do whatever it takes to preserve the euro." His statement immediately led the Spanish10yr bond yield to retract sharply to 6.6%.[186] ECB's "unlimited bond-buying plan," announced on Sept 6, is wellreceived by the market as the 10yr falls below 6%.[187]

CyprusIn September 2011, yields on Cyprus long-term bonds had risen above 12%, since the small island of 840,000 peoplewas downgraded by all major credit ratings agencies following a devastating explosion at a power plant in July andslow progress with fiscal and structural reforms. Since January 2012, Cyprus is relying on a € 2.5bn emergency loanfrom Russia to cover its budget deficit and re-finance maturing debt. The loan has an interest rate of 4.5% and it isvalid for 4.5 years[188] though it is expected that Cyprus will be able to fund itself again by the first quarter of2013.[189] On June 12, 2012 financial media reported that a bailout request by Cyprus was imminent. Despite its lowpopulation and small economy Cyprus has an off-shore banking industry which is disproportional to its economy.[69]

A request was made to the European Financial Stability Facility or the European Stability Mechanism on June 25,2012. It is anticipated that a bailout package would include requirements for fiscal reforms. The request follows adowngrade of Cyprus bonds to BB+ by Fitch, also on June 25, 2012, which disqualified bonds issued by Cyprusfrom being accepted as collateral by the European Central Bank.[190]

On 13 March 2012 Moody's has slashed Cyprus's credit rating into Junk status, warning that the Cyprus governmentwill have to inject fresh capital into its banks to cover losses incurred through Greece's debt swap. Cyprus's bankswere highly exposed to Greek debt and so are disproportionately hit by the haircut taken by creditors.[171] It wasreported on June 25, 2012 by The Financial Times that banks in Cyprus held €22 billion of Greek private sectordebt.[190]

European sovereign-debt crisis 15

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.

One of the central concerns prior to thebailout was that the crisis could spreadto several other countries afterreducing confidence in other Europeaneconomies. According to the UKFinancial Policy Committee "Marketconcerns remain over fiscal positionsin a number of euro area countries andthe potential for contagion to bankingsystems."[191] Besides Ireland, with agovernment deficit in 2010 of 32.4%of GDP, and Portugal at 9.1%, othercountries such as Spain with 9.2% arealso at risk.[192]

For 2010, the OECD forecast $16trillion would be raised in governmentbonds among its 30 member countries.Financing needs for the eurozone cometo a total of €1.6 trillion, while theU.S. is expected to issueUS$1.7 trillion more Treasurysecurities in this period,[193] and Japanhas ¥213 trillion of government bondsto roll over.[194] Greece has been thenotable example of an industrialisedcountry that has faced difficulties inthe markets because of rising debtlevels but even countries such as theU.S., Germany and the UK, have had fraught moments as investors shunned bond auctions due to concerns aboutpublic finances and the economy.[195]

Italy

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 debthas increased to almost 120 percent of GDP (U.S. $2.4 trillion in 2010) and economic growth was lower

European sovereign-debt crisis 16

The 2010 annual budget deficit and public debt, both relative to GDP for selectedEuropean countries.

Long-term interest rates of selected European countries.[1] Note that weak non-eurozonecountries (Hungary, Romania) lack the sharp rise in interest rates characteristic of weak

eurozone countries.

than the EU average for over adecade.[196] This has led investors toview Italian bonds more and more as arisky asset.[197]

On the other hand, the public debt ofItaly has a longer maturity and asubstantial share of it is helddomestically. Overall this makes thecountry more resilient to financialshocks, ranking better than France andBelgium.[198] About 300 billion eurosof Italy's 1.9 trillion euro debt maturesin 2012. It will therefore have to go tothe capital markets for significantrefinancing in the near-term.[199]

On 15 July and 14 September 2011,Italy's government passed austeritymeasures meant to save €124billion.[200][201] Nonetheless, by 8November 2011 the Italian bond yieldwas 6.74 percent for 10-year bonds,climbing above the 7 percent levelwhere the country is thought to loseaccess to financial markets.[202] On 11November 2011, Italian 10-yearborrowing costs fell sharply from 7.5to 6.7 percent after Italian legislatureapproved further austerity measuresand the formation of an emergencygovernment to replace that of PrimeMinister Silvio Berlusconi.[203]

The measures include a pledge to raise€15 billion from real-estate sales overthe next three years, a two-yearincrease in the retirement age to 67 by2026, opening up closed professionswithin 12 months and a gradualreduction in government ownership oflocal services.[197] The interimgovernment expected to put the newlaws into practice is led by formerEuropean Union CompetitionCommissioner Mario Monti.[197]

As in other countries, the social effects have been severe, with child labour even re-emerging in poorer areas.[204]

European sovereign-debt crisis 17

Belgium

In 2010, Belgium's public debt was 100% of its GDP—the third highest in the eurozone after Greece and Italy[205]

and there were doubts about the financial stability of the banks,[206] following the country's major financial crisis in2008–2009. After inconclusive elections in June 2010, by November 2011[207] the country still had only a caretakergovernment as parties from the two main language groups in the country (Flemish and Walloon) were unable toreach agreement on how to form a majority government.[205] In November 2010 financial analysts forecast thatBelgium would be the next country to be hit by the financial crisis as Belgium's borrowing costs rose.[206]

However the government deficit of 5% was relatively modest and Belgian government 10-year bond yields inNovember 2010 of 3.7% were still below those of Ireland (9.2%), Portugal (7%) and Spain (5.2%).[206] Furthermore,thanks to Belgium's high personal savings rate, the Belgian Government financed the deficit from mainly domesticsavings, making it less prone to fluctuations of international credit markets.[208] Nevertheless, on 25 November 2011,Belgium's long-term sovereign credit rating was downgraded from AA+ to AA by Standard and Poor[209] and10-year bond yields reached 5.66%.[207]

Shortly after, Belgian negotiating parties reached an agreement to form a new government. The deal includesspending cuts and tax rises worth about €11 billion, which should bring the budget deficit down to 2.8% of GDP by2012, and to balance the books in 2015.[210] Following the announcement Belgium 10-year bond yields fell sharplyto 4.6%.[211]

France

France's public debt in 2010 was approximately U.S. $2.1 trillion and 83% GDP, with a 2010 budget deficit of 7%GDP.[212] By 16 November 2011, France's bond yield spreads vs. Germany had widened 450% since July, 2011.[213]

France's C.D.S. contract value rose 300% in the same period.[214]

On 1 December 2011, France's bond yield had retreated and the country auctioned €4.3 billion worth of 10 yearbonds at an average yield of 3.18%, well below the perceived critical level of 7%.[215] By early February 2012,yields on French 10 year bonds had fallen to 2.84%.[216]

United Kingdom

According to the Financial Policy Committee "Any associated disruption to bank funding markets could spill over toUK banks."[191] The UK has the highest gross foreign debt of any European country (€7.3 trillion; €117,580 perperson) due in large part to its highly leveraged financial industry, which is closely connected with both the UnitedStates and the eurozone.[217]

In 2012 the U.K. economy was in recession, being negatively impacted by reduced economic activity in Europe, andapprehensive regarding possible future impacts of the Eurozone crisis. The Bank of England made substantial fundsavailable at reduced interest to U.K. banks for loans to domestic enterprises. The bank is also providing liquidity bypurchase of large quantities of government bonds, a program which may be expanded.[218] Bank of England supportof British banks with respect to the Eurozone crisis was backed by the British Treasury.[219]

Bank of England governor Mervyn King stated in May 2012 that the Eurozone is "tearing itself apart without anyobvious solution." He acknowledged that the Bank of England, the Financial Services Authority, and the Britishgovernment were preparing contingency plans for a Greek exit from the euro or a collapse of the currency, butrefused to discuss them to avoid adding to the panic.[220] Known contingency plans include emergency immigrationcontrols to prevent millions of Greek and other EU residents from entering the country to seek work, and theevacuation of Britons from Greece during civil unrest.[221]

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.[222] 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,[223] and a Greek exit from the euro would likely increase such transfer of

European sovereign-debt crisis 18

capital.[222]

Switzerland

Switzerland was affected by the Eurozone crisis as money was moved into Swiss assets seeking safety from theEurozone crisis as well as by apprehension of further worsening of the crisis. This resulted in appreciation of theSwiss franc with respect to the euro and other currencies which drove down internal prices and raised the price ofexports. Credit Suisse was required to increase its capitalization by the Swiss National Bank. The Swiss NationalBank stated that the Swiss franc was massively overvalued, and that risk of deflation in Switzerland existed. Ittherefore announced that it would buy foreign currency in unlimited quantities if the euro/Swiss Franc exchange ratefell below 1.20 CHF.[224] Purchases of the euro have the effect of maintaining the value of the euro. Real estatevalues in Switzerland are extremely high, thus posing a possible risk.[218][225]

Germany

In relationship to the total amounts involved in the Eurozone crisis, the economy of Germany is relatively small andwould be unable, even if it were willing, to guarantee payment of the sovereign debts of the rest of the Eurozone asSpain and even Italy and France are added to potentially defaulting nations. Thus, according to Chancellor AngelaMerkel, German participation in rescue efforts are conditioned on negotiation of Eurozone reforms which have thepotential to resolve the underlying imbalances which are driving the crisis.[226][227]

Slovenia

Slovenia joined the European Union in 2004. When it also joined the Euro area three years later interest rates wentdown. This led Slovenian banks to finance a construction boom and privatization of state assets by sale to trustedmembers of the national elite. When the financial crisis hit the country construction has stalled and once-soundbusinesses began to struggle, leaving the banks with bad loans of more than 6 billion euros, or 12 percent, of theirlending portfolio. Eventually the Slovenian government helped its banking sector unwind bad loans by guaranteeingas much as 4 billion euros - more than 11 percent of gross domestic product. This in turn led to rising borrowingcosts for the government, with yields on its 10-year bonds rising above 6 percent. In 2012 the government proposedan austerity budget and plans to adopt labor market reforms to cover the costs of the crisis. Despite these recentdifficulties Slovenia is nowhere close to actually requesting a bailout, according to the New York Times.[228]

Policy reactions

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 legalinstrument[229] aiming at preserving financial stability in Europe by providing financial assistance to eurozone statesin difficulty. The EFSF can issue bonds or other debt instruments on the market with the support of the German DebtManagement Office to raise the funds needed to provide loans to eurozone countries in financial troubles,recapitalize banks or buy sovereign debt.[230]

Emissions of bonds are backed by guarantees given by the euro area member states in proportion to their share in thepaid-up capital of the European Central Bank. The €440 billion lending capacity of the facility is jointly andseverally guaranteed by the eurozone countries' governments and may be combined with loans up to €60 billionfrom the European Financial Stabilisation Mechanism (reliant on funds raised by the European Commission usingthe EU budget as collateral) and up to €250 billion from the International Monetary Fund (IMF) to obtain a financialsafety net up to €750 billion.[231]

European sovereign-debt crisis 19

The EFSF issued €5 billion of five-year bonds in its inaugural benchmark issue 25 January 2011, attracting an orderbook of €44.5 billion. This amount is a record for any sovereign bond in Europe, and €24.5 billion more than theEuropean Financial Stabilisation Mechanism (EFSM), a separate European Union funding vehicle, with a €5 billionissue in the first week of January 2011.[232]

On 29 November 2011, the member state finance ministers agreed to expand the EFSF by creating certificates thatcould guarantee up to 30% of new issues from troubled euro-area governments, and to create investment vehiclesthat would boost the EFSF’s firepower to intervene in primary and secondary bond markets.[233]

Reception by financial marketsStocks surged worldwide after the EU announced the EFSF's creation. The facility eased fears that the Greek debtcrisis would spread,[234] and this led to some stocks rising to the highest level in a year or more.[235] The euro madeits biggest gain in 18 months,[236] before falling to a new four-year low a week later.[237] Shortly after the euro roseagain as hedge funds and other short-term traders unwound short positions and carry trades in the currency.[238]

Commodity prices also rose following the announcement.[239]

The dollar Libor held at a nine-month high.[240] Default swaps also fell.[241] The VIX closed down a record almost30%, after a record weekly rise the preceding week that prompted the bailout.[242] The agreement is interpreted asallowing the ECB to start buying government debt from the secondary market which is expected to reduce bondyields.[243] As a result Greek bond yields fell sharply from over 10% to just over 5%.[244] Asian bonds yields alsofell with the EU bailout.[245])Usage of EFSF funds

Debt profile of Eurozone countries

The EFSF only raises funds after anaid request is made by a country.[246]

As of the end of July 2012, it has beenactivated various times. In November2010, it financed €17.7 billion of thetotal €67.5 billion rescue package forIreland (the rest was loaned fromindividual European countries, theEuropean Commission and the IMF).In May 2011 it contributed one third ofthe €78 billion package for Portugal.As part of the second bailout forGreece, the loan was shifted to theEFSF, amounting to €164 billion(130bn new package plus 34.4bnremaining from Greek Loan Facility)throughout 2014.[247] On 20 July 2012,European finance ministers sanctionedthe first tranche of a partial bail-outworth up to €100 billion for Spanishbanks.[248] This leaves the EFSF with€148 billion[248] or an equivalent of€444 billion in leveraged firepower.[249]

The EFSF is set to expire in 2013, running some months parallel to the permanent €500 billion rescue fundingprogram called the European Stability Mechanism (ESM), which will start operating as soon as member statesrepresenting 90% of the capital commitments have ratified it. (see section: ESM)

European sovereign-debt crisis 20

On 13 January 2012, Standard & Poor’s downgraded France and Austria from AAA rating, lowered Spain, Italy (andfive other[250]) euro members further, and maintained the top credit rating for Finland, Germany, Luxembourg, andthe Netherlands; shortly after, S&P also downgraded the EFSF from AAA to AA+.[250][251]

European Financial Stabilisation Mechanism (EFSM)

On 5 January 2011, the European Union created the European Financial Stabilisation Mechanism (EFSM), anemergency funding programme reliant upon funds raised on the financial markets and guaranteed by the EuropeanCommission using the budget of the European Union as collateral.[252] It runs under the supervision of theCommission[253] and aims at preserving financial stability in Europe by providing financial assistance to EU memberstates in economic difficulty.[254] The Commission fund, backed by all 27 European Union members, has theauthority to raise up to €60 billion[255] and is rated AAA by Fitch, Moody's and Standard & Poor's.[256][257]

Under the EFSM, the EU successfully placed in the capital markets a €5 billion issue of bonds as part of thefinancial support package agreed for Ireland, at a borrowing cost for the EFSM of 2.59%.[258]

Like the EFSF, the EFSM will also be replaced by the permanent rescue funding programme ESM, which is due tobe launched in July 2012.[259]

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 Greeksovereign debt held by banks, a fourfold increase (to about €1 trillion) in bail-out funds held under the EuropeanFinancial Stability Facility, an increased mandatory level of 9% for bank capitalisation within the EU and a set ofcommitments from Italy to take measures to reduce its national debt. Also pledged was €35 billion in "creditenhancement" to mitigate losses likely to be suffered by European banks. José Manuel Barroso characterised thepackage as a set of "exceptional measures for exceptional times".[11][260]

The package's acceptance was put into doubt on 31 October when Greek Prime Minister George Papandreouannounced that a referendum would be held so that the Greek people would have the final say on the bailout,upsetting financial markets.[261] On 3 November 2011 the promised Greek referendum on the bailout package waswithdrawn by Prime Minister Papandreou.In late 2011, Landon Thomas in the New York Times noted that some, at least, European banks were maintaininghigh dividend payout rates and none were getting capital injections from their governments even while beingrequired to improve capital ratios. Thomas quoted Richard Koo, an economist based in Japan, an expert on thatcountry'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 areforced to raise capital at the same time, the result is going to be even weaker banks and an even longerrecession – 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 toraise funds, they will move faster to cut down on loans and unload lagging assets" as they work to improve capitalratios. This latter contraction of balance sheets "could lead to a depression”, the analyst said.[262] Reduced lendingwas a circumstance already at the time being seen in a "deepen[ing] crisis" in commodities trade finance in westernEurope.[263]

Final agreement on the second bailout packageIn 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

European sovereign-debt crisis 21

to between 117%[115] and 120.5% of GDP by 2020.[116]

European Central Bank

ECB Securities Markets Program (SMP) covering bond purchases from May 2010 tillAugust 2012.

The European Central Bank (ECB) hastaken a series of measures aimed atreducing volatility in the financialmarkets and at improvingliquidity.[264]

In May 2010 it took the followingactions:• It began open market operations

buying government and private debtsecurities,[265] reaching €219.5billion in February 2012,[266]

though it simultaneously absorbedthe same amount of liquidity toprevent a rise in inflation.[267]

According to Rabobank economistElwin de Groot, there is a “naturallimit” of €300 billion the ECB cansterilize.[268]

• It reactivated the dollar swaplines[269] with Federal Reservesupport.[270]

•• It changed its policy regarding the necessary credit rating for loan deposits, accepting as collateral all outstandingand 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, makingit difficult for the government to raise money on capital markets.[271]

On 30 November 2011, the ECB, the U.S. Federal Reserve, the central banks of Canada, Japan, Britain and theSwiss National Bank provided global financial markets with additional liquidity to ward off the debt crisis and tosupport the real economy. The central banks agreed to lower the cost of dollar currency swaps by 50 basis points tocome into effect on 5 December 2011. They also agreed to provide each other with abundant liquidity to make surethat commercial banks stay liquid in other currencies.[272]

Long Term Refinancing Operation (LTRO)Though the ECB's main refinancing operations (MRO) are from repo auctions with a (bi)weekly maturity andmonthly maturation, the ECB now conducts Long Term Refinancing Operations (LTROs), maturing after threemonths, six months, 12 months and 36 months. In 2003, refinancing via LTROs amounted to 45 bln euro which isabout 20% of overall liquidity provided by the ECB.[273]

The ECB's first supplementary longer-term refinancing operation (LTRO) with a six-month maturity was announcedMarch 2008.[274] Previously the longest tender offered was three months. It announced two 3-month and one6-month full allotment of Long Term Refinancing Operations (LTROs). The first tender was settled 3 April, and wasmore than four times oversubscribed. The €25 billion auction drew bids amounting to €103.1 billion, from 177banks. Another six-month tender was allotted on 9 July, again to the amount of €25 billion.[274] The first 12 monthLTRO in June 2009 had close to 1100 bidders.[275]

European sovereign-debt crisis 22

On 22 December 2011, the ECB[276] started the biggest infusion of credit into the European banking system in theeuro's 13 year history. Under its Long Term Refinancing Operations (LTROs) it loaned €489 billion to 523 banksfor an exceptionally long period of three years at a rate of just one percent.[277] Previous refinancing operationsmatured after three, six and twelve months.[275] The by far biggest amount of €325 billion was tapped by banks inGreece, Ireland, Italy and Spain.[278]

This way the ECB tried to make sure that banks have enough cash to pay off €200 billion of their own maturingdebts in the first three months of 2012, and at the same time keep operating and loaning to businesses so that a creditcrunch does not choke off economic growth. It also hoped that banks would use some of the money to buygovernment bonds, effectively easing the debt crisis.[279] On 29 February 2012, the ECB held a second auction,LTRO2, providing 800 Eurozone banks with further €529.5 billion in cheap loans.[280] 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.[281]

ECB lending has largely replaced inter-bank lending. Spain has €365 billion and Italy has €281 billion ofborrowings from the ECB (June 2012 data). Germany has €275 billion on deposit.[282]

ResignationsIn September 2011, Jürgen Stark became the second German after Axel A. Weber to resign from the ECB GoverningCouncil in 2011. Weber, the former Deutsche Bundesbank president, was once thought to be a likely successor toJean-Claude Trichet as bank president. He and Stark were both thought to have resigned due to "unhappiness withthe 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, whileBelgium's Peter Praet took Stark's original position, heading the ECB's economics department.[283]

Money supply growthIn 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 early2012. "'It is still early days but a further recovery in peripheral real M1 would suggest an end to recessions by late2012,' said Simon Ward from Henderson Global Investors who collects the data." While attributing the moneysupply growth to ECB's LTRO policies, an analysis in The Telegraph said lending "continued to fall across theeurozone in March [and] ... [t]he jury is out on the ... three-year lending adventure (LTRO)".[284]

Reorganization of the European banking systemOn June 16, 2012 the European Central Bank together with other European leaders hammered out plans for the ECBto become a bank regulator and to form a deposit insurance program to augment national programs. Other economicreforms promoting European growth and employment were also proposed.[285]

European Stability Mechanism (ESM)The European Stability Mechanism (ESM) is a permanent rescue funding programme to succeed the temporaryEuropean Financial Stability Facility and European Financial Stabilisation Mechanism in July 2012[259] but it had tobe postponed until after the Federal Constitutional Court of Germany had confirmed the legality of the measures on12 September 2012.[286][287] The permanent bailout fund is now expected to be up and running on 8 October2012.[288]

On 16 December 2010 the European Council agreed a two line amendment to the EU Lisbon Treaty to allow for apermanent bail-out mechanism to be established[289] including stronger sanctions. In March 2011, the EuropeanParliament approved the treaty amendment after receiving assurances that the European Commission, rather than EUstates, would play 'a central role' in running the ESM.[290][291] According to this treaty, the ESM will be anintergovernmental organisation under public international law and will be located in Luxembourg.[292][293]

European sovereign-debt crisis 23

Such a mechanism serves as a "financial firewall." Instead of a default by one country rippling through the entireinterconnected financial system, the firewall mechanism can ensure that downstream nations and banking systemsare protected by guaranteeing some or all of their obligations. Then the single default can be managed while limitingfinancial contagion.

European Fiscal Compact

Public debt to GDP ratio for selected Eurozone countries and the UK - 2008 to2011. Source Data: Eurostat.

In March 2011 a new reform of the Stabilityand Growth Pact was initiated, aiming atstraightening the rules by adopting anautomatic procedure for imposing ofpenalties in case of breaches of either thedeficit or the debt rules.[294][295] By the endof the year, Germany, France and someother smaller EU countries went a stepfurther and vowed to create a fiscal unionacross the eurozone with strict andenforceable fiscal rules and automaticpenalties embedded in the EUtreaties.[12][13] On 9 December 2011 at theEuropean Council meeting, all 17 membersof the eurozone and six countries that aspireto join agreed on a new intergovernmentaltreaty to put strict caps on governmentspending and borrowing, with penalties for those countries who violate the limits.[296] All other non-eurozonecountries apart from the UK are also prepared to join in, subject to parliamentary vote.[] The treaty will enter intoforce on 1 January 2013, if by that time 12 members of the euro area have ratified it.[297]

Originally EU leaders planned to change existing EU treaties but this was blocked by British prime minister DavidCameron, who demanded that the City of London be excluded from future financial regulations, including theproposed EU financial transaction tax.[298][299] By the end of the day, 26 countries had agreed to the plan, leavingthe United Kingdom as the only country not willing to join.[300] Cameron subsequently conceded that his action hadfailed to secure any safeguards for the UK.[301] Britain's refusal to be part of the Franco-German fiscal compact tosafeguard the eurozone constituted a de facto refusal (PM David Cameron vetoed the project) to engage in anyradical revision of the Lisbon Treaty at the expense of British sovereignty: centrist analysts such as John Rentoul ofThe Independent concluded that "Any Prime Minister would have done as Cameron did".[302]

European sovereign-debt crisis 24

Economic reforms and recovery proposals

Direct loans to banks and banking regulationOn June 28, 2012 Eurozone leaders agreed to permit loans by the European Stability Mechanism to be made directlyto stressed banks rather than through Eurozone states, to avoid adding to sovereign debt. The reform was linked toplans for banking regulation by the European Central Bank. The reform was immediately reflected by a reduction inyield of long-term bonds issued by member states such as Italy and Spain and a rise in value of theEuro.[303][304][305]

Increase investmentThere has been substantial criticism over the austerity measures implemented by most European nations to counterthis debt crisis. Some argue that an abrupt return to "non-Keynesian" financial policies" is not a viable solution[306]

and predict that deflationary policies now being imposed on countries such as Greece and Spain might prolong anddeepen their recessions.[307] In a 2003 study that analyzed 133 IMF austerity programmes, the IMF's independentevaluation office found that policy makers consistently underestimated the disastrous effects of rigid spending cutson economic growth.[308][309] Current austerity "cuts have been relatively small compared to the size of the problemand meaningful structural reforms were seldom implemented."[310] Most austerity cuts came with even larger taxincreases.[311][312][313]

In early 2012 an IMF official, who negotiated Greek austerity measures, admitted that spending cuts were harmingGreece.[89][89] Nouriel Roubini adds that the new credit available to the heavily indebted countries did not equate toan immediate revival of economic fortunes: "While money is available now on the table, all this money isconditional on all these countries doing fiscal adjustment and structural reform."[314]

Despite years of draconian austerity measures Greece has failed to reach abalanced budget as public revenues remain low.

According to Keynesian economists"growth-friendly austerity" relies on thefalse argument that public cuts would becompensated for by more spending fromconsumers and businesses, a theoreticalclaim that has not materialized. The case ofGreece shows that excessive levels ofprivate indebtedness and a collapse of publicconfidence (over 90% of Greeks fearunemployment, poverty and the closure ofbusinesses)[315] led the private sector todecrease spending in an attempt to save upfor rainy days ahead. This led to even lowerdemand for both products and labor, whichfurther deepened the recession and made it ever more difficult to generate tax revenues and fight publicindebtedness.[316] According to Financial Times chief economics commentator Martin Wolf, "structural tighteningdoes deliver actual tightening. But its impact is much less than one to one. A one percentage point reduction in thestructural deficit delivers a 0.67 percentage point improvement in the actual fiscal deficit." This means that Irelande.g. would require structural fiscal tightening of more than 12% to eliminate its 2012 actual fiscal deficit. A task thatis difficult to achieve without an exogenous eurozone-wide economic boom.[317] Austerity is bound to fail if it relieslargely on tax increases[311] instead of cuts in government expenditures coupled with encouraging "privateinvestment and risk-taking, labor mobility and flexibility, an end to price controls, tax rates that encouraged capitalformation ..." as Germany has done in the decade before the crisis.[318]

European sovereign-debt crisis 25

Instead of public austerity, a "growth compact" centering on tax increases[316] and deficit spending is proposed.Since struggling European countries lack the funds to engage in deficit spending, German economist and member ofthe German Council of Economic Experts Peter Bofinger and Sony Kapoor of the global think tank Re-Definesuggest providing €40 billion in additional funds to the European Investment Bank (EIB), which could then lend tentimes that amount to the employment-intensive smaller business sector.[316] The EU is currently planning a possible€10 billion increase in the EIB's capital base. Furthermore the two suggest financing additional public investmentsby growth-friendly taxes on "property, land, wealth, carbon emissions and the under-taxed financial sector". Theyalso called on EU countries to renegotiate the EU savings tax directive and to sign an agreement to help each othercrack down on tax evasion and avoidance. Currently authorities capture less than 1% in annual tax revenue onuntaxed wealth transferred between EU members.[316] According to the Tax Justice Network, worldwide, a globalsuper-rich elite had between $21 and $32 trillion (up to 26,000bn Euros) hidden in secret tax havens by the end of2010, resulting in a tax deficit of up to $280bn.[319][320]

Apart from arguments over whether or not austerity, rather than increased or frozen spending, is a macroeconomicsolution,[321] union leaders have also argued that the working population is being unjustly held responsible for theeconomic mismanagement errors of economists, investors, and bankers. Over 23 million EU workers have becomeunemployed as a consequence of the global economic crisis of 2007–2010, and this has led many to call foradditional regulation of the banking sector across not only Europe, but the entire world.[322]

In April, 2012, Olli Rehn, the European commissioner for economic and monetary affairs in Brussels,"enthusiastically announced to EU parliamentarians in mid-April that 'there was a breakthrough before Easter'. Hesaid the European heads of state had given the green light to pilot projects worth billions, such as building highwaysin Greece." Other growth initiatives include "project bonds" wherein the EIB would "provide guarantees thatsafeguard private investors. In the pilot phase until 2013, EU funds amounting to €230 million are expected tomobilize investments of up to €4.6 billion." Der Spiegel also said: "According to sources inside the Germangovernment, instead of funding new highways, Berlin is interested in supporting innovation and programs topromote small and medium-sized businesses. To ensure that this is done as professionally as possible, the Germanswould like to see the southern European countries receive their own state-owned development banks, modeled afterGermany's [Marshall Plan-era-origin] Kreditanstalt für Wiederaufbau (KfW) banking group. It's hoped that this willget the economy moving in Greece and Portugal."[323]

European sovereign-debt crisis 26

Increase competitiveness

Relative change in unit labour costs, 2000–2011

Slow GDP growth rates correspond toslower growth in tax revenues and highersafety net spending, increasing deficits anddebt levels. Indian-American journalistFareed Zakaria described the factorsslowing growth in the eurozone, writing inNovember 2011: "Europe's core problem[is] a lack of growth... Italy's economy hasnot grown for an entire decade. No debtrestructuring will work if it stays stagnantfor another decade... The fact is thatWestern economies – with high wages,generous middle-class subsidies andcomplex regulations and taxes – havebecome sclerotic. Now they face pressuresfrom three fronts: demography (an agingpopulation), technology (which has allowedcompanies to do much more with fewerpeople) and globalization (which hasallowed manufacturing and services to locate across the world)." He advocated lower wages and steps to bring inmore foreign capital investment.[324]

British economic historian Robert Skidelsky disagreed saying it was excessive lending by banks, not deficit spendingthat created this crisis. Government's mounting debts are a response to the economic downturn as spending rises andtax revenues fall, not its cause.[325]

To improve the situation, crisis countries must significantly increase their international competitiveness. Typicallythis is done by depreciating the currency, as in the case of Iceland, which suffered the largest financial crisis in2008–2011 in economic history but has since vastly improved its position. Since eurozone countries cannot devaluetheir currency, policy makers try to restore competitiveness through internal devaluation, a painful economicadjustment process, where a country aims to reduce its unit labour costs.[23][326]

German economist Hans-Werner Sinn noted in 2012 that Ireland was the only country that had implemented relativewage moderation in the last five years, which helped decrease its relative price/wage levels by 16%. Greece wouldneed to bring this figure down by 31%, effectively reaching the level of Turkey.[327][328]

Other economists argue that no matter how much Greece and Portugal drive down their wages, they could nevercompete with low-cost developing countries such as China or India. Instead weak European countries must shift theireconomies to higher quality products and services, though this is a long-term process and may not bring immediaterelief.[329]

Jeremy J. Siegel argues that the need to make labor competitive requires devaluation. This could be achieved byGreece leaving the Euro but that would lead to runs on the banks of Greece and other EU nations. Siegel argues thatthe only option left besides internal devaluation is for the devaluation of the Euro as a whole (parity with thedollar)--if it is to survive.[330]

Progress

European sovereign-debt crisis 27

Eurozone economic health and adjustment progress2011 (Source: Euro Plus Monitor)[331]

On 15 November 2011, the Lisbon Council published the EuroPlus Monitor 2011. According to the report most critical eurozonemember countries are in the process of rapid reforms. The authorsnote that "Many of those countries most in need to adjust [...] arenow making the greatest progress towards restoring their fiscalbalance and external competitiveness". Greece, Ireland and Spainare among the top five reformers and Portugal is ranked seventhamong 17 countries included in the report (see graph).[331]

Address current account imbalances

Current account imbalances (1997–2013)

Regardless of the corrective measures chosen tosolve the current predicament, as long as crossborder capital flows remain unregulated in the euroarea,[332] current account imbalances are likely tocontinue. A country that runs a large currentaccount or trade deficit (i.e., importing more than itexports) must ultimately be a net importer ofcapital; this is a mathematical identity called thebalance of payments. In other words, a country thatimports more than it exports must either decreaseits savings reserves or borrow to pay for thoseimports. Conversely, Germany's large trade surplus(net export position) means that it must eitherincrease its savings reserves or be a net exporter ofcapital, lending money to other countries to allowthem to buy German goods.[333]

The 2009 trade deficits for Italy, Spain, Greece,and Portugal were estimated to be $42.96 billion,$75.31bn and $35.97bn, and $25.6bn respectively,while Germany's trade surplus was $188.6bn.[334]

A similar imbalance exists in the U.S., which runsa large trade deficit (net import position) andtherefore is a net borrower of capital from abroad.Ben Bernanke warned of the risks of suchimbalances in 2005, arguing that a "savings glut" in one country with a trade surplus can drive capital into othercountries with trade deficits, artificially lowering interest rates and creating asset bubbles.[335][336][337]

A country with a large trade surplus would generally see the value of its currency appreciate relative to other currencies, which would reduce the imbalance as the relative price of its exports increases. This currency appreciation occurs as the importing country sells its currency to buy the exporting country's currency used to purchase the goods. Alternatively, trade imbalances can be reduced if a country encouraged domestic saving by

European sovereign-debt crisis 28

restricting or penalizing the flow of capital across borders, or by raising interest rates, although this benefit is likelyoffset by slowing down the economy and increasing government interest payments.[338]

Either way, many of the countries involved in the crisis are on the euro, so devaluation, individual interest rates andcapital controls are not available. The only solution left to raise a country's level of saving is to reduce budgetdeficits and to change consumption and savings habits. For example, if a country's citizens saved more instead ofconsuming imports, this would reduce its trade deficit.[338] It has therefore been suggested that countries with largetrade deficits (e.g. Greece) consume less and improve their exporting industries. On the other hand, export drivencountries with a large trade surplus, such as Germany, Austria and the Netherlands would need to shift theireconomies more towards domestic services and increase wages to support domestic consumption.[44][339] In itsspring 2012 economic forecast, the European Commission finds "some evidence that the current-account rebalancingis underpinned by changes in relative prices and competitiveness positions as well as gains in export market sharesand expenditure switching in deficit countries."[340] In May 2012 German finance minister Wolfgang Schäuble hassignaled support for a significant increase in German wages to help decrease current account imbalances within theeurozone.[341]

Mobilization of creditA number of proposals were made in the summer of 2012 to purchase the debt of distressed European countries suchas Spain and Italy. Markus Brunnermeier,[342] the economist Graham Bishop, and Daniel Gros were among thoseadvancing proposals. Finding a formula which was not simply backed by Germany is central in crafting anacceptable and effective remedy.[343]

CommentaryU.S. President Barack Obama stated in June 2012: "Right now, [Europe's] focus has to be on strengthening theiroverall banking system...making a series of decisive actions that give people confidence that the banking system issolid...In addition, they’re going to have to look at how do they achieve growth at the same time as they’re carryingout structural reforms that may take two or three or five years to fully accomplish. So countries like Spain and Italy,for example, have embarked on some smart structural reforms that everybody thinks are necessary -- everythingfrom tax collection to labor markets to a whole host of different issues. But they've got to have the time and the spacefor those steps to succeed. And if they are just cutting and cutting and cutting, and their unemployment rate is goingup and up and up, and people are pulling back further from spending money because they're feeling a lot of pressure-- ironically, that can actually make it harder for them to carry out some of these reforms over the long term...[I]naddition to sensible ways to deal with debt and government finances, there's a parallel discussion that's taking placeamong European leaders to figure out how do we also encourage growth and show some flexibility to allow some ofthese reforms to really take root."[344]

The Economist wrote in June 2012: "Outside Germany, a consensus has developed on what Mrs. Merkel must do topreserve the single currency. It includes shifting from austerity to a far greater focus on economic growth;complementing the single currency with a banking union (with euro-wide deposit insurance, bank oversight and jointmeans for the recapitalization or resolution of failing banks); and embracing a limited form of debt mutualization tocreate a joint safe asset and allow peripheral economies the room gradually to reduce their debt burdens. This is therefrain from Washington, Beijing, London and indeed most of the capitals of the euro zone. Why hasn’t thecontinent’s canniest politician sprung into action?"[345]

European sovereign-debt crisis 29

Proposed long-term solutions

European fiscal unionIncreased European integration giving a central body increased control over the budgets of member states wasproposed on June 14, 2012 by Jens Weidmann President of the Deutsche Bundesbank,[346] expanding on ideas firstproposed by Jean-Claude Trichet, former president of the European Central Bank. Control, including requirementsthat taxes be raised or budgets cut, would be exercised only when fiscal imbalances developed.[347] This proposal issimilar to contemporary calls by Angela Merkel for increased political and fiscal union which would "allow Europeoversight possibilities."[348]

EurobondsA growing number of investors and economists say Eurobonds would be the best way of solving a debt crisis,[349]

though their introduction matched by tight financial and budgetary coordination may well require changes in EUtreaties.[349] On 21 November 2011, the European Commission suggested that eurobonds issued jointly by the 17euro nations would be an effective way to tackle the financial crisis. Using the term "stability bonds", Jose ManuelBarroso insisted that any such plan would have to be matched by tight fiscal surveillance and economic policycoordination as an essential counterpart so as to avoid moral hazard and ensure sustainable public finances.[350][351]

Germany remains largely opposed at least in the short term to a collective takeover of the debt of states that have runexcessive budget deficits and borrowed excessively over the past years, saying this could substantially raise thecountry's liabilities.[352]

European Monetary FundOn 20 October 2011, the Austrian Institute of Economic Research published an article that suggests transforming theEFSF into a European Monetary Fund (EMF), which could provide governments with fixed interest rate Eurobondsat a rate slightly below medium-term economic growth (in nominal terms). These bonds would not be tradable butcould be held by investors with the EMF and liquidated at any time. Given the backing of all eurozone countries andthe ECB "the EMU would achieve a similarly strong position vis-a-vis financial investors as the US where the Fedbacks government bonds to an unlimited extent." To ensure fiscal discipline despite lack of market pressure, theEMF would operate according to strict rules, providing funds only to countries that meet fiscal and macroeconomiccriteria. Governments lacking sound financial policies would be forced to rely on traditional (national) governmentalbonds with less favorable market rates.[353]

The econometric analysis suggests that "If the short-term and long- term interest rates in the euro area werestabilized at 1.5% and 3%, respectively, aggregate output (GDP) in the euro area would be 5 percentage points abovebaseline in 2015". At the same time sovereign debt levels would be significantly lower with, e.g., Greece's debt levelfalling below 110% of GDP, more than 40 percentage points below the baseline scenario with market based interestlevels. Furthermore, banks would no longer be able to unduly benefit from intermediary profits by borrowing fromthe ECB at low rates and investing in government bonds at high rates.[353]

European sovereign-debt crisis 30

Drastic debt write-off financed by wealth tax

Overall debt levels in 2009 and write-offs necessary in the Eurozone, UK and U.S. toreach sustainable grounds.

According to the Bank forInternational Settlements, thecombined private and public debt of 18OECD countries nearly quadrupledbetween 1980 and 2010, and will likelycontinue to grow, reaching between250% (for Italy) and about 600% (forJapan) by 2040.[354] A BIS studyreleased in June 2012 warns thatbudgets of most advanced economies,excluding interest payments, "wouldneed 20 consecutive years of surplusesexceeding 2 per cent of gross domesticproduct - starting now - just to bringthe debt-to-GDP ratio back to its pre-crisis level".[355] The same authors found in a previous study that increasedfinancial burden imposed by aging populations and lower growth makes it unlikely that indebted economies cangrow out of their debt problem if only one of the following three conditions is met:[356]

•• government debt is more than 80 to 100 percent of GDP;•• non-financial corporate debt is more than 90 percent;•• private household debt is more than 85 percent of GDP.The Boston Consulting Group (BCG) adds that if the overall debt load continues to grow faster than the economy,then large-scale debt restructuring becomes inevitable. To prevent a vicious upward debt spiral from gainingmomentum the authors urge policy makers to "act quickly and decisively" and aim for an overall debt level wellbelow 180 percent for the private and government sector. This number is based on the assumption that governments,nonfinancial corporations, and private households can each sustain a debt load of 60 percent of GDP, at an interestrate of 5 percent and a nominal economic growth rate of 3 percent per year. Lower interest rates and/or highergrowth would help reduce the debt burden further.[357]

To reach sustainable levels the Eurozone must reduce its overall debt level by €6.1 trillion. According to BCG thiscould be financed by a one-time wealth tax of between 11 and 30 percent for most countries, apart from the crisiscountries (particularly Ireland) where a write-off would have to be substantially higher. The authors admit that suchprograms would be "drastic", "unpopular" and "require broad political coordination and leadership" but theymaintain that the longer politicians and central bankers wait, the more necessary such a step will be.[357]

Instead of a one-time write-off, German economist Harald Spehl has called for a 30 year debt-reduction plan, similarto the one Germany used after World War II to share the burden of reconstruction and development.[358] Similarcalls have been made by political parties in Germany including the Greens and The Left.[359][360]

Debt defaults and national exits from the EurozoneFurther information: GrexitIn mid May 2012 the financial crisis in Greece and the impossibility of forming a new government after elections ledto strong speculation that Greece would have to leave the Eurozone shortly.[361][362][363][364] This phenomenon hadalready become known as "Grexit" and started to govern international market behaviour. Economists have expressedconcern that the phenomenon may well become a typical example of what is called a self-fulfilling prophecy.[365]

Reuters stated that the implementation of Grexit would have to occur "within days or even hours of the decisionbeing made" [366] due to the high volatility that would result.

European sovereign-debt crisis 31

Commentary

"The euro should now be recognized as an experiment that failed", wrote Martin Feldstein in 2012.[367] Economists,mostly from outside Europe, and associated with Modern Monetary Theory and other post-Keynesian schoolscondemned the design of the Euro currency system from the beginning [368][369] and have since been advocating thatGreece (and the other debtor nations) unilaterally leave the eurozone, which would allow Greece to withdrawsimultaneously from the eurozone and reintroduce its national currency the drachma at a debased rate.[105][370][371]

Economists who favor this radical approach to solve the Greek debt crisis typically argue that a default isunavoidable for Greece in the long term, and that a delay in organising an orderly default (by lending Greece moremoney throughout a few more years), would just wind up hurting EU lenders and neighboring European countrieseven more.[372] Fiscal austerity or a euro exit is the alternative to accepting differentiated government bond yieldswithin the Euro Area. If Greece remains in the euro while accepting higher bond yields, reflecting its highgovernment deficit, then high interest rates would dampen demand, raise savings and slow the economy. Animproved trade performance and less reliance on foreign capital would be the result.However, there is opposition in this view. The national exits are expected to be an expensive proposition. Thebreakdown of the currency would lead to insolvency of several euro zone countries, a breakdown in intrazonepayments. Having instability and the public debt issue still not solved, the contagion effects and instability wouldspread into the system.[373] Having that the exit of Greece would trigger the breakdown of the eurozone, this is notwelcomed by many politicians, economists and journalists. According to Steven Erlanger from The New YorkTimes, a “Greek departure is likely to be seen as the beginning of the end for the whole euro zone project, a majoraccomplishment, whatever its faults, in the postwar construction of a Europe “whole and at peace.”[374] Likewise, thetwo big leaders of the Euro zone, German Chancellor Angela Merkel and former French President Nicolas Sarkozyhave said on numerous occasions that they would not allow the eurozone to disintegrate and have linked the survivalof the Euro with that of the entire European Union.[375][376] In September 2011, EU commissioner Joaquín Almuniashared this view, saying that expelling weaker countries from the euro was not an option: "Those who think that thishypothesis is possible just do not understand our process of integration".[377]

Solutions which involve greater integration of European banking and fiscal management and supervision of nationaldecisions by European umbrella institutions can be criticized as Germanic domination of European political andeconomic life:[378]

This would effectively turn the European Union into a kind of postmodern version of the oldAustro-Hungarian Empire, with a Germanic elite presiding uneasily over a polyglot imperium and itsrestive local populations.[378]

ControversiesThe European bailouts are largely about shifting exposure from banks and others, who otherwise are lined up forlosses on the sovereign debt they have piled up, onto European taxpayers.[119][379][380][381][382][383]

EU treaty violationsNo bail-out clauseThe EU's Maastricht Treaty contains juridical language which appears to rule out intra-EU bailouts. First, the “nobail-out” clause (Article 125 TFEU) ensures that the responsibility for repaying public debt remains national andprevents risk premiums caused by unsound fiscal policies from spilling over to partner countries. The clause thusencourages prudent fiscal policies at the national level.The European Central Bank's purchase of distressed country bonds can be viewed as violating the prohibition ofmonetary financing of budget deficits (Article 123 TFEU). The creation of further leverage in EFSF with access toECB lending would also appear to violate the terms of this article.

European sovereign-debt crisis 32

Articles 125 and 123 were meant to create disincentives for EU member states to run excessive deficits and statedebt, and prevent the moral hazard of over-spending and lending in good times. They were also meant to protect thetaxpayers of the other more prudent member states. By issuing bail-out aid guaranteed by prudent eurozonetaxpayers to rule-breaking eurozone countries such as Greece, the EU and eurozone countries also encourage moralhazard in the future.[384] While the no bail-out clause remains in place, the "no bail-out doctrine" seems to be a thingof the past.[385]

Convergence criteriaThe EU treaties contain so called convergence criteria, specified in the protocols of the Treaties of the EuropeanUnion. Concerning government finance the states have agreed that the annual government budget deficit should notexceed 3% of the gross domestic product (GDP) and that the gross government debt to GDP should not exceed 60%of the GDP (see protocol 12 and 13). For eurozone members there is the Stability and Growth Pact which containsthe same requirements for budget deficit and debt limitation but with a much stricter regime. Nevertheless manyEuropean countries, including Greece and Italy (status November 2011) have substantially exceeded these criteriaover a long period of time.[386]

Actors fueling the crisis

Credit rating agencies

Standard & Poor's Headquarters in LowerManhattan, New York City

The international U.S.-based credit rating agencies—Moody's,Standard & Poor's and Fitch—which have already been under fireduring the housing bubble[387][388] and the Icelandiccrisis[389][390]—have also played a central and controversial role[391] inthe current European bond market crisis.[392] On one hand, theagencies have been accused of giving overly generous ratings due toconflicts of interest.[393] On the other hand, ratings agencies have atendency to act conservatively, and to take some time to adjust when afirm or country is in trouble.[394] In the case of Greece, the marketresponded to the crisis before the downgrades, with Greek bondstrading at junk levels several weeks before the ratings agencies beganto describe them as such.[76]

According to a study by economists at St Gallen University credit rating agencies have fueled rising euro zoneindebtedness by issuing more severe downgrades since the sovereign debt crisis unfolded in 2009. The authorsconcluded that rating agencies were not consistent in their judgments, on average rating Portugal, Ireland and Greece2.3 notches lower than under pre-crisis standards, eventually forcing them to seek international aid.[395]

European policy makers have criticized ratings agencies for acting politically, accusing the Big Three of biastowards European assets and fueling speculation.[396] Particularly Moody's decision to downgrade Portugal's foreigndebt to the category Ba2 "junk" has infuriated officials from the EU and Portugal alike.[396] State owned utility andinfrastructure companies like ANA – Aeroportos de Portugal, Energias de Portugal, Redes Energéticas Nacionais,and Brisa – Auto-estradas de Portugal were also downgraded despite claims to having solid financial profiles andsignificant foreign revenue.[397][398][399][400]

France too has shown its anger at its downgrade. French central bank chief Christian Noyer criticized the decision of Standard & Poor's to lower the rating of France but not that of the United Kingdom, which "has more deficits, as much debt, more inflation, less growth than us". Similar comments were made by high-ranking politicians in Germany. Michael Fuchs, deputy leader of the leading Christian Democrats, said: "Standard and Poor's must stop playing politics. Why doesn't it act on the highly indebted United States or highly indebted Britain?", adding that the latter's collective private and public sector debts are the largest in Europe. He further added: "If the agency

European sovereign-debt crisis 33

downgrades France, it should also downgrade Britain in order to be consistent."[401]

Credit rating agencies were also accused of bullying politicians by systematically downgrading eurozone countriesjust before important European Council meetings. As one EU source put it: "It is interesting to look at thedowngradings and the timings of the downgradings ... It is strange that we have so many downgrades in the weeks ofsummits."[402]

Regulatory reliance on credit ratingsThink-tanks such as the World Pensions Council (WPC) have criticized European powers such as France andGermany for pushing for the adoption of the Basel II recommendations, adopted in 2005 and transposed in EuropeanUnion law through the Capital Requirements Directive (CRD), effective since 2008. In essence, this forced Europeanbanks and more importantly the European Central Bank, e.g. when gauging the solvency of EU-based financialinstitutions, to rely heavily on the standardized assessments of credit risk marketed by only two private US firms-Moody’s and S&P.[403]

Counter measuresDue to the failures of the ratings agencies, European regulators obtained new powers to supervise ratingsagencies.[391] With the creation of the European Supervisory Authority in January 2011 the EU set up a whole rangeof new financial regulatory institutions,[404] including the European Securities and Markets Authority (ESMA),[405]

which became the EU’s single credit-ratings firm regulator.[406] Credit-ratings companies have to comply with thenew standards or will be denied operation on EU territory, says ESMA Chief Steven Maijoor.[407]

Germany's foreign minister Guido Westerwelle has called for an "independent" European ratings agency, whichcould avoid the conflicts of interest that he claimed US-based agencies faced.[408] European leaders are reportedlystudying the possibility of setting up a European ratings agency in order that the private U.S.-based ratings agencieshave less influence on developments in European financial markets in the future.[409][410] According to Germanconsultant company Roland Berger, setting up a new ratings agency would cost €300 million. On 30 January 2012,the company said it was already collecting funds from financial institutions and business intelligence agencies to setup an independent non-profit ratings agency by mid 2012, which could provide its first country ratings by the end ofthe year.[411] In April 2012, in a similar attempt, the Bertelsmann Stiftung presented a blueprint for establishing aninternational non-profit credit rating agency (INCRA) for sovereign debt, structured in way that management andrating decisions are independent from its financiers.[412]

But attempts to regulate more strictly credit rating agencies in the wake of the European sovereign debt crisis havebeen rather unsuccessful. World Pensions Council (WPC) financial law and regulation experts have argued that thehastily drafted, unevenly transposed in national law, and poorly enforced EU rule on ratings agencies (RegulationEC N° 1060/2009) has had little effect on the way financial analysts and economists interpret data or on the potentialfor conflicts of interests created by the complex contractual arrangements between credit rating agencies and theirclients"[413]

Media

There has been considerable controversy about the role of the English-language press in regard to the bond marketcrisis.[414][415]

Greek Prime Minister Papandreou is quoted as saying that there was no question of Greece leaving the euro andsuggested that the crisis was politically as well as financially motivated. "This is an attack on the eurozone by certainother interests, political or financial".[416] The Spanish Prime Minister José Luis Rodríguez Zapatero has alsosuggested that the recent financial market crisis in Europe is an attempt to undermine the euro.[417][418] He orderedthe Centro Nacional de Inteligencia intelligence service (National Intelligence Center, CNI in Spanish) to investigatethe role of the "Anglo-Saxon media" in fomenting the crisis.[419][420][421][422][423][424][425] So far no results havebeen reported from this investigation.

European sovereign-debt crisis 34

Other commentators believe that the euro is under attack so that countries, such as the U.K. and the U.S., cancontinue to fund their large external deficits and government deficits,[426] and to avoid the collapse of theUS$.[427][428][429] The U.S. and U.K. do not have large domestic savings pools to draw on and therefore aredependent on external savings e.g. from China.[430][431] This is not the case in the eurozone, which isself-funding.[432][433]

Speculators

Both the Spanish and Greek Prime Ministers have accused financial speculators and hedge funds of worsening thecrisis by short selling euros.[434][435] German chancellor Merkel has stated that "institutions bailed out with publicfunds are exploiting the budget crisis in Greece and elsewhere."[436]

According to The Wall Street Journal several hedge-fund managers launched "large bearish bets" against the euro inearly 2010.[437] On 8 February, the boutique research and brokerage firm Monness, Crespi, Hardt & Co. hosted anexclusive "idea dinner" at a private townhouse in Manhattan, where a small group of hedge-fund managers fromSAC Capital Advisors LP, Soros Fund Management LLC, Green Light Capital Inc., Brigade Capital ManagementLLC and others argued that the euro was likely to fall to parity with the US dollar and were of the opinion that Greekgovernment bonds represented the weakest link of the euro and that Greek contagion could soon spread to infect allsovereign debt in the world. Three days later the euro was hit with a wave of selling, triggering a decline that broughtthe currency below $1.36.[437] There was no suggestion by regulators that there was any collusion or other improperaction.[437] On 8 June, exactly four months after the dinner, the Euro hit a four year low at $1.19 before it started torise again.[438] Traders estimate that bets for and against the euro account for a huge part of the daily three trilliondollar global currency market.[437]

The role of Goldman Sachs[439] in Greek bond yield increases is also under scrutiny.[440] It is not yet clear to whatextent this bank has been involved in the unfolding of the crisis or if they have made a profit as a result of the sell-offon the Greek government debt market.In response to accusations that speculators were worsening the problem, some markets banned naked short sellingfor a few months.[441]

Speculation about the breakup of the eurozoneEconomists, mostly from outside Europe and associated with Modern Monetary Theory and other post-Keynesianschools, condemned the design of the euro currency system from the beginning because it ceded national monetaryand economic sovereignty but lacked a central fiscal authority. When faced with economic problems, theymaintained, "Without such an institution, EMU would prevent effective action by individual countries and putnothing in its place."[368][369] Some non-Keynesian economists, such as Luca A. Ricci of the IMF, contend theeurozone does not fulfill the necessary criteria for an optimum currency area, though it is moving in thatdirection.[331][442]

As the debt crisis expanded beyond Greece, these economists continued to advocate, albeit more forcefully, thedisbandment of the eurozone. If this was not immediately feasible, they recommended that Greece and the otherdebtor nations unilaterally leave the eurozone, default on their debts, regain their fiscal sovereignty, and re-adoptnational currencies.[443][444] Bloomberg suggested in June 2011 that, if the Greek and Irish bailouts should fail, analternative would be for Germany to leave the eurozone in order to save the currency through depreciation[445]

instead of austerity. The likely substantial fall in the euro against a newly reconstituted Deutsche Mark would give a"huge boost" to its members' competitiveness.[446]

The Wall Street Journal conjectured that Germany could return to the Deutsche Mark,[447] or create another currency union[448] with the Netherlands, Austria, Finland, Luxembourg and other European countries such as Denmark, Norway, Sweden, Switzerland and the Baltics.[449] A monetary union of these countries with current account surpluses would create the world's largest creditor bloc, bigger than China[450] or Japan. The Wall Street Journal

European sovereign-debt crisis 35

added that without the German-led bloc, a residual euro would have the flexibility to keep interest rates low[451] andengage in quantitative easing or fiscal stimulus in support of a job-targeting economic policy[452] instead of inflationtargeting in the current configuration.George Soros warns in “Does the Euro have a Future?” that there is no escape from the “gloomy scenario” of aprolonged European recession and the consequent threat to the Eurozone’s political cohesion so long as “theauthorities persist in their current course.” He argues that to save the Euro long-term structural changes are essentialin addition to the immediate steps needed to arrest the crisis. The changes he recommends include even greatereconomic integration of the European Union.[453]

Soros writes that a treaty is needed to transform the European Financial Stability Fund into a full-fledged EuropeanTreasury. Following the formation of the Treasury, European Council could then ask the European CommissionBank to step into the breach and indemnify the European Commission Bank in advance against potential risks to theTreasury’s solvency. Soros acknowledges that converting the EFSF into a European Treasury will necessitate “aradical change of heart.” In particular, he cautions, Germans will be wary of any such move, not least because manycontinue to believe that they have a choice between saving the Euro and abandoning it. Soros writes however that acollapse of European Union would precipitate an uncontrollable financial meltdown and thus “the only way” to avert“another Great Depression” is the formation of a European Treasury.[453]

The Economist provides a somewhat modified approach to saving the euro in that "a limited version of federalizationcould be less miserable solution than break-up of the euro."[454] The recipe to this tricky combination of the limitedfederalization, greatly lies on mutualization for limiting the fiscal integration. In order for overindebted countries tostabilize the dwindling euro and economy, the overindebted countries require "access to money and for banks tohave a "safe" euro-wide class of assets that is not tied to the fortunes of one country" which could be obtained by"narrower Eurobond that mutualises a limited amount of debt for a limited amount of time."[454] The propositionmade by German Council of Economic Experts provides detailed blue print to mutualize the current debts of alleuro-zone economies above 60% of their GDP. Instead of the breakup and issuing new national governments bondsby individual euro-zone governments, "everybody, from Germany (debt: 81% of GDP) to Italy(120%) would issueonly these joint bonds until their national debts fell to the 60% threshold. The new mutualized-bond market, worthsome €2.3 trillion, would be paid off over the next 25 years. Each country would pledge a specified tax (such as aVAT surcharge) to provide the cash." However, so far German Chancellor Angela Merkel has opposed to all formsof mutualization.[454]

German Chancellor Angela Merkel and French President Nicolas Sarkozy[455] have, on numerous occasions,publicly said that they would not allow the eurozone to disintegrate, linking the survival of the euro with that of theentire European Union.[375][456] In September 2011, EU commissioner Joaquín Almunia shared this view, sayingthat expelling weaker countries from the euro was not an option.[377] Furthermore, former ECB presidentJean-Claude Trichet also denounced the possibility of a return of the Deutsche Mark.[457]

Iceland, not part of the EU, is regarded as one of Europe's recovery success stories. It defaulted on its debt anddrastically devalued it currency, which has effectively reduced wages by 50% making exports more competitive.[458]

Lee Harris argues that floating exchange rates allows wage reductions by currency devaluations, a politically easieroption than the economically equivalent but politically impossible method of lowering wages by politicalenactment.[459] Sweden's floating rate currency gives it a short term advantage, structural reforms and constraintsaccount for longer-term prosperity. Labor concessions, a minimal reliance on public debt, and tax reform helped tofurther a pro-growth policy.[460]

The British betting company Ladbrokes stopped taking bets on Greece exiting the Eurozone in May 2012 after oddsfell to 1/3, and reported "plenty of support" for 33/1 odds for a complete disbanding of the Eurozone during2012.[222]

The challenges to the speculation about the breakup or salvage of the eurozone is rooted in its innate nature that the breakup or salvage of eurozone is not only an economical decision but also a critical political decision followed by

European sovereign-debt crisis 36

complicated ramifications that "If Berlin pays the bills and tells the rest of Europe how to behave, it risks fosteringdestructive nationalist resentment against Germany and ....it would strengthen the camp in Britain arguing for anexit—a problem not just for Britons but for all economically liberal Europeans.[454]

Wolfson economics prizeIn July 2012, the Wolfson economics prize, a prize for the "best proposal for a country to leave the EuropeanMonetary Union," was awarded to a Capital Economics team led by Roger Bootle, for their submission titled"Leaving the Euro: A Practical Guide."[461] The winning proposal argued that a member wishing to exit shouldintroduce a new currency and default on a large part of its debts. The net effect, the proposal claimed, would bepositive for growth and prosperity. It also called for keeping the euro for small transactions and for a short period oftime after the exit from the Eurozone, along with a strict regime of inflation-targeting and tough fiscal rulesmonitored by "independent experts."The Roger Bootle/Capital Economics plan also suggested that "key officials" should meet "in secret" one monthbefore the exit is publicly announced, and that Eurozone partners and international organisations should be informed"three days before." The judges of the Wolfson economics prize found that the winning plan was the "most crediblesolution" to the question of a member state leaving the eurozone.

Odious debtSome protesters, commentators such as Libération correspondent Jean Quatremer and the Liège based NGOCommittee for the Abolition of the Third World Debt (CADTM) allege that the debt should be characterized asodious debt.[462] The Greek documentary Debtocracy,[463] and a book of the same title and content examine whetherthe recent Siemens scandal and uncommercial ECB loans which were conditional on the purchase of military aircraftand submarines are evidence that the loans amount to odious debt and that an audit would result in invalidation of alarge amount of the debt.[464]

National statisticsIn 1992, members of the European Union signed an agreement known as the Maastricht Treaty, under which theypledged to limit their deficit spending and debt levels. However, a number of EU member states, including Greeceand Italy, were able to circumvent these rules and mask their deficit and debt levels through the use of complexcurrency and credit derivatives structures.[37][38] The structures were designed by prominent U.S. investment banks,who received substantial fees in return for their services and who took on little credit risk themselves thanks tospecial legal protections for derivatives counterparties.[37] Financial reforms within the U.S. since the financial crisishave only served to reinforce special protections for derivatives—including greater access to governmentguarantees—while minimizing disclosure to broader financial markets.[465]

The revision of Greece’s 2009 budget deficit from a forecast of "6–8% of GDP" to 12.7% by the new PasokGovernment in late 2009 (a number which, after reclassification of expenses under IMF/EU supervision was furtherraised to 15.4% in 2010) has been cited as one of the issues that ignited the Greek debt crisis.This added a new dimension in the world financial turmoil, as the issues of "creative accounting" and manipulationof statistics by several nations came into focus, potentially undermining investor confidence.The focus has naturally remained on Greece due to its debt crisis. There has however been a growing number ofreports about manipulated statistics by EU and other nations aiming, as was the case for Greece, to mask the sizes ofpublic debts and deficits. These have included analyses of examples in several countries[466][467][468][469] or havefocused on Italy,[470] the United Kingdom,[471][472][473][474][475][476][477][478] Spain,[479] the UnitedStates,[480][481][482] and even Germany.[483][484]

European sovereign-debt crisis 37

Collateral for FinlandOn 18 August 2011, as requested by the Finnish parliament as a condition for any further bailouts, it becameapparent that Finland would receive collateral from Greece, enabling it to participate in the potential new €109billion support package for the Greek economy.[485] Austria, the Netherlands, Slovenia, and Slovakia responded withirritation over this special guarantee for Finland and demanded equal treatment across the eurozone, or a similar dealwith Greece, so as not to increase the risk level over their participation in the bailout.[486] The main point ofcontention was that the collateral is aimed to be a cash deposit, a collateral the Greeks can only give by recyclingpart of the funds loaned by Finland for the bailout, which means Finland and the other eurozone countries guaranteethe Finnish loans in the event of a Greek default.[487]

After extensive negotiations to implement a collateral structure open to all eurozone countries, on 4 October 2011, amodified escrow collateral agreement was reached. The expectation is that only Finland will utilise it, due to i.a.requirement to contribute initial capital to European Stability Mechanism in one installment instead of fiveinstallments over time. Finland, as one of the strongest AAA countries, can raise the required capital with relativeease.[488]

At the beginning of October, Slovakia and Netherlands were the last countries to vote on the EFSF expansion, whichwas the immediate issue behind the collateral discussion, with a mid-October vote.[489] On 13 October 2011Slovakia approved euro bailout expansion, but the government has been forced to call new elections in exchange.In February 2012, the four largest Greek banks agreed to provide the €880 million in collateral to Finland in order tosecure the second bailout program.[490]

Finland's recommendation to the crisis countries is to issue asset-backed securities to cover the immediate need, atactic successfully used in Finland's early 1990s recession,[491] in addition to spending cuts and bad banking.

Political impactHandling of the ongoing crisis has led to the premature end of a number of European national governments andimpacted the outcome of many elections:• Republic of Ireland – February 2011 – After a high deficit in the governments budget in 2010 and the uncertainty

surrounding the proposed bailout from the International Monetary Fund, the 30th Dáil (parliament) collapsed thefollowing year, which led to a subsequent general election, collapse of the preceding government parties, FiannaFáil and the Green Party, the resignation of the Taoiseach (PM) Brian Cowen and the rise of the Fine Gaelparliamentary party, which formed a government alongside the Labour Party in the 31st Dáil, which led to achange of government and the appointment of Enda Kenny as Taoiseach.

• Portugal – March 2011 – Following the failure of parliament to adopt the government austerity measures, PMJosé Sócrates and his government resigned, bringing about early elections in June 2011.[492][493]

• Finland – April 2011 – The approach to the Portuguese bailout and the EFSF dominated the April 2011 electiondebate and formation of the subsequent government.[494][495]

• Spain – July 2011 – Following the failure of the Spanish government to handle the economic situation, PM JoséLuis Rodríguez Zapatero announced early elections in November.[496] "It is convenient to hold elections this fallso a new government can take charge of the economy in 2012, fresh from the balloting" he said.[497] Followingthe elections, Mariano Rajoy became PM.

• Slovenia – September 2011 – Following the failure of June referendums on measures to combat the economiccrisis and the departure of coalition partners, the Borut Pahor government lost a motion of confidence andDecember 2011 early elections were set, following which Janez Janša became PM.[498]

• Slovakia – October 2011 – In return for the approval of the EFSF by her coalition partners, PM Iveta Radičováhad to concede early elections in March 2012, following which Robert Fico became PM.

European sovereign-debt crisis 38

• Italy – November 2011 – Following market pressure on government bond prices in response to concerns aboutlevels of debt, the Government of Silvio Berlusconi lost its majority, resigned and was replaced by theGovernment of Mario Monti.[203]

• Greece – November 2011 – After intense criticism from within his own party, the opposition and other EUgovernments, for his proposal to hold a referendum on the austerity and bailout measures, PM George Papandreouof the PASOK party announced his resignation in favour of a national unity government between three parties, ofwhich only two currently remain in the coalition.[87] Following the vote in the Greek parliament on the austerityand bailout measures, which both leading parties supported but many MPs of these two parties voted against,Papandreou and Antonis Samaras expelled a total of 44 MPs from their respective parliamentary groups, leadingto PASOK losing its parliamentary majority.[499] The early Greek legislative election, 2012 were the first time inthe history of the country, at which the bipartisanship (consisted of PASOK and New Democracy parties), whichruled the country for over 40 years, collapsed in votes as a punishment for their support to the strict measuresproposed by the country's foreign lenders and the Troika (consisted of the European Union, the IMF and theEuropean Central Bank). The popularity of PASOK dropped from 42.5% in 2010 to as low as 7% in some polls in2012.[500] The extreme right-wing, radical left-wing, communist and populist political parties that have opposedthe policy of strict measures, won the majority of the votes.

• Netherlands - April 2012 - After talks between the VVD, CDA and PVV over a new austerity package of about14 billion euros failed, the Rutte cabinet collapsed. Early elections were called for 12 September 2012. To preventfines from the EU - a new budget was demanded by April 30 - five different parties called the kunduz coalitionforged together an emergency budget for 2013 in just two days.[501][502]

• France - May 2012 - The French presidential election, 2012 became the first time since 1981 that an incumbentfailed to gain a second term, when Nicolas Sarkozy lost to François Hollande.

ProjectionsSome investors with reasonably good track records expect that the crisis will run its course in 3 to 5 years. It ispossible to invest in hedge funds which follow investment plans based on that projection. However, even they shyaway from Greek investments.[503]

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External links• 2011 Dahrendorf Symposium (http:/ / www. dahrendorf-symposium. eu/ ) – Changing the Debate on Europe –

Moving Beyond Conventional Wisdoms• 2011 Dahrendorf Symposium Blog (http:/ / blog. dahrendorf-symposium. eu/ )• Eurostat – Statistics Explained: Structure of government debt (http:/ / epp. eurostat. ec. europa. eu/

statistics_explained/ index. php/ Structure_of_government_debt) (October 2011 data)• Interactive Map of the Debt Crisis (http:/ / www. economist. com/ blogs/ dailychart/ 2011/ 02/

europes_economies) Economist Magazine, 9 February 2011• European Debt Crisis (http:/ / topics. nytimes. com/ top/ reference/ timestopics/ subjects/ e/

european_sovereign_debt_crisis/ index. html?ref=global) New York Times topic page updated daily.• Tracking Europe's Debt Crisis (http:/ / www. nytimes. com/ interactive/ business/ global/

european-debt-crisis-tracker. html?ref=europeansovereigndebtcrisis) New York Times topic page, with latestheadline by country (France, Germany, Greece, Italy, Portugal, Spain).

• Map of European Debts (http:/ / www. nytimes. com/ interactive/ 2010/ 04/ 06/ business/ global/european-debt-map. html) New York Times 20 December 2010

• Budget deficit from 2007 to 2015 (http:/ / www. eiu. com/ eurodebt) Economist Intelligence Unit 30 March 2011• Protests in Greece in Response to Severe Austerity Measures in EU, IMF Bailout (http:/ / www. democracynow.

org/ 2010/ 5/ 4/ protests_in_greece_in_response_to) – video report by Democracy Now!• Diagram of Interlocking Debt Positions of European Countries (http:/ / www. nytimes. com/ interactive/ 2010/ 05/

02/ weekinreview/ 02marsh. html) New York Times 1 May 2010• Argentina: Life After Default (http:/ / www. soundsandcolours. com/ articles/ argentina/

argentina-lessons-learnt-from-the-aftermath-of-default/ ) Sand and Colours 2 August 2010• Google – public data (http:/ / www. google. com/ publicdata/ overview?ds=ds22a34krhq5p_): Government Debt

in Europe• Stefan Collignon: Democratic requirements for a European Economic Government (http:/ / library. fes. de/

pdf-files/ id/ ipa/ 07710. pdf) Friedrich-Ebert-Stiftung, December 2010 (PDF 625 KB)• Nick Malkoutzis: Greece – A Year in Crisis (http:/ / library. fes. de/ pdf-files/ id/ ipa/ 08208. pdf)

Friedrich-Ebert-Stiftung, Juni 2011• SOME OF ASPECTS OF STATE NATIONAL ECONOMY EVOLUTION IN THE SYSTEM OF THE

INTERNATIONAL ECONOMIC ORDER (http:/ / simon31. narod. ru/ syndromeofsocialism. htm/ )• Rainer Lenz: Crisis in the Eurozone (http:/ / library. fes. de/ pdf-files/ id/ ipa/ 08169. pdf)

Friedrich-Ebert-Stiftung, Juni 2011• Wolf, Martin, "Creditors can huff but they need debtors" (http:/ / www. ft. com/ intl/ cms/ s/ 0/

e71ab1d6-049d-11e1-ac2a-00144feabdc0. html#axzz1cYDHnKg3), Financial Times, 1 November 2011 7:28 pm.• More Pain, No Gain for Greece: Is the Euro Worth the Costs of Pro-Cyclical Fiscal Policy and Internal

Devaluation? (http:/ / www. cepr. net/ documents/ publications/ greece-2012-02. pdf) Center for Economic andPolicy Research, February 2012

• "Liquidity only buys time" – Where are European experts for a long-term and holistic approach? Interview withLiu Olin: The Euro Crisis. A Chinese Economist's View. (03/2012) (http:/ / 99faces. tv/ liuolin/ ?preview=true&preview_id=2542& preview_nonce=a5f23749b4)

• Michael Lewis-How the Financial Crisis Created a New Third World-October 2011 (http:/ / www. npr. org/templates/ transcript/ transcript. php?storyId=140948138) NPR, October 2011

• This American Life - Continental Breakup (http:/ / www. thisamericanlife. org/ radio-archives/ episode/ 455/continental-breakup) NPR, January 2012

• Global Financial Stability Report (http:/ / www. imf. org/ external/ pubs/ ft/ gfsr/ 2012/ 01/ pdf/ text. pdf)International Monetary Fund, April 2012

European sovereign-debt crisis 58

• OECD Economic Outlook-May 2012 (http:/ / www. oecd. org/ document/ 18/0,3746,en_2649_33733_20347538_1_1_1_1,00. html)

• SSA Markets: news and data on the sovereign, supra-national and agency debt market, by the publishers ofEuroWeek. (http:/ / www. ssamarkets. com)

• "Leaving the Euro: A Practical Guide" by Roger Bootle, winner of the 2012 Wolfson Economics Prize (http:/ /www. policyexchange. org. uk/ images/ WolfsonPrize/ wolfson economics prize winning entry. pdf)

• "Breaking the Deadlock: A Path Out of the Crisis" (http:/ / ineteconomics. org/ sites/ inet. civicactions. net/ files/INET Council on the Euro Zone Crisis - 23-7-12. pdf)

Article Sources and Contributors 59

Article Sources and ContributorsEuropean sovereign-debt crisis  Source: http://en.wikipedia.org/w/index.php?oldid=516501491  Contributors: 4pq1injbok, ABMvandeBult, Adaniels85, Aid85, Albicor, Alcea setosa,Alex1011, Alinor, Allens, Andi47, Andrewlp1991, Anna Lincoln, AnonMoos, Anothroskon, Arnoutf, Art LaPella, Arthur Rubin, Athenean, B.Andersohn, BD2412, BIL, Bdell555, Belchman,Bender235, Benjamin M. Anderson, Benjamin9832, Bentery, Binksternet, Blaisorblade, Bomazi, Boson, Brandmeister, Branlon, Breein1007, Brenont, Briaboru, CYYK, CactusWriter,Caeruleancentaur, Capedia, Carachi, Cassowary, Cattus, CecilWard, Cerebellum, Che829, Chiton magnificus, Chris the speller, ChrisGualtieri, Circeus, Ckatz, Clithering, Cogiati, Connolly15,CopperSquare, CorvetteZ51, CouchRambo, Creedence, Crnorizec, Cs32en, CultureArchitect, Curb Chain, Cybercobra, DaLeBu, Damac, Dan Guan, DanielRigal, Danish Expert, Datastat,Daveopen, Davepoth, De Administrando Imperio, Dearieme, Deenoe, Deltabeignet, Delusion23, Devourer09, Dewritech, Dimboukas, Dinkytown, Doctorhawkes, Dondervogel 2, Dr.K.,Dreamer5656, DriveMySol, Drpickem, Dumelow, Eastlaw, Eco84, Edward, El Duende, Elatanatari, Eleassar, ElfMage, Emanuel Kingsley, Enok, Erathouis, Erget2005, Espoo, Eug.galeotti,Eumolpo, Ewawer, Exok, Facts707, Falcon9x5, Farcaster, Farzaneh, Faustbol, Fayries, FeydHuxtable, FinHits, FormerIP, Fred Bauder, Friginator, Funandtrvl, Gammondog, Gareth E Kegg,Gcruzlop, Georgeloy, Gfcvoice, Gniniv, Gposes01, Green-ops, Greenshed, Gregkaye, Ground Zero, Grrr81, Gsarwa, Guyphillips, HJ Mitchell, Hairgelmare, Halsteadk, Happolati, Hari akku,Haslaki, Henry4444, Hideokun, Hmains, Holy Santa, HonorTheKing, Hooiwind, Hugo999, Hvn0413, Hydrox, Ianare, Iloveandrea, Imperial Monarch, Impru20, Inhumanfat, Insilvis,InverseHypercube, Ipafes, Ipigott, Its snowing in East Asia, Ivibee, J intela, JaGa, Jason from nyc, Jethro B, Jnn0810, Jo3sampl, John, John Ericson, John Z, JohnC, JohnGH, Johnmccoll,JokerXtreme, Jollyr, Jph, Jprw, Jpvandijk, Keenan Pepper, Keith D, Kintetsubuffalo, Kittybrewster, Kozuch, Kris1912, Ktr101, Kuru, Ky23, L1A1 FAL, LMB, Lady Pablo, Lawrencekhoo,Leotohill, Lex Pecunia, Lihaas, LittleWink, Luisldq, MER-C, MSkriver, Majorbolz, Malekhanif, Mansmokingacigar, Marek69, Mark t young, MathewTownsend, Mecanismo, Megiddo1013,Mens Sana, Menswear, Mephistophelian, Mgiganteus1, Michael Zimmermann, Mike Young, Mild Bill Hiccup, Miltimj, Mimihitam, Mistakefinder, Mjs1991, Mk5384, Molh394, Moorehaus,Moriori, Mporter, MrOllie, Mrfebruary, Mulder1982, Mw0001, Myriamrobin, Naccy5122, Narayanese, NativeClient, Nbarth, Neumannk, Neun-x, Nhb2011, Nheilmann, Noclador, Nopetro,Nsk92, Nunocordeiro, Oakley77, Ohconfucius, Ohnoitsjamie, Oneiros, Onepebble, Opera hat, Oreo Priest, Paris1127, Paul Pieniezny, Paul White, Pauli133, Pavlos03, PedroPVZ, Peregrine981,Pgreenfinch, Phalinshah, Philly boy92, Piotrus, Planetary Chaos Redux, Plankto, Platinumshore, Pointillist, Polisciasu, Pontificalibus, Professionalgeek, ProgRockLover, Psinu, Pufferfish101,Pyrotec, Quest for Truth, Quest09, Rannpháirtí anaithnid, Rcsprinter123, Red Hurley, Red King, Redrose64, Redthoreau, Reidlos, Renewolf, Rich Farmbrough, Richardbourke, Rick AUT,Rickyrab, Rinconsoleao, Rizalninoynapoleon, Rjwilmsi, Robo Cop, Rod57, Ronanmurphy98, RoyBoy, Rubinkumar, Rye1967, S.Örvarr.S, Samofi, Sandstein, Sardath, Saurael, Schrödinger'sNeurotoxin, SchuminWeb, Seemorr, SelectSplat, Sfan00 IMG, Shadowmorph, Shattered, Shawnc, ShoWPiece, Shokioto22, Shrike, SimonP, Skartsis, Skogkatten, Skookum1, Slaterino, Sligocki,Sm8900, Smallbones, Smocking, Smsagro, Smyth, Snow storm in Eastern Asia, Solferino, Spitzl, Sreyan, Stanjourdan, Staticshakedown, Statisfactions, StephenDawson, SteveSoho,Stifynsemons, Strike Eagle, Student7, Sulmues, Sun Creator, Suomi Finland 2009, Supreme Deliciousness, Surv1v4l1st, Sustainlogic, Swliv, SylviaStanley, Tech56, Tenth Plague, TerraFrost,ThaddeusB, The Celestial City, The Gnome, Theyenguy, Tim!, TimidGuy, Tophat13, Tpbradbury, Treybien, Trinitresque, Ubernot, Uditichopra, Uxejn, Van Vidrine, Vanakaris, Vcirulli, Velho,Vgy7ujm, Vitacore, Volgar, VsevolodKrolikov, Vuo, Vvarkey, Walter Görlitz, Wasbeer, Wasell, Watercolor merger, Waterdorf, Wavelength, Welshleprechaun, WikiWikiPhil, Wikibioecoeros,Wikidea, Wikireader41, Will Beback, Williameis, Wipsenade, Wolftengu, Woohookitty, Wportre, WriterHound, Wwoods, Xaliqen, Y256, YechezkelZilber, Yellowdesk, Ykliu, Ylee, Yug,Zachlipton, Zidonuke, 660 anonymous edits

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Public revenue vs expenditure.png  Source: http://en.wikipedia.org/w/index.php?title=File:Greece_-_Public_revenue_vs_expenditure.png  License: Creative CommonsAttribution-Sharealike 3.0  Contributors: User:SpitzlFile:Unit labor costs.svg  Source: http://en.wikipedia.org/w/index.php?title=File:Unit_labor_costs.svg  License: Creative Commons Attribution-Sharealike 3.0,2.5,2.0,1.0  Contributors: SpitzlFile:Economic health (plain).png  Source: http://en.wikipedia.org/w/index.php?title=File:Economic_health_(plain).png  License: Creative Commons Attribution-Sharealike 3.0,2.5,2.0,1.0 Contributors: SpitzlFile:Current account imbalances EN (3D).svg  Source: http://en.wikipedia.org/w/index.php?title=File:Current_account_imbalances_EN_(3D).svg  License: Creative CommonsAttribution-Sharealike 3.0,2.5,2.0,1.0  Contributors: SpitzlFile:BCG-necessary debt reduction.png  Source: http://en.wikipedia.org/w/index.php?title=File:BCG-necessary_debt_reduction.png  License: Creative Commons Attribution-Sharealike3.0,2.5,2.0,1.0  Contributors: SpitzlFile:StandardPoors Headquarters.JPG  Source: http://en.wikipedia.org/w/index.php?title=File:StandardPoors_Headquarters.JPG  License: Creative Commons Attribution 3.0  Contributors:B64. 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LicenseCreative Commons Attribution-Share Alike 3.0 Unported//creativecommons.org/licenses/by-sa/3.0/