European Sovereign Debt Crisis

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What was the '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 primarily to Greece, Ireland and Portugal during 2009. The debt crisis led to a crisis of confidence for European businesses and economies. (See also: The European Banking Crisis Explained.)

BREAKING DOWN '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 deficit 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.


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 several bailouts from the EU and IMF over the following years in exchange for adopting EU-mandated austerity measures to cut public spending and significantly increase taxes, while experiencing a further economic recession. These measures, along with the economic situation in itself caused social unrest, and in June 2015 Greece, with divided political and fiscal leadership and a continued recession, was facing a sovereign default. The following month the Greek people voted against bailout and further EU austerity measures, which opened 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. The Greek economy is still highly uncertain with unemployment over 23% (though declining), and GDP still shrinking.


In June, 2016, the United Kingdom voted to leave the European Union in a referendum. This fueled Eurosceptics across the continent and speculations of other countries leaving the EU soared (see: Italeave, Oustria and Frexit). It is common perception that this movement has gained stronger roots during the debt crisis. And the campaigns have described EU as a "sinking ship," referring to an unsalvageable economy and unfair pressure on the economically-stable countries to bail out and clean up after the countries in crisis. The UK referendum sent shock waves through the economy. Investors fled to safety pushing several government yields to a negative, and the British pound was at its lowest against the dollar since 1985. The S&P 500 and Dow Jones first plunged, then recovered in the following weeks hitting all-time highs as investors ran out of investment options because of the negative yields. (See more about bond yields here)


A combination of market volatility triggered by Brexit, questionable politicians and a poorly managed financial system worsened the situation for Italian banks in mid 2016. It was reported that a staggering 17%, or about $400 billion worth, of Italian loans were junk, and the banks would need a significant bailout. A full collapse of the Italian banks is arguably a bigger risk to the European economy than a Greek, Spanish or Portuguese collapse because Italy's economy is much larger. Italy has repeatedly asked for help from the EU, however, the EU recently introduced "bail-in" rules that prohibits countries from bailing out financial institutions with taxpayer's money without investors taking the first loss. Germany in particular has 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 next in May 2011. Italy and Spain were also vulnerable, with Spain requiring official assistance in June 2012 along with Cyprus. By 2014 the situation in Ireland, Portugal and Spain, had improved due to various fiscal reforms, domestic austerity measures and other unique economic factors. However, with an emerging banking crisis in Italy and the instabilities followed by Brexit, the road to full economic recovery is anticipated to be long.