Eurozone Crisis 2011

The eurozone has been plunged into renewed turmoil by Greece’s decision to hold a referendum on the EU’s efforts to bail out its stricken economy.

In October, the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) said they had reached agreement with Greece on reforms to put the nation back on track. However, the leaders of Germany and France, as well as the IMF, have now said that Athens will not receive its next tranche of emergency aid until Greece decides whether or not to remain in the eurozone.  This is money from the 110bn-euro ($148bn; £95bn) bailout agreed last summer. Eurozone leaders have subsequently agreed a more comprehensive bailout package, including losses for banks and a larger bailout fund. The whole point is to prevent what started in Greece spreading to other European economies.

Why is Greece in trouble?

Greece has been living beyond its means since even before it joined the euro, and its rising level of debt has placed a huge strain on the country’s economy. The Greek government borrowed heavily and went on something of a spending spree after it adopted the euro. Public spending soared and public sector wages practically doubled in the past decade. It has more than 340bn euros of debt – for a country of 11 million people.

However, as the money flowed out of the government’s coffers, tax income was hit because of widespread tax evasion. When the global financial downturn hit, Greece was ill-prepared to cope. It was given 110bn euros of bailout loans in May 2010 to help it get through the crisis – and then in July 2011, it was earmarked to receive another 109bn euros. But that still was not considered enough. Another summit was called in October in Brussels to solve the crisis once and for all.

Why did the crisis not end with the Greek bailout?

The aim of the original Greece bailout was to contain the crisis. That did not happen. Both Portugal and the Irish Republic needed a bailout too because of their debts. Then Greece needed a second bailout, worth 109bn euros. In July this year, eurozone leaders proposed a plan that would see private lenders to Greece writing off about 20% of the money they originally lent.

But bond yields continued to rise on Spanish and Italian debt – leading to fears that their huge economies will need to be bailed out too. The failure of Franco-Belgian lender Dexia also added to woes – French and German banks are large holders of Greek debt. The eurozone rescue fund – the European Financial Stability Facility – was 440bn euros, nowhere near big enough to deal with that scenario.

And so, in October, the eurozone agreed to expand the EFSF to 1tn euros and got banks to agree to a 50% “haircut” on their Greek holdings. But then Greece’s Prime Minister George Papandreou shocked European leaders by calling a referendum on the bailout package. That has led the leaders of Germany and France, as well as the IMF, to declare that Athens would not receive its next tranche of emergency aid until the referendum had passed.

What would happen if Greece defaulted?

Europe’s banks are big holders of Greek debt, with perhaps $50bn-$60bn outstanding. An “orderly” default could mean a substantial part of this debt being rescheduled so that repayments are pushed back decades. A “disorderly” default could mean much of this debt not being repaid – ever. Either way, it would be extremely painful for banks and bondholders. What’s more, Greek banks are exposed to the sovereign debts of their country. They would need new capital, and it is likely some would need nationalising. A crisis of confidence could spark a run on the banks as people withdrew their money, making the problem worse.

A Greek exit from the euro is seen by some as inevitable if the country defaulted. The big question would then be, what about other heavily-indebted nations in the eurozone? It might be a repeat of the collapse of Lehman Brothers, which sparked the credit crunch that pushed Europe and the US into recession.

Source : BBC

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