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Euro Zone Debt Crisis

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With the ongoing financial crisis around the world few countries have a difficult or impossible road ahead to re finance their debts without the assistance of other countries or organizations such as the IMF. From 2009 fears of a sovereign debt crisis developed among investors as a result of the rising government debt levels around the world together with downgrading of government debt in some countries. In Europe fears intensified when the finance ministers approved a rescue package worth €750 billion aimed at ensuring financial stability. With contingency plans not providing economic stability. EU leaders agreed on more measures designed to prevent the collapse of member economies. This included an agreement whereby banks would accept a 53% write off of Greek debt owed to private creditors,increasing the European financial stability facility to about 1 trillion euros, and requiring European banks to achieve 9% subsidization.

While sovereign debt has risen substantially in only a few euro zone countries, it has become a perceived problem for the union as a whole, the three countries most affected Greece, Ireland and Portugal conjointly account for 6% of the E.U.’s gross domestic product. The main causes of the crisis include Rising government debt levels ie. The European Union signed a financial treaty which they pledged to limit their deficit spending and debt levels. Though a number of EU members including Greece and Italy, were able to bypass these rules and mask their deficit and debt levels through the use of complex currency and credit derivative structures. The structures were designed by prominent U.S. Investment banks who received substantial fees in return for their services. The Loss of confidence prompted by banks having substantial holdings of bonds from weaker economies such as Greece which offered a small premium and seemingly were equally sound.

As the crisis developed it became obvious that Greek and possibly other countries bonds offered substantially more risk. Contributing to lack of information about the risk of European sovereign debt was conflict of interest by banks that were earning substantial sums underwriting the bonds. The loss of confidence is marked by rising sovereign credit default swap prices, indicating market expectations about countries creditworthiness. Furthermore investors have doubts about the possibilities of policy makers to quickly contain the crisis.


The main solution to the crisis was the creation of European Financial Stability Facility a legal entity which addresses European sovereign debt similar to the IMF. The EFSF can issue bonds or other debt instruments on the market with the support of the German Finance Agency to raise the funds needed to provide loans to euro zone countries in financial troubles, recapitalize banks or buy sovereign debt. The EFSF has €440 billion lending capacity and is guaranteed by the euro zone countries governments and up to another €250 billion from the IMF to obtain a financial safety net up to €750 billion. Stocks surged worldwide after the EU announced the EFSF’s creation. The facility eased fears that the Greek debt crisis would spread and this led to some stocks rising to the highest level in a year or more. The euro made its biggest gain in 18 months before falling to a new four year low a week later.

Growing number of investors and economists say Euro bonds would be the best way of solving a debt crisis,though the bonds introduction matched by tight financial and budgetary coordination may well require changes in EU treaties. Germany remains largely opposed at least in the short term to a collective takeover of the debt of states that have run excessive budget deficits and borrowed excessively over the past years, saying this could substantially raise the country’s liabilities. To reach sustainable levels the Euro zone must reduce its overall debt level by €6.1 trillion. this could be financed by a one-time wealth tax of between 11 and 30 percent for most countries, apart from the crisis countries where a write-off would have to be substantially higher.

The financial entanglement in Europe and their course of action with social and political responses is a great way for the rest of the world to analyze and employ successful strategies on tackling the global recession which has been a burden on everyone since 2008 with no end in sight.


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