Economics - EU Crisis

7/29/2019 Economics - EU Crisis

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EUROPEAN SOVEREIGN

DEBT CRISISWITH SPECIAL FOCUS ON

GREECES FINANCIAL CRISIS

Presentation by:

Devesh D LalwaniAditya Vohra

Srishti Kapoor

Kunal Madan


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INTRODUCTION

Historically, financial crises have been followed by a wave

of governments defaulting on their debt obligations.

Financial crises tend to lead to, or exacerbate, sharp

economic downturns, low government revenues, widening

government deficits, and high levels of debt, pushing

many governments into default. As recovery from the

global financial crisis begins, but the global recession

endures, some point to the threat of a second wave of the

crisis: sovereign debt crises.

PIGS Countries -> Portugal, Italy, Greece & Spain.


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EuroZone

Countries havingEURO as their

primary form of

currency.


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The Debt Crisis Explained.

ECONOMICS 101

If you are rich, you have to be an idiot not to stay rich

& If you are poor, you have to be really smart to get rich.


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ThePROB

LEM


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When a rich man gets poor, he doesnt

really get rich again.

And hence, the status quo.

The current situation in the EU today.


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CAUSES

Manipulation of numbers to hide the reality

Too much dependency on foreign institutions to raisefunds

Government driven crisis than a market failure

Failure of credit rating agencies to discover financialviability

So-called "carry trades" whereby investors borrow incurrencies with low interest rates and invest in higher yieldingcurrencies while mostly disregarding exchange rate risk,implied the spillover of global liquidity in European financialmarkets.


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Impact of Crisis

Impact on private individuals:The most obvious way would be through tax bills, as Europeagrees to ride to the rescue and help Greece deal with itsmounting public and foreign debts.

Any assistance to Greece will come at a cost that will ultimatelyhave to be borne by taxpayers in the nations that contribute.

Reduced wealth:Take-home pay is likely to fall as it is eroded by rising taxesand everyone will have to work longer before they retire - bywhich time they are likely to find that their pensions have

shrunk.

Slower recoveryThe crisis is also set to slow down the embryonic economicrecovery.


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Spill-over effect:

Some spillover effects have already started to manifest themselves.

As Greek 10-year bonds fall and yields continue to remain above 6%,sovereign debt issuance and the risk premium investors demand to

hold securities emitted by Romania, Serbia, Bulgaria and Turkey have

been adversely affected.

Contagion Effect

Greek crisis has made investors nervous about lending money to

governments through buying government bonds.

Everybody's interest rates are heading higher as governments are

having to pay a greater risk premium to borrow money.


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WHAT COULD HAVE GONE BETTER?

No leadership from EU-level institutions

-Countries acted unilaterally

-Often felt they had no choice

Politicization of crisis management efforts

-Coordination depended on political initiatives

Non-binding ex ante commitments of limited value

Domestic political incentives

Lack of expertise, notably among politicians

Practical difficulties and stress

Personality-dependent

Lack of a referee or mediator to help resolve disagreementsbetween countries

Information sharing was a broad problem


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EU STRESS TEST

WHAT IS A STRESS TEST?

The European Banking Authority (EBA) released the

results of EU-wide stress results on 15th

July 2011.

Before we move ahead what exactly is a stress test. The

EU-wide stress test is a tool designed to assess the

resilience of European banks to external shocks. Itconsiders the period between 2010 and 2012.


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The stress test assesses what might happen to banks ifexternal circumstances deteriorate markedly and helps toidentify vulnerabilities and relevant remedial action. Itincludes a marked deterioration in the main macro-

economic variables, such as GDP (which falls fourpercentage points) unemployment, and house prices andeffects of other factors such as interest rates.

In simple words it is the measure of a bank's strength to

absorb losses in worst-case scenarios. The benchmarkfor passing the test was that whether the banks have atleast 5% core tier 1 capital, which a bank should hold tomake up any losses.


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THE RESULTS OF THE TEST

Eight banks out of ninety banks from twenty-one countriesfailed to meet the minimum standard. German bank, Helaba,backed out of the test at the end moment potentially making itthe 9th bank which is failing in the test. The failing banks arerequired to raise fresh capital by the end of this year.

Sixteen banks barely passed the test with the ratios of between5 and 6 percent need to improve their capital position by April2012.

Spain was the worst performing nation. Among those twenty-four failing or nearly failing banks, twelve are Spanish and fourare Greek. These were followed by Spanish and greek banks.

UK was the most impressive one with all the four bankspassing the test comfortably.


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CONCLUSION AND CREDIBILITY

Investors and analysts claim that the test was not tough

enough and failed to restore confidence in Europes

financial markets as the markets continued to plunge

even after the results

One of the biggest drawbacks is that the tests worst-case

scenario did not include the chance of a Greek default

which can shaken the economic foundation of European

countries. Greece is witnessing one bailout package afterthe other.


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The test had been a catalyst for pressure to raise capital

as over the period of four months from the end of

December to the end of April, banks raised around100

billion of additional capital.

If these banks cannot raise the capital, their national

governments may have to provide assistance to them.

The EBA will publish two reports on the progress thosebanks make in February and July next year.


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STEPS TO SOLVE

EUROPES DEBT CRISIS

Step 1 : Solving the Capital ConfusionEuropes weaker banks need capital if they are to be prevented from pulling the systemdown. The solution is to repurpose Europes sovereign bailout fund to inject capital directlyinto banks much the same way America retooled its Troubled Asset Relief Program in late2008.

For this, On 9 May 2010 the 27 member states of the European Union agreed to createthe European Financial Stability Facility (EFSF), a legal instrumentaiming at preservingfinancial stability in Europe by providing financial assistance to eurozone states in difficulty.

Step 2: Solving The Funding FreezeEuropean banks, especially those in Italy and Spain, risk a liquidity crisis if wholesale

markets do not reopen to them by autumn. And even if they are able to issue longer

term debt, it is likely to be expensive. That could choke off credit to the economy.The answer again lies in reinventing the stability fund to offer temporary financing

guarantees. The idea, first proposed by Morgan Stanley analysts, has worked before.

The United States and several European countries restored calm after the collapse of

Lehman Brothers by guaranteeing bank finances
http://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/bailout_plan/index.html?inline=nyt-classifierhttp://en.wikipedia.org/wiki/European_Financial_Stability_Facilityhttp://en.wikipedia.org/wiki/European_Financial_Stability_Facilityhttp://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/bailout_plan/index.html?inline=nyt-classifierhttp://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/bailout_plan/index.html?inline=nyt-classifierhttp://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/bailout_plan/index.html?inline=nyt-classifier


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Step 3 : Preventing Bank RunsEven with capital and wholesale funding worries addressed, banks would still be

vulnerable to a loss of confidence by depositors. Deposits at Greek banks have shrinkby roughly 15 percent since the beginning of 2010, according to European Central

Bank data.

But if there were a single pan-European deposit plan, savers would be more likely to

stay put.

Step 4: A Pan-european Regulator With TeethIf the first three steps were taken, the risk would be that sovereign-bank

Codependency would re-emerge, but on a pan-European level.

Preventing that from happening requires creditors to face real losses if a bank falls

Over. Big lenders must also be structured so they can be safely wound down.

Achieving that would require a single euro zone financial supervisor something

national regulators would no doubt resist. But America provides a good model, with

the Federal Reserve and the Federal Deposit Insurance Corporation overseeing the

system with the help of regional bodies.


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Conclusion

Greeces Debt Crisis has put the EU under the scope, & it hasshifted the attention to the efficiency & the success of the Euro-zone. Its considered as probably the biggest test the EU (& theEMU-in particular) has gone through. How the EU & Greeceare handling the crisis with the whole bail-out plan will reflect to

what extent the EU is able to function on its own as a powerfuleconomic entity.

These ideas would not instantly fix the sovereign debt, largedeficits and stagnant growth that plague the euro zone. Butremoving banks from the equation would lift one large potentialfiscal burden from governments.

Economics - EU Crisis

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