European Financial Crisis

Sai Kumar Swamy

Course Director, T.I.M.E.
PGPM IIM Bangalore
Agenda
Genesis
Sub-Prime Crisis
Contagion Effect
European Financial Crisis
Iceland
Principal Actors
PIIGS
Portugal
Ireland
Italy
Greece
Spain
Current Status
Future Scenario
Genesis
EU
Economic & Political Union of 27 member states
500 Mn citizens
GDP - $18Tn and 20% of total world output
Free movement of people, goods, services & capital
Schengen Free movement Abolition of passport controls
Treaty of Maastricht 1
st
Nov 1993
Salient Features
Common Currency - Euro
EMU
SGP - Stability & Growth Pact
Convergence Criteria Article 121
Inflation; Deficit & Debt; Interest rates
Fiscal Monitoring of members
Article 122
EC can take measures to help an ailing country


Sub-Prime Crisis
Sub-Prime loans
Housing Bubble
Fuelled by Low interest rates
Supply Glut
Foreclosures
MBS
CDS
Failure of Banks
Credit Crunch
Reduced Output Unemployment
Government Bail-outs
Stimulus Packages
Fannie Mae and Freddie Mac
Keynesian model adopted Deficit Spending
Contagion effect Global linkages

European Financial Crisis

Principal Actors - Iceland
Pre 1990s
Natural resources
Tourism Fiords, Glaciers and Geysers
Fishing Salted Cod
David Oddsson
Mayor of Reykjavik
Prime Minister in 1991
Promised to end the boom and bust cycles based on Fish catch
Privatization - $2Bn
Privatized banking industry
Thrust on
Biotechnology
Software

Principal Actors - Iceland
Banking
Tapped Overseas markets
Landbanski Icesave Scheme
High interest rates
Banking accounted for 75% of stock market
Kaupthing Bank
Assets 208Bn Krn in 2000 6600Bn Krn in 2008
Loans & Assets were 10 times Iceland GDP
High inflows Strong kronor
Consumption led economy
Global Financial Crisis large scale outflow of funds
Central bank had 2Bn Loans were 70Bn
Defaults by Glitner bank 600Mn
Govt. bailout for Glitner Landsbanski Kaupthing
Misuse of banks by promoters
Too big to fail hypothesis negated by Iceland


Principal Actors - Ireland
Economic Transformation in the 90s
Low Taxes Educated workforce Entry of MNCs
Bridge between US and Europe
GDP Growth rate of 6.5%
Celtic Tiger
Housing Boom
Cheap Loans Tax Incentives
House prices increased 3 fold in a decade
40% of houses built in 1996-2006
Housing Bubble
Over Supply
Speculative nature of demand
Sub-prime echoes of the US
Multi unit loans to property developers with sub-prime characteristics
Principal Actors - Greece
Cause
Economic downturn post 2008
Tourism & Shipping badly hit
Govt. revenues decreased significantly
Govt. expenditure increased worsened debt situation
Huge spending Deficit Budgets
Cheap lending
Lack of financial reform
Government cooking the accounts
Effect
300 billion Debt
Budget Deficit 12.7%
Violation of Growth & Stability Pact
Accumulated debt Estd. at 160% in 2011
Credit Rating downgraded
Bond Yield 34%
Principal Actors - Greece
Bailouts 45Bn (2010) 130Bn (2011)
Troika EC, ECB, IMF
Steps Taken
Debt Restructuring
Cut in spending Austerity measures
Increase in Taxes Better Tax collection
Public Sector Pay cuts Inc in retirement age by 2 yrs Later by 4
Denationalization to raise money
Fears
Civil Unrest
Anti austerity parties winning 2012 elections - GREXIT
Sovereign Debt default
Orderly Default Debt write off - 50%
Euro under pressure
Light at the end of the tunnel Bond yields below 10%

Principal Actors - Spain
GDP contracted in 2008
Construction Sector 10% of GDP
Housing Bubble
Price increases of more than 200%
Bubble started in 1995 and sustained till 2007
28% of houses vacant
Fuelled by tax incentives similar to India
High indebtedness
High Inflation
High Oil prices
High Interest Rates pricks the bubble
Large scale unemployment ~ 25-30%
Severe pressure on Banking system
Bond Yield 5%

Principal Actors - Portugal
GDP $220Bn
Tourism, Cork, Fishing, Wine
High Debt to GDP Ratio 113%
Mostly external debt
Socialist Govt. with excess spending
Very low GDP growth rates
Debt Servicing Issues
Unable to generate new loans
Required a bailout from EU
Bond Yield 12-15%
Severe unemployment 12.4% in 2011
Emigration
Austerity measures
Social Unrest



Italy
7
th
largest economy
GDP - $2 Tn
Manufacturing & Services led economy
Big brands Quality products
Current Issue
Huge Debt to GDP ratio roughly 120% in 2010
Similar to Greece
Key difference is that most of it is internal
Recession
Contraction of almost 7% in GDP
Political Weakness
High Govt. Spending Profligacy
Black market economy
Organized crime 7% of GDP
Protection money
Bond Yield 5-6%
Current Status
Greece
Austerity measures
Looking for a bail-out
Germany against such a bailout France in favour
Portugal
Govt. trying to raise money to prop up banking system
Failed Bond Auction to raise 500Mn
Bailout required
Spain & Ireland
Reduce fiscal deficit
Rollback Keynesian debt fuelled monetary policies


Future Scenario
Sovereign Debt Crisis looms
Euro under threat
The concept of United States of Europe in grave danger
Political Union of Europe unlikely
Issues of Solidarity & Responsibility
Return to Non-Keynesian policies can further deflate
the economies
Double Dip recession possible
Common Fiscal Policy for the EU
Two Solutions
EMF Fund for Bailouts - EFSF
European Treasury Single authority for
Tax policy
Govt. Spending
Annexures

Long Term Interest Rates
Deficit & Public Debt - 2009
Deficit & Public Debt - 2012
Debt of Eurozone Countries
Public Debt and Debt as % of GDP
Public Debt as % of GDP - World
S&P Ratings
Belief in God
Cartoons
Cartoons
Cartoons
Cartoons
Cartoons
Cartoons
Cartoons
Cartoons
Cartoons
Cartoons
Cartoons
Cartoons
PIIGS
Foreclosures
Sub-Prime Vicious Cycle
Geyser Economy
Greek Debt vs. Eurozone average
US vs. the Eurozone
Housing Prices - Ireland
100% Loans
Portugal Sick Man of Europe