When the euro was launched in 1999, it was meant to bind Europe together. A decade later, a debt crisis in Greece spread to other countries and raised the real possibility that the single currency could break apart. In Part 18 of Great Financial Crises, we look at the eurozone debt crisis.
A currency without a common treasury
Countries that joined the euro gave up their own currencies and the ability to set interest rates or devalue. But they kept control of their own budgets. In the 2000s, borrowing costs for countries such as Greece, Portugal, Spain and Ireland fell close to Germany's, because investors assumed euro members were nearly equally safe.
Cheap credit fuelled different problems in different places:
- Greece ran large government deficits and had weak tax collection.
- Ireland and Spain experienced huge property and banking booms.
- Portugal and Italy suffered from slow growth and high debt.
Wages and prices in southern countries rose faster than in Germany, making their exports less competitive, but they could no longer devalue to adjust.
October 2009: the Greek revelation
After an election in October 2009, Greece's new government revealed that the budget deficit would be about 12% of GDP or more, roughly double the previous estimate. It was later revised to more than 15%. Investors were shocked that official statistics had been so unreliable.
Ratings agencies cut Greece's credit rating. In April 2010, Standard & Poor's downgraded Greek debt to junk status. Borrowing costs soared, and Greece was shut out of markets.
The bailouts
- May 2010: eurozone countries and the IMF agreed €110 billion in rescue loans for Greece, in return for harsh austerity. Days later, European officials announced a package of about $1 trillion to protect the euro, including a new rescue fund.
- November 2010: Ireland received a bailout after its government guaranteed its collapsing banks.
- May 2011: Portugal received a bailout.
- 2011 to 2012: Greece needed a second bailout of about €130 billion.
- 2012: Spain received support for its banks; Cyprus followed in 2013, including losses for large bank depositors.
The Greek debt haircut
In early 2012, private holders of Greek government bonds agreed to a restructuring called private sector involvement (PSI), accepting a loss of more than half the face value of their bonds. It was one of the largest sovereign debt restructurings in history.
Contagion fears
In 2011 and 2012, the crisis spread to bigger economies. Borrowing costs for Italy and Spain rose to levels many considered unsustainable. European banks held large amounts of government bonds, so sovereign problems and banking problems fed each other, a "doom loop".
Investors worried about countries leaving the euro, which would mean redenominating debts and savings into new, weaker currencies.
"Whatever it takes"
The turning point came on 26 July 2012, when European Central Bank President Mario Draghi said in London that the ECB was ready "to do whatever it takes to preserve the euro" and added, "believe me, it will be enough." The ECB soon announced a programme called Outright Monetary Transactions, offering to buy government bonds of countries that accepted a reform programme.
Bond yields fell sharply, even though the programme was never actually used. It showed the power of a credible central bank promise.
The social cost
The crisis caused deep recessions in several countries. Greece's economy shrank by about a quarter from its peak, and unemployment rose to above 25%, with youth unemployment far higher. Spain also saw unemployment above 25%. Austerity measures sparked large protests across southern Europe. In 2015, Greece came close to leaving the euro before agreeing to a third bailout.
Reforms
- A permanent rescue fund, the European Stability Mechanism (ESM).
- Banking union, with the ECB supervising large eurozone banks from 2014.
- Stricter budget rules and closer monitoring of national economies.
Lessons for investors today
- Government bonds are not risk-free, especially for countries that cannot print their own currency.
- Check the quality of data. Unreliable statistics hid Greece's problems for years.
- Banks and governments are linked. Troubles in one can spread to the other.
- Central banks can change the game with credible commitments.
In Part 19, we look at the fastest market crash in history: the Covid crash of March 2020.
Sources
- Salon / AP – Key dates in Greece's debt crisis
- Lawyer Monthly – How the 2012 PSI eased Greece's debt crisis
Great Financial Crises: the full series
- Part 1: Tulip Mania (1637)
- Part 2: The Mississippi and South Sea Bubbles (1720)
- Part 3: The Panic of 1907
- Part 4: The Wall Street Crash and Great Depression
- Part 5: Weimar Hyperinflation (1923)
- Part 6: The 1970s Oil Shocks and Stagflation
- Part 7: The Latin American Debt Crisis (1982)
- Part 8: Black Monday (1987)
- Part 9: Japan's Bubble and Lost Decades
- Part 10: The Savings and Loan Crisis
- Part 11: The Mexican Peso Crisis (1994)
- Part 12: The Asian Financial Crisis (1997)
- Part 13: Russia's Default and LTCM (1998)
- Part 14: The Dot-Com Bubble (2000)
- Part 15: Argentina's Collapse (2001)
- Part 16: The Global Financial Crisis (2008)
- Part 17: Iceland's Banking Collapse (2008)
- Part 18: The Eurozone Debt Crisis (you are here)
- Part 19: The Covid Crash (2020)
- Part 20: The 2023 Banking Turmoil
This series is for education only and is not investment advice. Figures are taken from the sources listed and other commonly cited historical records, and may vary slightly between sources.
