European Sovereign Debt Crisis

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DEFINITION of 'European Sovereign Debt Crisis'

The European sovereign debt crisis occurred during a period of time in which several European countries faced the collapse of financial institutions, high government debt and rapidly rising bond yield spreads in government securities. The European sovereign debt crisis started in 2008, with the collapse of Iceland's banking system, and spread to primarily to Greece, Ireland and Portugal during 2009. The debt crisis led to a crisis of confidence for European businesses and economies.

INVESTOPEDIA EXPLAINS 'European Sovereign Debt Crisis'

The European sovereign debt crisis was brought to heel by the financial guarantees by European countries, who feared the collapse of the euro and financial contagion, and by the International Monetary Fund (IMF). Ratings agencies downgraded the debt of several eurozone countries, with Greek debt at one point being moved to junk status. As part of the loan agreements, countries receiving bailout funds were required to meet austerity measures designed to slow down the growth of public sector debt.

History of the European Sovereign Debt Crisis

The European sovereign debt crisis began at the end of 2009, when the peripheral eurozone member states of Greece, Spain, Ireland, Portugal and Cyprus were unable to repay or refinance their government debt, or bail out their beleaguered banks without the assistance of third-party financial institutions such as the European Central Bank (ECB), the International Monetary Fund (IMF) and the European Financial Stability Facility (EFSF). Seventeen eurozone countries voted to create the EFSF in 2010 specifically to address and assist the European sovereign debt crisis.

Some of the contributing causes of the sovereign debt crisis include the financial crisis of 2007-2008, the Great Recession of 2008-2012, as well as the real estate market crisis and property bubbles in several countries, and the aforementioned states’ fiscal policies regarding government expenses and revenues. This culminated in 2009 when Greece unveiled its 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.

A 2012 report for the United States Congress summarizes: “The eurozone debt crisis began in late 2009, when a new Greek government revealed that previous governments had been misreporting government budget data. Higher than expected investor levels eroded investor confidence, causing bond spreads to rise to unsustainable levels. Fears quickly spread that the fiscal positions and debt levels of a number of eurozone countries were unsustainable."

In 2010, with increasing fear of excessive sovereign debt, lenders demanded higher interest rates from eurozone states with high debt and deficit levels, making it harder for these countries to finance their budget deficits when faced with overall low economic growth. Some affected countries raised taxes and slashed expenditures in order to combat the crisis, which contributed to social upset within their borders and a crisis of confidence among their leadership, particularly in Greece. During this crisis, several of these countries including Greece, Portugal and Ireland had their sovereign debt downgraded to junk status by international credit rating agencies, worsening investor fears.

Greece’s Case

In early 2010 these difficult developments reflected in rising spreads on sovereign bond yields between the affected peripheral member states of Greece, Ireland, Portugal and Spain, and most notably Germany. The Greek yield diverged in early 2010 with Greece needing eurozone assistance by May 2010. Greece received two bailouts from the EU over the following five years during which the country adopted EU-mandated austerity measures to cut costs while experiencing a further economic recession as well as social unrest. In June 2015 Greece, with divided political and fiscal leadership and a continued recession, was facing a sovereign default. However, on July 5, 2015 the Greek people voted against further EU austerity measures, with a possibility of Greece leaving the European Monetary Union entirely. The withdrawal of a nation from the EMU is unprecedented, and the speculated effects on Greece's economy if the currency is returned to the drachma range from total economic collapse to a surprise recovery. 

Further Effects

Ireland followed Greece in requiring a bailout in November 2010, with Portugal next in May 2011. Italy and Spain were also vulnerable, with Spain requiring official assistance in June 2012 along with Cyprus. By 2014, Ireland, Portugal and Spain, due to various fiscal reforms, domestic austerity measures and other unique economic factors, all successfully exited their bailout programs requiring no further assistance. The road to full economic recovery is still underway. Cyprus, too, reported a slow but steady ongoing recovery, averting further financial crisis thus far.

 

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