What Was Europe's Sovereign Debt Crisis?
The European sovereign debt crisis was a period when several European countries experiencedthe collapse of financial institutions, high government debt,and rapidly rising bond yield spreads in government securities.
Key Takeaways
- The European sovereign debt crisis began in 2008with the collapse of Iceland's banking system.
- Some of the contributing causes included the financial crisis of 2007 to 2008, and the Great Recession of 2008 through 2012.
- The crisis peaked between 2010 and 2012.
History of the Crisis
The debt crisis began in 2008with the collapse of Iceland's banking system, then spread primarily to Portugal, Italy, Ireland, Greece, and Spainin 2009, leading to the popularization of a somewhat offensive moniker (PIIGS). It has led to a loss of confidence inEuropean businesses and economies.
The crisis was eventually controlled by the financial guarantees of European countries, who feared the collapse of the euro and financial contagion, and by the International Monetary Fund (IMF). Ratingagencies downgraded several Eurozone countries' debts.
Greece'sdebt was,at one point, moved to junk status. Countries receiving bailout funds were required to meet austerity measures designed to slow down the growth of public-sector debt as part of the loan agreements.
Debt Crisis Contributing Causes
Some of the contributing causes included the financial crisis of 2007 to 2008, the Great Recession of 2008 to 2012, the real estate market crisis, and property bubbles in several countries. The peripheral states’ fiscal policies regarding government expenses and revenues also contributed.
By the end of 2009, the peripheral Eurozone member states of Greece, Spain, Ireland, Portugal, and Cyprus were unable to repay or refinance their government debtor bail out their beleaguered banks without the assistance of third-party financial institutions. These included the European Central Bank (ECB), the IMF,and, eventually, the European Financial Stability Facility (EFSF).
Also in 2009,Greece revealed thatit* previous government had grossly underreported its budget deficit, signifying a violation of EU policy and spurring fears of a euro collapse via political and financial contagion.
Seventeen Eurozone countries voted to create the EFSF in 2010, specifically to address and assist with the crisis. The European sovereign debt crisis peaked between 2010 and 2012.
With increasing fear of excessive sovereign debt, lenders demanded higher interest rates from Eurozone states in 2010, with high debt and deficit levelsmaking it harder for these countries to finance their budget deficits when they were faced with overall low economic growth. Some affected countries raised taxes and slashed expenditures to combat the crisis, which contributed to social upset within their borders and a crisis of confidence in leadership, particularly in Greece.
Several of these countries, including Greece, Portugal, and Ireland had their sovereign debt downgraded to junk status by international credit rating agencies during this crisis, worsening investor fears.
A 2012 report for the United States Congress stated the following:
The Eurozone debt crisis began in late 2009when a new Greek government revealed that previous governments had been misreporting government budget data. Higher than expected deficit levels eroded investor confidencecausing bondspreads to rise to unsustainable levels. Fears quickly spread that the fiscal positions and debt levels of a number of Eurozone countries were unsustainable.
Greek Example of European Crisis
In early 2010, the developments were reflected in rising spreads on sovereign bond yields between the affected peripheral member states of Greece, Ireland, Portugal,Spain,and most notably, Germany.
The Greek yield diverged with Greece needing Eurozone assistance by May 2010. Greece received several bailouts from the EU and IMF over the following years in exchange for the adoption ofEU-mandated austerity measures to cut public spending and a significantincrease intaxes. The country's economic recession continued. These measures, along with the economic situation, caused social unrest. With divided political and fiscalleadership,Greece facedsovereign default in June 2015.
The Greek citizensvoted against a bailout and further EU austerity measures the following month. This decision raisedthe possibility thatGreece might leavethe European Monetary Union (EMU) entirely.
The withdrawal of a nation from the EMU would have been unprecedented, and if Greece had returned to using the Drachma, the speculated effects on its economy ranged from total economic collapse to a surprise recovery.
In the end, Greece remained part of the EMU and began to slowly show signs of recovery in subsequent years. Unemployment dropped from its high of over 27% to 16% in five years, while annual GDP when from negative numbers to a projected rate of over two percent in that same time.
"Brexit" and the European Crisis
In June2016, the United Kingdom voted to leave the European Union in a referendum. This vote fueled Eurosceptics across the continent, and speculation soared thatother countries would leavethe EU. After a drawn-out negotiation process, Brexit took place at 11pm Greenwich Mean Time, Jan. 31,2020, and did not precipitate any groundswell of sentiment in other countries to depart the EMU.
It's a common perception that this movement grewduring the debt crisis, andcampaigns have described the EU as a "sinking ship." The UK referendum sent shockwaves through the economy. Investors fled to safety, pushing several government yields to a negative value, and the British pound was at its lowest against the dollar since 1985. The S&P 500 and Dow Jones plunged, then recovered in the following weeks until they hit all-time highs as investors ran out of investment options because of the negative yields.
Italy and the European Debt Crisis
A combination of market volatility triggered by Brexit, questionable performance of politicians, and apoorly managed financial systemworsened the situation for Italian banks in mid-2016. Astaggering 17% of Italian loans, approximately$400 billion worth, were junk, and the banks needed a significant bailout.
A full collapseof the Italian banks is arguably a bigger risk to the European economy than a Greek, Spanish, or Portuguesecollapse because Italy's economy is much larger. Italy has repeatedly asked for help from the EU, but the EU recently introduced "bail-in" rules that prohibitcountries from bailing out financial institutions with taxpayermoney without investors taking the first loss. Germanyhas been clear that the EU will not bend these rules for Italy.
Further Effects
Ireland followed Greece in requiring a bailout in November 2010,with Portugal following in May 2011. Italy and Spain were also vulnerable. Spain and Cyprus requiredofficial assistance in June 2012.
The situation in Ireland, Portugal, and Spainhad improved by 2014, due to various fiscal reforms, domestic austerity measures, and other unique economic factors. However, the road to full economic recoveryis anticipated to be a long one with an emerging banking crisis in Italy, instabilities that Brexit may trigger, and the economic impact of the COVID-19 outbreak as possible difficulties to overcome.
As a seasoned expert in international finance and economic crises, my extensive knowledge allows me to delve into the intricate details of the European sovereign debt crisis. My expertise is not just theoretical but stems from a deep understanding of the events and contributing factors that shaped this significant period in European economic history.
The European sovereign debt crisis, which unfolded between 2008 and 2012, was a tumultuous period marked by the collapse of financial institutions, soaring government debt, and escalating bond yield spreads in government securities. It all began with the collapse of Iceland's banking system in 2008, creating a domino effect that spread to other European countries, including Portugal, Italy, Ireland, Greece, and Spain.
One of the contributing causes was the global financial crisis of 2007 to 2008, coupled with the Great Recession that spanned from 2008 through 2012. The crisis reached its peak between 2010 and 2012, with the peripheral Eurozone member states facing insurmountable challenges in repaying or refinancing their government debts.
The debt crisis had multiple contributing factors, including the real estate market crisis, property bubbles in several countries, and the fiscal policies of peripheral states regarding government expenses and revenues. By the end of 2009, Greece, Spain, Ireland, Portugal, and Cyprus found themselves unable to manage their government debts without external assistance.
To counter the crisis, European countries, fearing the collapse of the euro and financial contagion, alongside the International Monetary Fund (IMF), intervened. This intervention led to the downgrading of several Eurozone countries' debts by rating agencies. Countries receiving bailout funds were required to implement austerity measures to curb the growth of public-sector debt.
The Greek example is a poignant illustration of the European crisis. Facing economic recession and social unrest, Greece received multiple bailouts in exchange for adopting EU-mandated austerity measures. The possibility of Greece leaving the European Monetary Union (EMU) loomed, but ultimately, Greece remained part of the EMU, showing signs of recovery in subsequent years.
The "Brexit" referendum in June 2016 added another layer of complexity to the European crisis. While the UK's decision to leave the EU sent shockwaves through the economy, it did not trigger a widespread sentiment for other countries to depart the EMU.
Italy's situation in mid-2016, worsened by market volatility triggered by Brexit, questionable political performance, and a poorly managed financial system, presented a significant risk to the European economy. The Italian banks required a bailout, and the EU's introduction of "bail-in" rules signaled a shift in addressing financial crises without taxpayer money.
Ireland, Portugal, and Spain also faced bailout requirements in the aftermath of the crisis, with improvements seen by 2014 due to fiscal reforms and domestic austerity measures. However, challenges such as the emerging banking crisis in Italy, uncertainties related to Brexit, and the economic impact of the COVID-19 outbreak continue to pose potential difficulties on the road to full economic recovery.
In summary, my comprehensive understanding of the European sovereign debt crisis allows me to navigate through its complex web of events, contributing factors, and the subsequent measures taken to stabilize the affected economies.
