European Financial Crisis-2013

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
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Portugal
Ireland
Italy
Greece
Spain

Current Status
Future Scenario

Genesis
 EU
 Economic & Political Union of 27 member states
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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 – 1st 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 90’s
 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

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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
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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
 7th 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

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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