The genesis of the European economic crises emerged out of the collapsed of the subprime mortgage crisis in the US financial market. Europe financial market was affected through the securitization of these mortgage debts, which was package and sold to the European banks by the financial institutions in the US. The connectivity of the global financial markets is so interwoven that a financial crisis in a large and important economy can easily spread to neighbouring countries. The first sign of problem in Europe surfaced in the euro zone peripheral economy of Ireland. It had to impose draconian austerity measures to avoid defaulting on its sovereign debt. However, those measures were not enough to stave off a default. Therefore, the Irish Government had to seek help from the EU and IMF, and in the latter part of 2010, Ireland got ?80 billion loan package from them in order for Ireland to continue its austerity plans for the next four years.
The financial crisis spread to Greece
Everyone hoped that the problem would have been contained in Ireland, but like a viral infection, the financial turmoil spread its tentacle, this time to Greece. The problem in Greece is probably worst than that of Ireland, but no doubt, we can all agree that Greece back is against the wall. A few months ago, Greek parliament voted to pass an austerity bill necessary for them to “drawdown” on 12 billion Euros aid package to service the interest on its debt. Their sovereign debt is over 400 billion Euros, which is over a 100% of its GDP, the ECB/IMF are working together to bail out there economy. If Greece is allowed to default on its debt, the fallout could have serious implication for the euro zone. However, in an ironical twist, Greece probably will default on its debt. And if so, they would have to go the route of a selective default in order to address its solvency problem.
The Euro zone has decided to help Greece with a bailout package of $155bn to address its financial crisis. It was first thought that Greece had a liquidity problem but it is now clear that it is a solvency problem that is crippling Greece.
The package is to address certain variables by changing the term of the loan from 8 to 15 years and reduce the interest cost to 3.75%. Those proposals would have no doubt given Greece “some breathing room” in order for it to manoeuvre itself out of the crisis. Once the term of the loans has been changed to a more favourable term for the country, it would technically be a selective default by Greece. The EU members who are most exposed to Greek debt are France and Germany, together they hold 18.68% of Greek debt. Greece total debt stands at $485bn, with a debt to GDP ratio of 142.8%. Although, the Greek parliament has passed the necessary austerity measures for its survival, some may argue that these measures are not a solution to its ailing economy. It is in fact kicking the can down the road but how much further down can you kick, without sitting down at the table with its creditors in coming up with a long term solution.
Kudos, to Germany for rolling over Greek’s debt and giving them a helping hand, Germany knows full well that Greece defaulting on its debts is not in their best interest. Not even a write down of 50% of Greece debts would be in their favour either, Because Germany holds a significant portion of Greece debt and a default or a write down would be nothing short of a catastrophe for them.
The Greece bailout aid package of ?120bn should be borne by the Euro zone members, the Greek Prime Minister George Papandreou is asking for more money, an additional amount of $40bn. Is this enough giving the magnitude of the crisis? Was it fiscal irresponsibility that got Greece in this economic dilemma? Or is it because the problem in the euro zone is a systemic one?
The politicians, in the euro zone, have been warned by both Christine Lagarde, the IMF boss and Tim Geithner, the US Treasury Secretary, to act now. European officials have acceded to the request and have sought the guidance of Geithner to assist them in creating a bailout fund, similar to that of the US stimulation fund in 2008, to the tune of $750 billion. This definitely will be a Herculean task to pass, given the fact that, there are 17 members within the euro zone and they all have to sign off on the creation of this fund. Not all the European leaders have agreed to it, especially Germany and France who are the strongest economy in the euro zone. The reason why both Germany and France are declining to commit to the fund is that they are not willing to contribute anymore funds. But before they can ponder the notion of a bailout fund, they have to contend with the reality of the undercapitalisation of the European banks, and shoring up those banks reserve is of paramount importance. if Greece were the only peripheral economy in trouble; I don’t think it would be a bother. However, other peripheral economies have popped up on the financial radar too. Such as, Italy, Spain and Portugal, these countries also would have to get assistance from the fund. Nevertheless, a solution must be found to avert potentially calamitous disaster in the euro zone and by extension the world economy.
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