Understanding The European Debt Crisis

by Stephanie Berenbaum – May 13, 2010

Greece Is the Word

It’s not easy to give a nutshell run-down of major global economic events, but the economic woes of Greece have been front page news lately, and the crisis affects us all.  Heck, if Saturday Night Live’s ‘Weekend Update’ is discussing it, we thought we’d get us all up to speed – Fab & Fru style!

The European “Debt Set”

International economist Ben Carliner sat down with us to explain how the problems of Greece are not all that different from the problems of individuals who are in debt.  Basically, Greece was living beyond her means, spending more than she was making.  Pretty soon, it became clear that Greece had borrowed too much money and was having trouble paying it back.  Sound familiar? Like many people in debt, Greece had a hard time admitting just how much trouble she was really in.  Were her friends shocked? Not really – this was pretty typical behavior of their old friend.

Ben explained how “the recession exacerbated the fact that Greece had borrowed too much money.  The economy shrunk and tax revenues decreased which made it even harder to make the debt payments.”  In individual terms, it’s like someone who has maxed out their credit cards, then gets a pay cut and can’t keep up with their monthly payments.

‘The Greek System’

Well, no man or woman is an island, and neither is a country (even when it is made up of islands).  When something bad happens to a friend it affects everyone in their circle, and Greece is no exception.

To make matters worse, since Greece is now part of the ‘sorority’ known as the European Union, her sorority sisters all have a vested financial interest in preserving their good name, credit rating and value of their currency – the Euro.  Sure, you can always debate if it was the right choice to invite someone to join your organization, but once they’re in – it’s hard to de-pledge them!

Now That’s A Big Package!

After mulling their options, the Eurozone countries agreed their only option was to rescue their friend Greece, thereby rescuing themselves from exposure to the failing Greek economy.  Ben explained that Greece’s European neighbors had a good reason to provide a lifeline. The bigger European economies like France and Germany had lent Greece billions of Euros.  If Greece defaulted on the loans, that could threaten the big banks – and therefore the economy – of the rest of Europe.

Investors therefore started becoming wary of any institution that had significant exposure to Greece and other debt ridden European countries like Portugal and Spain… You can see how the global ripple starts to take place. That’s why here in America our financial markets – YOUR MONEY – were so affected by the European crisis.  If investors lose confidence in Europe’s economy, that will lead to a global economic slowdown, affecting investors worldwide.  In addition, U.S. banks (and therefore U.S. investors) hold European debt, which if defaulted on would lose investors lots of money. So in both a direct and indirect way, your money is affected by what is playing out overseas right now!

Rather than risk a wider European melt down, the EU governments and IMF came up with a $1 TRILLION rescue plan!  First, Ben explains, they guaranteed that at risk countries like Greece would be able to continue to borrow money over the next couple of years in order to finance their budget deficits. Second, the big European banks who held Greek bonds were allowed to sell them to the European Central Bank, thereby transferring the risk to the ECB.  Both the lenders and the lendee got bailed out – at least temporarily – via this rescue package.

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4 Responses to “Understanding The European Debt Crisis”

  1. Rick says:

    Sounds like Ben summed up this situation quite eloquently. Let’s see if we are awake enough here, in our own Country, to take a lesson from this. Basics are basics, and it doesn’t take an economist to know that you can’t spend more than what you have. Also, “save for a rainy day” wasn’t an idle “old Timers saying”. Whether it be a Country, State, municipality, or your own personal finances, these basic problems and their common sense solutions are well worth taking to heart.

  2. [...] like the USA,  Europe has been dealing with it’s own financial crisis (i.e. the bailout of Greece last spring and most recently Ireland).  The ECB has been helping [...]

  3. FinWeek says:

    The debt crisis in Europe is really causing big problems to the whole Union. Really countries like Portugal, Greece and Ireland should pay more attention to their finances and their fiscal policy.

  4. Alan Rich says:

    Finweek, It’s not just the euro zone, it’s the whole globe :-)

Any Thoughts?