Eurozone Crisis

Bankground to Eurozone Crisis
The Euro single currency introduced in 1999 removed currency risk from cross border investments within the Eurozone.

In addition, banking regulations (like Basel) in western world consider government debts as risk-free and bank holders of such bonds therefore do not need to put aside capital as reserve against loss! This arrangement benefitted both the governments that set the 'regulations' (they can borrow more) and the banks which theoretically can buy as much government bonds as they like and earn more interest.
The above encouraged banks and funds in stronger Euro countries like Germany and France (more so than banks from outside Eurozone) to buy government bonds from weaker countries paying higher interest rates to increase profit.

It also tended to redirected capital to the non-productive public sector instead of the private sector.

Over time, cost of financing for weaker countries dropped to close to that of stronger countries and encouraged those weaker countries to borrow even more. The low cost of government borrowing also reduced cost of borrowing by their households and private sector(including banks) resulting in not just huge government debt to GDP ratios but also private debts and financial bubbles in housing etc. That was the case from 1997 to 2007.

However, when crisis started in 2008 fears about solvency and default of banks and governments in those weaker countries (as well as their potential Eurozone exit and currency devaluation) caused a reverse flow from weaker to stronger countries. That worsened the weaker countries' and their banks' bad situation even more. Financing to rollover their debts dropped and interest rates jumped. By 2011, interest rates for German 10 year bonds was 2-3% vs 6-7% for countries like Italy and Spain. Irish and Greek rates were worse at more than 10% at the peak of their crises.

As those fears increased, some holders of weak country bonds started to sell them and their price dropped. That wiped out the profits and capital of many banks which then had to be bailed out by their governments which bought the all sorts of collaterals including dubious ones from their troubled banks. That resulted in the transfer of the problem from banks to governments, and the crises transformed from 'banking crisis' or 'banking liquidity crisis' to 'sovereign crisis'.

Holders (like the banks doing 'national service') that continue to hold onto the problem bonds started to buy protection in the form of credit default swaps (CDS) whose cost (or insurance premium) then jumped. The high CDS premium in turn attracted other banks and funds into 'writing' or selling CDS to profit from the high premium. In addition, the fears caused the price of those bonds to collapse and attracted new buyers hoping to profit from price recovery later.

As a result, when the weak countries like Ireland and Greece entered their respective 'crisis', banks and funds all over the world had taken their respective 'bets' on whether the country involved would eventually default or not.

As example, in 2011 the American broker-dealer MF Global in US bet wrongly that Greece would not default. They went bankrupt in end 2011 when Greece eventually defaulted with 75% haircut on all their debts. MF Global then illegally used (i.e. stole) US$1.5 billion of their customer funds to pay off its largest creditor JP Morgan who was also one of the largest seller of CDS on European bonds. In May 2012, JPM announced they incurred US$2 billion loss on hedge trades but did not give any detail.

(Side note: top 4 US banks - JPM, Citi, Goldman, BOA - and HSBC account for more than 95% of all derivative trades in the world. Total notional value is more than US$220 trillion)

The MF Global case showed that many American funds and banks may have been betting that the weak Eurozone countries would everntually be bailed out by the rest of the Eurozone countries the way the US and Irish governments bailed out all their insolvent banks.

Thus one can see that there are opposing interests with opposing preferences on how the Eurozone would resolve this debt crisis. That was the reason why in 2011 EU officials publicly said that the rating downgrades of many EU countries by credit rating agencies (all owned by US) were 'politically motivated'.

As weak countries' financing cost increased, they were forced to cut back on expenses (i.e. enter into austerity) which resulted in large loss in public sector jobs that they supported in the past using borrowed money. Unemployment in those problem countries were very high e.g. 25% in Spain where 50% of youths are jobless. As more people lost their jobs, households and companies cut back on expenses and investments and government tax revenues nose dived resulting in a vicious downward spiral for the whole country...


2008/09 Irish Banking Crisis
 - largest creditors to Irish banks were British banks
 - government bailed out & nationalised Irish banks thereby bailing out also British banks
 - accepted low quality collaterals incl Irish gov bonds and 'IOUs' issued by the banks
   (note: practice suppose to end according to new EU agreeement of 2011?)

2009/10 Icelandic Crisis
 - Iceland not in Eurozone devalued currency Kroner
 - government refused to bail out banks

2011/12 Greek Crisis
 - Greek gov aided by US/UK banks hid their true debt levels to qualify as Eurozone member
 - government debt (EUR200 billion) to GDP was 160% by end 2011 (from 115% at start 2010)
 - legislated retroactive 'collective action' law that forces all creditors to go along with 'voluntary' haircut of 75% on gov debts held by private creditors (although as result of ECB bail etc most were held by ECB, Greek banks and Greek Central Bank)
 - US broker-dealer MF Global announced bankruptcy due to betting on Greek bonds
   (USD1.5B of missing customer funds - transferred to creditors like JP Morgan etc)
 - JP Morgan announced USD 2B loss on 'hedge' trades (May 2012)

Note: due to fear of Greek bank solvency & Euro exit, people transferred money out to other Euro countries thereby causing a 'run' on Greek banks which made problem worse (same problem for all weak Euro countries)

2011 Nov: New EU Fiscal Agreement
 - UK & Poland? opt out
 - Tobin tax on banking transactions
 - reduction of national deficits to ?%
 - banks stop dubious collaterals (own gov bonds & bank IOUs) to obtain financing fr own government?
 -

Spain
 - gov and private sector started borrowing a lot since 1999
 - gov debt to GDP 50% in 2007
 - private sector (households & corporate) reversed borrowing binge in 2008
 - this resulted in gov deficits & jump in gov debt to 70% of GDP
 - unemployment rate 25% (youth 50%)