The Eurozone Crisis For Dummies

by Simone Foxman

Business Insider
December 30, 2011

The market still seems to be moving to every headline out of the eurozone, but it's hard to remember what's important.

So let's bring this back into perspective.

A little background:

• Since joining the euro back in 1999, the governments of Greece and Portugal (among other offenders) have gotten used to spending a LOT of money. When times were good, it wasn't a problem — banks and other investors were willing to lend them money on the cheap and their public sectors became bloated.
• When the financial crisis hit, however, problems came to a head. Debt levels in Portugal, Italy, and Greece became unsustainable, and taxes in a contracting economy are no longer enough to pay the bills.
• Greece, Portugal, and Ireland are still struggling to bring their public debt under control, after receiving billions of euros in bailout aid from the European Commission, the International Monetary Fund, and the European Central Bank (the so-called troika). Some of this aid was provided through a temporary Special Purpose Vehicle called the European Financial Stability Facility (EFSF).
• These governments needed this money because it became too expensive for them to borrow cash on the open markets, with speculators demanding high rates for lending and traders even betting on a disorderly sovereign default.
• The initial round of aid money helped these governments prop up their banks and pay their bills.
• The ECB also started buying government bonds on the secondary market in order to keep borrowing costs low.
• But now Greece needs more dough to stay solvent. EU leaders agreed back in July that a "selective default" was the only option for Greece. Under this situation, euro area nations will guarantee payouts on Greek sovereign debt, but the private sector will bear take a loss — a "haircut" — on their debt holdings, reducing the face value of those holdings.
• Italy and Spain are now crucial to the debate. The former has an incredible level of public debt (120% in 2010) and the latter has been crushed by a housing bubble and subsequent banking crisis.
• The July agreement also expanded the EFSF to €440 billion and allowed the ECB to purchase Spanish and Italian government bonds.

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