Some concluding remarks

Upon starting this blog I had heard so much about the Greek crisis, it was (and still is) a hot topic, not only in the financial world but it the general media.  However, I felt I did not know a great deal about it.

This was the motivation behind my blog, not only to satisfy curriculum requirements but to further my knowledge of the world around me. Perhaps in the process of being bombarded with information we tend to switch off, or feel like there is too much to really get to grips with, especially if you haven't been keeping up to date thus far.  This blog aimed to simplify what we hear in the media or read in financial newspapers and explain why the crisis happened, what has happened as a result and what is being done to deal with the issues.  The findings of the blog, and what is happening with Greece, are aligned with the extant literature of Mishkin (1999) in his paper 'Lessons from the Asian crisis'.  He outlines that "...there is a strong rationale for government intervention to get the financial system back on its feet", we see this in Greece by the eurozone countries attempting to bail out Greece with various bailout packages, most recently for 130bn euros.  Another lesson from the Asian crisis is that "...an international lender of last resort has to impose appropriate conditionality on its lending in order if it wants to aviod creating excessive moral hazard which encourages financial instability", this has also been demonstrated in the Greek crisis since the bailout packages have come with the condition of imposing austerity measures.

What the future holds for Greece and the euro is anyone's guess.  Some say it has turned in to a legal issue now rather than a financial one, as to whether Greece will default or not.  In my opinion it will be a long road ahead for Greece and the EU, and will certainly be one that will dominate media headlines for many years to come. However, I hope that we see the day where Greece is once again remembered for its beauty and coastline rather than its bottom line.

Combating the crisis

If Greece were to default on its debts it would have a negative knock on effect for the rest of the EU. In an attempt to prevent such an event, the Greek government, the Eurozone and IMF have been trying to sort out the crisis over the past two years with a series of bailout packages and austerity measures. 

It feels nowadays that it is impossible to turn on the news without hearing about another bailout for Greece, and with so much information to digest, it can sometime feel hard to keep up.  Let’s take a look back and try to summarise the attempts at fixing the problem.

When the crisis started in 2009, Greece's credit rating was downgraded in fear that it would default on its ever growing debt.  Greek prime minister George Papandreou announced a series of tough cuts in public spending. 

January 2010 saw the government announcing a second round of severe austerity measures including public sector pay cuts, an increase in fuel prices and a crackdown on tax evasion.  Obviously unpopular with the public, the austerity measures led to various strikes which continued for a few months.  By April 2010 a 100bn euro bailout package was agreed by eurozone countries in an attempt to rescue the country, as fears of default grew.  The bailout package meant stricter austerity measures were to be put in place.

No further bailouts were given in 2011, however, the year seen many talks between eurozone countries, more downgrades and even more austerity measures to try and get Greek finances back on track. 

By 2012 tension in Athens had reached an all time high and the people of Greece took to the streets in violent protests.  

Most recently and a new 130bn euro bailout has been agreed by the EU to aid Greece.

Greek Aftermath

Reinhart & Rogoff (2009) believe that "The aftermath of sever financial crisis share three characteristics".  The first of these so called characteristics being that asset market collapses are deep and prolonged, on equity markets declining on average 55% in three and a half years.The second, that on average output declines by 9% and employment decreases by 7%.  The third being that the real value of government debt increases dramatically by an average figure of 86%.  The graphs below show how the statistics for Greece compare to those given by Reinhart & Rogoff (2009).

The graph to the right show that from 2008 to 2011 unemployment in Greece increased from approximately 7% to 21%, hence a decrease in in employment of 14%.

The graph to the left shows the development of Greece's debt and Economic output over the same period.  The Debt Ratio, as a percentage of GDP, has increased by 50% in those three years, with debt massively increasing and economic output on the decline. 

Reinhart and Rogoff (2009) find that interestingly the main cause of the exploding levels of debt come not from the recapitalization and bailing out of banks (which is obviously large but has an upper limit); but rather from the reduction in taxes which results from the decline in economic output; which seems to coinside with what has happened in Greece.

Greek Debt Crisis explained in 4 minutes

Five years after the crisis began financial markets around the world are still in decline and are being dragged down further by the debt crisis in Europe.  At the forefront of the debt crisis is Greece. 

Like most countries, Greece has to rely on debt to finance its spending, ie spending money it doesn't have.  Greece took advantage of the good economic times(pre-crisis) to borrow money to increase public sector wages and to spend on projects such as the 2004 olympics.  It began to run up a larger and larger deficit (the difference between what the country brings in in taxes and what it spends).  When the global crisis struck, Greece suffered.  Banks around the world began to see it as a country that may not be able to manage its money; becoming concerned that Greece could perhaps default on its loans, and eventually even go bankrupt.  To hedge againts this risk, banks started charging Greece more to borrow money which in turn exasperated the problem further.

In 2009 when the current socialist government came into power the Greek Prime Minister, George Papandreou, announced that the previous conservative government had falsified budget figures, masking their rapidly growing debt figure. Greece was quickly cut out of the bond market and began relying on the aid of other EU countries.  This help however comes with tough conditions, Greece has promised to cut its budget deficit which has led to uproar in Athens.

This video gives a condensed and amusing insight into explaination behind the crisis in Greece.

  

The lead up to the EU crisis

Mishkin (1992) defines a financial crisis in terms of asymmetric information “A financial crisis is a disruption to financial markets in which adverse selection and moral hazard problems become much worse, so that financial markets are unable to efficiently channel funds to those who have the most productive investment opportunities.  As a result, a financial crisis can drive the economy away from an equilibrium with high output in which financial markets perform well to one in which output declines sharply. … It indicates that financial crisis have effects over and above those resulting from bank panics and therefore provides a rationale for an extended lender-of-last-resort role for the central bank in which the central bank uses the discount window to provide liquidity…”

This definition by Mishkin, although rather long, gives a good overview in to the most recent financial crisis and those which have come before it.  Hall (2010) argues that the worst crisis to hit the US and most other countries struck in 1929 and was followed by the Great Depression.  He refers the current crisis, from 2007 onwards ,as being the second worst in history aligning it to the 1929 crisis by calling it the ‘Great Recession’.  It is to this global crisis we must look to begin to unfold why Europe is in such a mess today.

The European Commission in 2009 published a document which aimed to get to the root of the global crisis and outlined it main causes.  The findings showed that the crisis in 2007 started in a similar manner to any past financial crisis; it was preceded by a long period of rapid credit growth (shown most obviously by mortgages given for over 100% of house value), abundant availability of liquidity, high leverage, increasing asset prices and the development of bubbles in the real estate industry.  

The high levels of leverage preceding the crisis left the markets massively exposed to any changes. One such change was that of the subprime mortgage market in the US, and when that fell it was sufficient to “topple the whole structure”, European Commission (2009).  And so the crisis was born due to the liquidity shortage of financial institutions as they expected ever tougher market conditions for rolling over their short term debt.  Even though the was a growing concern over the solvency of financial institutions, a systemic collapse remained unlikely, that was until the fall of Lehman Brothers in 2008 when perceptions changed.  Investors were now largely liquidating their positions and the stock markets ‘nose-dived’ sending the global economy and the EU into the deepest downturn since the 1930’s.   

The Euro - a history

After more than a decade of planning and preparation, Europe's single currency, the euro, finally came in to effect on January 1, 1999.  Originally designed by the European Union to be a medium of exchange between countries within the EU, while people within individual countries still used their own currency. However, within three years the euro had replaced many of the domestic currencies and became an everyday currency for the union members, when euro notes and coins were introduced on January 1, 2002.

Finland became the first country to join the euro, followed closely by Portugal and Ireland.  Initially Denmark, Sweden and Greece were not part of the euro, but conformed in later years.  Greece joined in 2001.

It was felt that the euro held many economic advantages for the EU, making travel easier for its citizens as there was now no need to exchange money when moving between countries; and perhaps most importantly removing exchange rate risk for trading. 

In 1999 Jacques Santer, the president of the European Commission, argued that the launch of the single currency was a historic event which would bring growth and stability to Europe.  More than a decade on, how wrong could he have been?

Europe. Sun, sea, sand.....sovereign debt crisis?

Once known for its idyllic beaches, postcard views and picturesque holiday locations; now the only thing that comes to mind when one mentions Europe is the current mess of its economy. So what happened? How did Europe get itself into such a dire state of affairs? Will it ever recover? These are some of the many tough questions being asked of politicians today.

This blog aims to get back to the roots of the crisis, outlining the answers to the questions above on what really happened, what the government are doing to combat the crisis and what will be the results for Europe’s future.