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Euro crisis


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Euro crisis

  1. 1. the crisis begins with the significant increase in savings available for investment duringthe 2000–2007 period. During this time, the global pool of fixed income securitiesincreased from approximately $36 trillion in 2000 to $70 trillion by 2007. This "GiantPool of Money" increased as savings from high-growth developing nations enteredglobal capital markets. Investors searching for higher yields than those offered by U.S.Treasury bonds sought alternatives globally. The temptation offered by this readilyavailable savings overwhelmed the policy and regulatory control mechanisms in countryafter country as global fixed income investors searched for yield, generating bubble afterbubble across the globe. While these bubbles have burst causing asset prices(e.g., housing and commercial property) to decline, the liabilities owed to globalinvestors remain at full price, generating questions regarding the solvency ofgovernments and their banking systems.
  2. 2. How each European country involved in this crisis borrowed and invested the moneyvaries.For example:Irelands banks lent the money to property developers, generating a massive propertybubble. When the bubble burst, Irelands government and taxpayers assumed privatedebts.In Greece, the government increased its commitments to public workers in the form ofextremely generous pay and pension benefits.Icelands banking system grew enormously, creating debts to global investors("external debts") several times GDP.
  3. 3. The interconnection in the global financial system means that if one nation defaults onits sovereign debt or enters into recession that places some of the external private debtat risk as well, the banking systems of creditor nations face losses. For example:in October 2011 Italian borrowers owed French banks $366 billion (net). Should Italybe unable to finance itself, the French banking system and economy could come undersignificant pressure, which in turn would affect Frances creditors and so on. This isreferred to as financial contagion.Further creating interconnection is the concept of debt protection. Institutions enteredinto contracts called credit default swaps (CDS) that result in payment should defaultoccur on a particular debt instrument (including government issued bonds). But, sincemultiple CDS can be purchased on the same security, it is unclear what exposure eachcountrys banking system now has to insurance you can insure only that thing which you own, but in case of cds youcan insure something which is owned by someone else there by creating multipleinsurance on one thing. Thus loss of that one thing will result in claim by manycreating pressure on insurer.
  4. 4. Some politicians, notably Angela Merkel, have sought to attribute some of the blame forthe crisis to hedge funds and other speculators stating that "institutions bailed out withpublic funds are exploiting the budget crisis in Greece and elsewhere―.Rising government debt levelsIn 1992 members of the European Union signed the Maastricht Treaty, under which theypledged to limit their deficit spending and debt levels. However, a number of EU memberstates, including Greece and Italy, were able to circumvent these rules and mask theirdeficit and debt levels through the use of complex currency and credit derivativesstructures. The structures were designed by prominent U.S. investment banks, whoreceived substantial fees in return for their services and who took on little credit riskthemselves thanks to special legal protections for derivatives counterparties.
  5. 5. A number of "appalled economists" have condemned the popular notion in the mediathat rising debt levels of European countries were caused by excess governmentspending. According to their analysis increased debt levels are due to the largebailout packages provided to the financial sector during the late-2000s financialcrisis, and the global economic slowdown thereafter.The average fiscal deficit in the euro area in 2007 was only 0.6% before it grew to7% during the financial crisis. In the same period the average government debt rosefrom 66% to 84% of GDP.The authors also stressed that fiscal deficits in the euro area were stable or evenshrinking since the early 1990s. US economist Paul Krugman named Greece as theonly country, where fiscal irresponsibility is at the heart of the crisis.(see thegraph)Either way, high debt levels alone may not explain the crisis. According to TheEconomist Intelligence Unit, the position of the euro area looked "no worse and in somerespects, rather better than that of the US or the UK." The budget deficit for the euroarea as a whole is much lower and the euro areas government debt/GDP ratio of86% in 2010 was about the same level as that of the US.
  6. 6. Greeces debt percentage between 1999 and 2010 compared to the average of the eurozone
  7. 7. Trade imbalancesCommentators such as Financial Times journalist Martin Wolf have assertedthe root of the crisis was growing trade imbalances. He notes in the run-upto the crisis, from 1999 to 2007, Germany had a considerably better public debtand fiscal deficit relative to GDP than the most affected eurozone members. Inthe same period, these countries (Portugal, Ireland, Italy and Spain) had farworse balance of payments positions. Whereas German trade surplusesincreased as a percentage of GDP after 1999, the deficits of Italy, Franceand Spain all worsened.More recently, Greeces trading position has improved; in the period November2010 to October 2011 imports dropped 12% while exports grew 15% (40% tonon-EU countries in comparison to October 2010).
  8. 8. Monetary policy inflexibilitySince membership of the eurozone establishes a single monetary policyindividual member states can no longer act independently. Paradoxically, thissituation creates a higher default risk than faced by smaller non-eurozoneeconomies, like the United Kingdom, which are able to "print money" inorder to pay creditors and ease their risk of default. (Such an option is notavailable to a state such as France.) By "printing money" a countrys currencyis devalued relative to its (eurozone) trading partners, making it exportscheaper, in principle leading to an improving balance of trade, increased GDPand higher tax revenues in nominal terms. In the reverse directionmoreover, assets held in a currency which has devalued suffer losses on thepart of those holding them. For example by the end of 2011, following a 25percent fall in the rate of exchange and 5 percent rise in inflation, eurozoneinvestors in Sterling, locked in to Euro exchanges rates, had suffered anapproximate 30 percent cut in the repayment value of this debt.
  9. 9. Loss of confidencePrior to development of the crisis it was assumed by both regulators and banks thatsovereign debt from the eurozone was safe. Banks had substantial holdings of bondsfrom weaker economies such as Greece which offered a small premium and seeminglywere equally sound.As the crisis developed it became obvious that Greek, and possibly othercountries, bonds offered substantially more risk. Contributing to lack of informationabout the risk of European sovereign debt was conflict of interest by banks that wereearning substantial sums underwriting the bonds. The loss of confidence is markedby rising sovereign CDS prices, indicating market expectations about countriescreditworthiness (see graph).
  10. 10. Sovereign CDS prices of selected European countries (2010–2011). The left axis is in basis points; a level of 1,000 means it costs $1 million to protect $10 million of debt for five years.
  11. 11. Furthermore, investors have doubts about the possibilities of policy makers toquickly contain the crisis. Since countries that use the Euro as their currency havefewer monetary policy choices (e.g., they cannot print money in their own currencies topay debt holders), certain solutions require multi-national cooperation. Further, theEuropean Central Bank has an inflation control mandate but not an employmentmandate, as opposed to the U.S. Federal Reserve, which has a dual mandate.According to the Economist, the crisis "is as much political as economic" .
  12. 12. Rating agency viewsOn December 5, 2011 S&P placed its long-term sovereign ratings on 15 members of theeurozone on "CreditWatch" with negative implications; S&P wrote this was due to"systemic stresses from five interrelated factors:1) Tightening credit conditions across the eurozone;2) Markedly higher risk premiums on a growing number of eurozone sovereigns including some that are currently rated AAA;3) Continuing disagreements among European policy makers on how to tackle the immediate market confidence crisis and, longer term, how to ensure greater economic, financial, and fiscal convergence among eurozone members;4) High levels of government and household indebtedness across a large area of the eurozone; and5) The rising risk of economic recession in the eurozone as a whole in 2012. Currently, we expect output to decline next year in countries such as Spain, Portugal and Greece, but we now assign a 40% probability of a fall in output for the eurozone as a whole."
  13. 13. In the early-mid 2000s, Greeces economy was strong and the government tookadvantage by running a large deficit, partly due to high defense spending amid historicenmity to Turkey. As the world economy cooled in the late 2000s, Greece was hitespecially hard because its main industries—shipping and tourism—wereespecially sensitive to changes in the business cycle. As a result, the countrys debtbegan to pile up rapidly. In early 2010, as concerns about Greeces national debtgrew, policy makers suggested that emergency bailouts might be necessary.On 23 April 2010, the Greek government requested that the EU/IMF bailoutpackage be activated, with an initial loan package of €45 billion ($61 billion). A fewdays later Standard & Poors slashed Greeces sovereign debt rating to BB+ or"junk" status amid fears of default, in which case investors were thought to lose 30–50% of their money. Stock markets worldwide and the Euro currency declined inresponse to this announcement.
  14. 14. On 1 May 2010, the Greek government announced a series of austerity measures topersuade Germany, the last remaining holdout, to sign on to a larger EU/IMF loanpackage. The next day the eurozone countries and the International Monetary Fundagreed to a three year €110 billion loan retaining relatively high interest rates of5.5%, conditional on the implementation of harsh austerity measures. Credit ratingagencies immediately downgraded Greek governmental bonds to an even lowerjunk status. This was followed by an announcement of the ECB on 3 May that it will stillaccept as collateral all outstanding and new debt instruments issued or guaranteed bythe Greek government, regardless of the nations credit rating, in order to maintainbanks liquidity. The new austerity package was met with great anger by the Greekpublic, leading to massive protests, riots and social unrest throughout Greece. On 5May 2010, a national strike was held in opposition to the planned spending cuts and taxincreases. In Athens some protests turned violent, killing three people.
  15. 15. still €110 billion loan did not help as it was found that the process of re-establishingGreek access to private capital markets by 2012, would take even much longer.The November 2010 revisions of 2009 deficit and debt levels made accomplishment ofthe 2010 targets even harder, and indications signaled a recession harsher thanoriginally feared. In May 2011 it became evident that due to the severe economic crisistax revenues were lower than expected, making it even harder for Greece to meet itsfiscal goals.Following the findings of a bilateral EU-IMF audit in June, which called for even furtherausterity measures, Standard and Poors downgraded Greeces sovereign debt rating toCCC, the lowest in the world.To ensure the release of the next 12 billion euros from the eurozone bail-out package(without which Greece would have had to default on loan repayments in mid-July), thegovernment proposed additional spending cuts worth €28 billion over five years.
  16. 16. EU emergency measures continued at an extraordinary summit on 21 July 2011 inBrussels, where euro area leaders agreed to extend Greek (as well as Irish andPortuguese) loan repayment periods from 7 years to a minimum of 15 years and to cutinterest rates to 3.5%. They also approved a new €109 billion supportpackage, conditional on large privatization efforts. In the early hours of 27 October2011, eurozone leaders and the IMF also came to an agreement with banks toaccept a 50% write-off of (some part of) Greek debt, the equivalent of €100 billion, toreduce the countrys debt level from €340bn to €240bn or 120% of GDP by 2020.The unprecedented austerity measures have helped Greece bring down its primarydeficit from €24.7bn (15.8% of GDP) in 2009 to just over €5bn (9.3%) in 2011 but theyalso dragged the country into five consecutive years of recession.Industrial output is more than 28% lower than in 2005 and unemployment ratesare hitting a record high reaching almost 20 percent by 2011. Youthunemployment reached 48%, up from 22.4% back in 2008 when the financial crisisbegan. By 2011 more than a third of the nation had fallen into poverty and thenumber of 111,000 Greek companies that went bankrupt was 27% higher than oneyear before.
  17. 17. Some of the economic experts argued in 2010, that the best option for Greece and therest of the EU, would be to engineer an ―orderly default‖ on Greece’s public debt, whichwould allow Athens to withdraw simultaneously from the eurozone and reintroduce itsnational currency the drachma at a debased rate.However, if Greece were to leave the euro, the economic and political impact would bedevastating. According to Japanese financial company Nomura an exit would lead to a60 percent devaluation of the new drachma. UBS warned of"hyperinflation, military coups and possible civil war that could afflict a departingcountry".
  18. 18. In February 2012, the second bailout package from July 2011 was extended from €109billion to €130 billion. The activation of the extended lending package was needed nolater than March 20, when a debt burden of €14.4bn had to be refinanced or paid, orelse Greece would fall into default.There were three requirements of the package•finalize an agreement whereby all private holders of governmental bonds would accepta 50% haircut with yields reduced to 3.5%, thus facilitating a €100bn debt reduction forGreece.•Greece needed to implement another demanding austerity package in order to bring itsbudget deficit into sustainable territory.•a majority of the Greek politicians should sign an agreement guaranteeing theircontinued support for the new austerity package, even after the elections in April 2012.On February 12, amid riots in Athens and other cities that left stores looted and burnedand more than 120 people injured, the Greek parliament approved the austerity packageand the post election guarantee.
  19. 19. On 21 February 2012 the Eurogroup finalized the second bailout package. In amarathon meeting in Brussels private holders of governmental bonds accepted a slightlybigger haircut of 53.5% Creditors are invited to swap their Greek bonds into new 3.65%bonds with a maturity of 30 years, thus facilitating a €107bn debt reduction forGreece. EU Member States agreed to an additional retroactive lowering of the bailoutinterest rates. Furthermore they will pass on to Greece all profits that their central banksmade by buying Greek bonds at a debased rate until 2020. Altogether this shouldbring down Greeces debt to 120.5% by 2020.
  20. 20. The Irish sovereign debt crisis was not based on government over-spending, but fromthe state guaranteeing the six main Irish-based banks who had financed a propertybubble. On 29 September 2008 the Finance Minister Brian Lenihan, Jnr issued a one-year guarantee to the banks depositors and bond-holders. He renewed it for anotheryear in September 2009 soon after the launch of the National Asset ManagementAgency (NAMA), a body designed to remove bad loans from the six banks.Irish banks had lost an estimated 100 billion euros, much of it related to defaulted loansto property developers and homeowners made in the midst of the property bubble, whichburst around 2007. Ireland could have guaranteed bank deposits and let privatebondholders who had invested in the banks face losses, but instead borrowed moneyfrom the ECB to pay these bondholders, shifting the losses and debt to its taxpayers.The economy collapsed during 2008. Unemployment rose from 4% in 2006 to 14% by2010, while the federal budget went from a surplus in 2007 to a deficit of 32% GDP in2010
  21. 21. In April 2010, following a marked increase in Irish 2-year bond yields, Irelands NTMAstate debt agency said that it had "no major refinancing obligations" in 2010. Itsrequirement for €20 billion in 2010 was matched by a €23 billion cash balance, and itremarked: "Were very comfortably circumstanced“. On 18 May the NTMA tested themarket and sold a €1.5 billion issue that was three times oversubscribed.By September 2010 the banks could not raise finance and the bank guarantee wasrenewed for a third year. This had a negative impact on Irish governmentbonds, government help for the banks rose to 32% of GDP, and so the governmentstarted negotiations with the EU, the IMF and three nations: the UnitedKingdom, Denmark and Sweden, resulting in a €67.5 billion "bailout" agreement of 29November 2010Together with additional €17.5 billion coming from Irelands own reserves andpensions, the government received €85 billion, of which €34 billion were used to supportthe countrys ailing financial sector. In return the government agreed to reduce its budgetdeficit to below three percent by 2015. In February the government lost the ensuing Irishgeneral election, 2011. In April 2011, despite all the measures taken, Moodysdowngraded the banks debt to junk status.
  22. 22. In July 2011 European leaders agreed to cut the interest rate that Ireland is paying onits EU/IMF bailout loan from around 6% to between 3.5% and 4% and to double theloan time to 15 years. The move is expected to save the country between 600–700million euros per year.On 14 September 2011 the European Commission announced to cut the interest rate onits €22.5 billion loan coming from the European Financial Stability Mechanism, down to2.59 per cent – which is the interest rate the EU itself pays to borrow from financialmarkets.The Euro Plus Monitor report from November 2011 attests to Irelands vast progress indealing with its financial crisis, expecting the country to stand on its own feet again andfinance itself without any external support from the second half of 2012 onwards.According to the Centre for Economics and Business Research Irelands export-ledrecovery "will gradually pull its economy out of its trough". As a result of theimproved economic outlook, the cost of 10-year government bonds, which has alreadyfallen substantially since mid July 2011 (see the graph "Long-term Interest Rates"), isexpected to fall further to 4 per cent by 2015.
  23. 23. Long-term interest rates of all eurozone countries except Estonia (secondary market yields of government bonds with maturities of close to ten years) A yieldof 6 % or more indicates that financial markets have serious doubts about credit- worthiness.
  24. 24. According to A report released in January 2011 by the Diário de Notícias and publishedin Portugal by Gradiva the democratic Portuguese Republic governments in the periodbetween 1974 and 2010have encouraged over-expenditure and investment bubbles through unclear public-private partnerships and funding of numerous ineffective and unnecessary externalconsultancy and advisory of committees and firms. This allowed considerable slippagein state-managed public works and inflated top management and head officer bonusesand wages.Risky credit, public debt creation, and European structural and cohesion funds weremismanaged across almost four decades. The Prime Minister Sócratess cabinet wasnot able to forecast or prevent this in 2005, and later it was incapable of doing anythingto improve the situation when the country was on the verge of bankruptcy by 2011.Robert Fishman, in the New York Times article "Portugals Unnecessary Bailout", pointsout that Portugal fell victim to successive waves of speculation by pressure from bondtraders, rating agencies and speculators. In the first quarter of 2010, before marketspressure, Portugal had one of the best rates of economic recovery in the EU.
  25. 25. On 16 May 2011 the eurozone leaders officially approved a €78 billion bailout packagefor Portugal, which became the third eurozone country, after Ireland and Greece, toreceive emergency funds. The bailout loan will be equally split between the EuropeanFinancial Stabilisation Mechanism, the European Financial Stability Facility, and theInternational Monetary Fund. According to the Portuguese finance minister, the averageinterest rate on the bailout loan is expected to be 5.1 percent. As part of the deal, thecountry agreed to cut its budget deficit from 9.8 % of GDP in 2010 to 5.9% in2011, 4.5 percent in 2012 and 3 % in 2013.On 6 July 2011 the ratings agency Moodys had cut Portugals credit rating to junkstatus, Moodys also launched speculation that Portugal may follow Greece inrequesting a second bailout.In December 2011 it was reported that Portugals estimated budget deficit of 4.5 percentin 2011 will be substantially lower than expected, due to a one-off transfer of pensionfunds.Despite the fact that the economy is expected to contract by 3 percent in 2011 the IMFexpects the country to be able to return to medium and long-term debt sovereignmarkets by late 2013.
  26. 26. In 2010, Belgiums public debt was 100% of its GDP—the third highest in the eurozoneafter Greece and Italy and there were doubts about the financial stability of thebanks, following the countrys major financial crisis in 2008–2009.However the government deficit of 5% was relatively modest and Belgian government10-year bond yields in November 2010 of 3.7% were still below those of Ireland(9.2%), Portugal (7%) and Spain (5.2%). Furthermore, thanks to Belgiums high personalsavings rate, the Belgian Government financed the deficit from mainly domesticsavings, making it less prone to fluctuations of international credit markets. Neverthelesson 25 November 2011, Belgiums long-term sovereign credit rating was downgradedfrom AA+ to AA by Standard and Poor and 10-year bond yields reached 5.66%.Shortly after Belgian negotiating parties reached an agreement to form a newgovernment. The deal includes spending cuts and tax rises worth about €11billion, which should bring the budget deficit down to 2.8% of GDP by 2012, and tobalance the books in 2015. Following the announcement Belgium 10-year bond yieldsfell sharply to 4.6%.
  27. 27. Frances public debt in 2010 was approximately U.S. $2.1 trillion and 83% GDP, with a2010 budget deficit of 7% GDP. By 16 November 2011, Frances bond yield spreads vs.Germany had widened 450% since July, 2011. Frances C.D.S. contract value rose300% in the same period. On 1 December 2011, Frances bond yield had retreated andthe country successfully auctioned €4.3 billion worth of 10 year bonds at an averageyield of 3.18 %, well below the perceived critical level of 7 %
  28. 28. Italys deficit of 4.6% of GDP in 2010 was similar to Germany’s at 4.3% and less thanthat of the U.K. and France. Italy even has a surplus in its primary budget, whichexcludes debt interest payments. However, its debt has increased to almost 120 % ofGDP (U.S. $2.4 trillion in 2010) and economic growth was lower than the EU average forover a decade. This has led investors to view Italian bonds more and more as a riskyasset. On the other hand, the public debt of Italy has a longer maturity and a big share ofit is held domestically.About 300 billion euros of Italys 1.9 trillion euro debt is due in 2012, so it must go to thecapital markets for significant refinancing in the near-term. On 15 July and 14September 2011, Italys government passed austerity measures meant to save €124billion. Nonetheless, by 8 November 2011 the Italian bond yield was 6.74% for 10-yearbonds, climbing above the 7% level. On 11 November 2011, Italian 10-year borrowingcosts fell sharply from 7.5 to 6.7% after Italian legislature approved further austeritymeasures and the formation of an emergency government to replace that of PrimeMinister Silvio Berlusconi. The measures include a pledge to raise €15 billion from real-estate sales over the next three years, a two-year increase in the retirement age to 67by 2026, opening up closed professions within 12 months and a gradual reduction ingovernment ownership of local services.
  29. 29. Spain has a comparatively low debt among advanced economies and it does not face arisk of default. The countrys public debt relative to GDP in 2010 was only 60%, morethan 20 points less than Germany, France or the US, and more than 60 points less thanItaly, Ireland or Greece.As one of the largest eurozone economies the condition of Spains economy is ofparticular concern to international observers, and faced pressure from the UnitedStates, the IMF, other European countries and the European Commission to cut itsdeficit more aggressively.shortly after the announcement of the EUs new "emergency fund" for eurozonecountries in early May 2010, Spain had to announce new austerity measures designedto further reduce the countrys budget deficit, in order to signal financial markets that itwas safe to invest in the country.Spain succeeded in trimming its deficit from 11.2% of GDP in 2009 to 9.2% in 2010 andoriginally expected its 2011 deficit to be at 6%. However, due to the European crisis andover spending by regional governments, the real deficit likely overshoot the latesttarget reaching between 6.6% and 8%.
  30. 30. To build up additional trust in the financial markets, the government amended theSpanish Constitution in 2011 to require a balanced budget at both the national andregional level by 2020.The amendment states that public debt can not exceed 60% of GDP, though exceptionswould be made in case of a natural catastrophe, economic recession or otheremergencies.The new conservative Spanish government led by Mariano Rajoy aims to cut thedeficit further to 4.4 percent in 2012 and 3 percent in 2013.
  31. 31. According to the Financial Policy Committee "Any associated disruption to bank fundingmarkets could spill over to UK banks.‖ Bank of England governor Mervyn King declaredthat the UK is very much at risk from a domino-fall of defaults and called on banks tobuild up more capital when financial conditions allowed. This is because the UK has thehighest gross foreign debt of any European country (€7.3 trillion; €117,580 perperson) due in large part to its highly leveraged financial industry, which is closelyconnected with both the United States and the eurozone.
  32. 32. European Financial Stability Facility (EFSF)On 9 May 2010, the 27 EU member states agreed to create the European FinancialStability Facility, a legal instrument aiming at preserving financial stability in Europe byproviding financial assistance to eurozone states in difficulty.Emissions of bonds are backed by guarantees given by the euro area member states inproportion to their share in the paid-up capital of the European Central Bank. The €440billion lending capacity of the Facility is jointly and severally guaranteed by the eurozonecountries governments and may be combined with loans up to €60 billion from theEuropean Financial Stabilisation Mechanism and up to €250 billion from theInternational Monetary Fund (IMF) to obtain a financial safety net up to €750 billion.On November 29, 2011 the member state finance ministers agreed to expand the EFSFby creating certificates that could guarantee up to 30% of new issues from troubledeuro-area governments and to create investment vehicles that would boost the EFSF’sfirepower to intervene in primary and secondary bond markets.
  33. 33. European Financial Stabilisation Mechanism (EFSM)On 5 January 2011, the European Union created the European Financial StabilisationMechanism (EFSM), an emergency funding programme reliant upon funds raised on thefinancial markets and guaranteed by the European Commission using the budget of theEuropean Union as collateral. It runs under the supervision of the Commission and aimsat preserving financial stability in Europe by providing financial assistance to EUmember states in economic difficulty. The Commission fund, backed by all 27 EuropeanUnion members, has the authority to raise up to €60 billion and is rated AAA by Fitch,Moodys and Standard & Poors.Under the EFSM, the EU successfully placed in the capital markets a €5 billion issue ofbonds as part of the financial support package agreed for Ireland, at a borrowing cost forthe EFSM of 2.59%.
  34. 34. ECB interventionsOn 22 December 2011, the ECB started the biggest infusion of credit into the Europeanbanking system in the euros 13 year history. It loaned €489 billion to 523 banks for anexceptionally long period of three years at a rate of just one percent. This way theECB tries to make sure that banks have enough cash to pay off €200 billion of their ownmaturing debts in the first three months of 2012, and at the same time keep operatingand loaning to businesses so that a credit crunch does not choke off economic growth. Italso hopes that banks use some of the money to buy government bonds, effectivelyeasing the debt crisis. A second auction will be held on 29 February 2012.
  35. 35. European fiscal union and revision of the Lisbon TreatyIn March 2011 a new reform of the Stability and Growth Pact was initiated, aiming atstraightening the rules by adopting an automatic procedure for imposing of penalties incase of breaches of either the deficit or the debt rules. By the end of theyear, Germany, France and some other smaller EU countries went a step further andvowed to create a fiscal union across the eurozone with strict and enforceable fiscalrules and automatic penalties embedded in the EU treaties. On 9 December 2011 at the European Council meeting, all 17 members of theeurozone and six countries that aspire to join agreed on a new intergovernmental treatyto put strict caps on government spending and borrowing, with penalties for thosecountries who violate the limits. All other non-eurozone countries except Great Britainare also prepared to join in, subject to parliamentary vote
  36. 36. Eurobonds On 21 November 2011, the European Commission suggested that eurobonds issuedjointly by the 17 euro nations would be an effective way to tackle the financial crisis.Using the term "stability bonds", Jose Manuel Barroso insisted that any such plan wouldhave to be matched by tight fiscal surveillance and economic policy coordination as anessential counterpart so as to avoid moral hazard and ensure sustainable publicfinances.However, Germany remains opposed to take over the debt and interest risk of statesthat have run excessive budget deficits and borrowed excessively over the past years.The German government sees no point in making borrowing easier for states who haveproblems borrowing so much that they go into debt crisis. Germany says thatEurobonds, jointly issued and underwritten by all 17 members of the currencybloc, could substantially raise the countrys liabilities in a debt crisis.
  37. 37. European Stability Mechanism (ESM)The European Stability Mechanism (ESM) is a permanent rescue funding programme tosucceed the temporary European Financial Stability Facility and European FinancialStabilisation Mechanism in July 2012.the ESM will be an intergovernmental organisation under public international law and willbe located in Luxembourg.Such a mechanism serves as a "financial firewall." Instead of a default by one countryrippling through the entire interconnected financial system, the firewall mechanism canensure that downstream nations and banking systems are protected by guaranteeingsome or all of their obligations. Then the single default can be managed while limitingfinancial contagion.
  38. 38. European Monetary FundOn 20 October 2011, the Austrian Institute of Economic Research published an articlethat suggests to transform the EFSF into a European Monetary Fund (EMF), whichcould provide governments with fixed interest rate Eurobonds at a rate slightly belowmedium-term economic growth (in nominal terms). These bonds would not be tradablebut could be held by investors with the EMF and liquidated at any time. Given thebacking of the entire eurozone countries and the ECB "the EMU would achieve asimilarly strong position vis-a-vis financial investors as the US where the Fed backsgovernment bonds to an unlimited extent." To ensure fiscal discipline despite the lack ofmarket pressure, the EMF would operate according to strict rules, providing funds onlyto countries that meet agreed on fiscal and macroeconomic criteria. Governments thatlack sound financial policies would be forced to rely on traditional (national)governmental bonds with less favorable market rates.
  39. 39. Source:• Wikipedia