The European Property Bubble & the Sovereign Debt Crisis

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The same as the United States experienced a major housing bubble, Europe was faced with a financial crisis leading to their housing bubble a few years following. This crisis is ongoing and has made it nearly impossible for many European nations to re-finance their debt without third parties to help. It started at the end of 2009 with a fear of a sovereign debt crisis initiated because of an increase in international debt levels. By 2010 the concerns intensified and led the finance ministers of Europe to create and approve a rescue package which was worth €750 billion. The rescue package was created in an effort to offer financial stability throughout Europe. Eurozone leaders took necessary measures at the end of 2011 and beginning of 2010 to avoid the collapse of member economies. This included an agreement for Greece wherein banks accepted 53.5% write-off of the debt they owed to private creditors. Moves were done to restore confidence by creating a common fiscal union and introducing a balanced budget amendment (Stoddard, 2009).

Pre-bubble boom

This European financial crisis has become a perceived problem for the whole of Europe in spite of the fact that debt has only risen substantially in a few countries. The currency for Europe has remained stable in the meantime. Greece, Portugal, and Ireland were most widely affected. Combined they represent 5% of the GDP for the Eurozone (Colombo, 2012b).
Many financial analysts and economists have determined that the cause was the result of the trade policies of the European Union. The crisis was initiated by globalization of finance, international trade imbalances, the bursting of many real estate bubbles, easy credit between 2002 and 2008 which allowed for high-risk lending and borrowing, as well as fiscal policies related to expenses and revenues for the government, slow economic growth during 2008, and bailout policies (Walter, 2009).
Other causes of the European housing bubble and financial crisis relate to the increase in available savings for investment between 2000 and 2007. Investors sought higher yields than what was offered by bonds from the U.S. Treasury. Policy control and regulatory control were overwhelmed. Each bubble began to burst and caused the asset price for housing and commercial property to fall. As this occurred, the liabilities which were owed to those international investors stayed at their full price which created questions pertaining to the solvency of the banking systems and governments (Colombo, 2012a).

Bubble mania

Each European country was involved to a different degree and invested money to a different degree. Ireland’s banks generated a massive housing bubble because the banks loaned money to property developers. As this housing bubble burst the government as well as taxpayers was held responsible for the private debts. As the banking system continued to grow, the external debts increased as well. In Greece, the government remained committed to public workers through pension benefits and generous pay (Stoddard, 2009).

The global financial system is interconnected which means that if a single nation defaults on their sovereign debt or they enter into a recession, it puts private debt at risk as well and banking systems for that nation will decline. When Italian borrowers owed the French banks $366 billion in the end of 2011, it created a crisis for everyone, not just Italy. If Italy had been unable to finance the debt itself, the French banking system could be placed under pressure which would change the economy and affect the creditors. This situation is called financial contagion (The Financial Times, 2012).

Debt protection is another factor which contributed to the interconnection between the Eurozone countries. Institutions were allowed to enter into credit default swaps. The Eurozone members had a single monetary policy which means that printing money in an effort to ease default risk and pay creditors could not be done by individual states. Before the crisis was developed, regulators and banks alike assumed that sovereign debt in the Eurozone was safe and that banks which had bonds from weaker economies were sound. As the crisis continued it became clear that the bonds from failing countries such as Greece were increasing in risk. There was a conflict of interest thanks to the European banks and an overall loss of confidence (Moen, 2012).

Since the end of 2011 15 members of the Eurozone have been placed on “CreditWatch” and endured low ratings from S&P. This was due to the tightening of credit conditions throughout the area, higher risk premiums, continuing disagreements regarding how to tackle the market problems and ensure confidence, as well as high government debt and household debt, and the risk of a complete economic recession (Walter, 2009).

Bubble Burst

For most of Europe, the crisis began in October of 2009. It was in this month that a new Greek government was formed after receiving a majority of the popular vote and the seats in parliament. In 2010, Greece unveiled a plan to reduce its deficit. The next month the government of Greece froze wages for the public sector. The EU Commission urged Greece to cut the wage bill while civil servants continued to strike against the government. The 24-hour strike halted the transportation system and the public services in the area. Experts from the International Monetary Fund were sent to assess the finances (The Financial Times, 2012).

By March tax increases and wage cuts for the public sector were passed by Greece in an effort to save €4.8 billion. Public sector bonuses were reduced, taxes on alcohol, fuel, and tobacco were increased, state-funded pensions were frozen, and the value-added tax was increased. The European Monetary Union agreed to help Greece by creating an aid package. Rules were softened on collateral in an attempt to avoid future situations were Moody’s would determine in country bonds were eligible for collateral (Colombo, 2012a).

By April, a bailout plan was created for Greece. In spite of progress, the debt ratings for Greece were placed to junk bond status by S&P. That same month Portugal’s debt was also downgraded. Spanish bonds were downgraded to AA- status. Additional measures were taken by Greece as stick market fell, fearing contagion. Violence broke out in two Greek cities on the 5th of May and concerns began to spread regarding a crisis throughout Europe. This prompted a major market selloff and a 1000 point intra-day drop for the DJIA. Volatility began to spread relating to the dollar-yen and the dollar-euro and Brussels took action in order to prevent the euro from falling further by approving one hundred billion in bailouts for Greece. By the end of May debt raged in the United Kingdom as they fell into a financial crisis. Two days later, bonds from the Spanish government were downgraded from AAA to AA+ (Colombo, 2012b).  

In June, Moody’s affirmed Hungary’s good record while American markets dropped 3% and the euro fell to the lowest it had been in four years. The cash deficit for the Greek central government was reduced in July. A second bailout was approved by September. German polls indicated by October that bondholders may have to pay for Eurozone financial crises. The Irish debt was sold starting in September and the ten year bonds from Ireland surged against the German bonds. Ireland began talking about a bailout which, when combined with Portugal and Greece, made for increased worry. A new election was called in November after the Green Party withdrew from the governing coalition (Wolf, 2010).

By 2011 Greek debt was downgraded to junk bond status by three rating agencies. Debt restructuring began. Germany condemned additional help to Greece noting that it would become the burden of private investors as well as taxpayers were it to continue. By July an agreement was made. The European markets continued to fall and the French government soon revealed a deficit cutting packages which could lose loopholes in the tax system and tax the rich at an increased rate. Still, international alarm continued with even the United States being scared. Italy was downgraded by credit rating agencies alongside Spain in October of 2011 while Belgium nationalized their government thanks to the burden of Greek debt. China soon began to back bailout packages in Europe (Keenan, 2009).

In November Italy’s prime minister resigned and legislation was approved to form an emergency government. Belgium’s rating was downgraded that same month. The crisis not only affected the aforementioned areas, but Iceland as well. Iceland found itself in a major political and economic crisis starting in 2008 thanks to the three major commercial banks collapsing. Because of its size, the collapse of the banks in Iceland amounted to the worse suffering any country had seen in history. External debt for Iceland was nearly €50 billion, which was over 80% of what the banking sector held. The national currency for Iceland fell almost immediately and the stock exchange dropped over 90%. Right now the full cost of this crisis has exceeded 75% of the GDP in the country (Wolf, 2010).

It began when Lehman Brothers went bankrupt in the states, which froze money markets throughout the world. The banks in Iceland began encountering severe financial problems. In September it was announced that the bank would be nationalized by the government (Colombo, 2012a).

Conclusion

Overall for a variety of reasons countries throughout the Eurozone began to experience small housing bubbles. Locations such as Spain and Ireland were faced with exploding bubbles thanks to years of high risk loans. Iceland watched as its economy virtually fell apart and the entire banking system collapsed. This bubble is currently different from other financial bubbles in that the crisis itself is still taking place. It is far from over and it not near being fixed completely. In fact, certain measures which were recently taken in a combined European effort to reduce the negative consequences of the bubble and financial crisis have contributed to the increase in the financial crisis.

References

Colombo, J.(2012a). The Post-2009 Northern & Western European Housing Bubble. Here Is the Next Bubble (Actually, the Next Eight Bubbles). Retrieved on 26th April 2012,  from http://www.thebubblebubble.com/european-housing-bubble/

Colombo, J.(2012b). The Northern and Western European Housing Bubble: Infowars. Retrieved on 25th April 2012, from http://www.infowars.com/the-northern-and-western-european-housing-bubble/

Keenan, B. (2009). Fixing the Government Is Now More Important than Fixing Our Banks. Retrieved on 26th April 2012, from http://www.independent.ie/opinion/columnists/brendan-keenan/fixing-the-government-is-now-more-important-than-fixing-our-banks-1835596.html

Moen, J. (2012).  John Law and the Mississippi Bubble: 1718-1720. Retrieved on 25th April 2012,  from http://mshistory.k12.ms.us/articles/70/john-law-and-the-mississippi-bubble-1718-1720

Stoddard, K. (2009). How Iceland’s financial crisis unfolded. The Guardian. Retrieved on 25th April 2012,  from http://www.guardian.co.uk/world/2009/jan/26/iceland-crisis-timeline

The Financial Times. (2012). World business, finance and political news from the Financial Times FT.com Europe: World Business, Finance and Political News from the Financial Timesâ FT.com Europe. Retrieved on 27th April 2012, from http://www.ft.com/home/europe

Walter, N. (2009). Understanding the financial crisis: Roots and developments in the financial sector. European View8(1), 97-103.

Wolf, M. (2010). The European Economy in the Global Financial Crisis. CFA Institute Conference Proceedings Quarterly27(1), 45-54.

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