Issue link: https://read.dmtmag.com/i/73372
Europe's Dilemma: Understanding the Sovereign Debt Crisis PRESIDENT'S POST O nce again Europe is fl ooding the headlines of world news. Th e European debt crisis has been dragging on – and on – for the past three years, and every quick fi x only seems to exacer- bate the crisis and the pain that comes with it. Until European Union members agree to real structural reforms and on ways to sustainably stimulate their economies, the crisis will undoubtedly continue to get worse. A few days ago, Jeremy Batstone, Director of Private Client Research at Charles Stanley, stated on CNBC, "Markets simply want someone to take responsibility, and, at the moment, what we have instead is just a high-stakes game of pass-the-parcel. Markets want central banks to ride to the rescue and provide some liquidity into the system. It is not a long-term solution, but it would do for the moment. But the problem is the EU authorities are bogged down by the terms and conditions of their own agree- ments and can't be suffi ciently nimble to do anything that is required. " Th e European sovereign-debt crisis has intensi- fi ed and grown rapidly over the last few months. Until late last year, the crisis centered on a chronic problem tied largely to failure to stabilize Greece's fi nances and economic woes. Since then, the crisis has spread rapidly to Spain, Italy, and France. Europe is now battling an acute systemic debt crisis that threatens the global fi nancial system. Th e worsening crisis constitutes the largest single threat to the U.S. economy and its fi nancial system. Th e causes of the European sovereign debt crisis resulted from a combination of complex factors, including the globalization of the fi nancial sector; easy credit conditions during 2002-2008 that encour- aged high-risk lending and borrowing practices; the 2007-2010 global fi nancial crisis; international trade imbalances; fi scal policy choices related to govern- ment revenues and expenses; and approaches used by nations to bail out troubled banking industries and private bondholders assuming private debt burdens or socializing losses. How each European country involved in this crisis borrowed and invested the money varies. For example, in Greece, the government increased its commitments to public workers in the form of extremely generous wage and pension benefi ts, dou- 6 Roger Teran IDA President 2012 bling in real terms in just 10 years. In Ireland, banks lent money to property developers, generating a mas- sive property bubble. In Spain, real estate prices tri- pled from 1995 to 2007. For years, the country relied on residential and offi ce building activity as a source of growth. At the height of the boom, construction accounted for more than 20 percent of Spain's GDP. Th at is the same level it reached in Ireland. But while both countries experienced similar booms and bust, their actions post-crash have been very diff erent. Ireland worked quickly to address the solvency of its banks by nationalizing them and removing billions of Euros' worth of toxic debt from their balance sheets by transferring to a so-called "bad bank." Spanish leaders under the previous socialist government of Mr. Rodriguez-Zapatero pushed banks to absorb weaker lenders, and there was a kind of denial on the scale of the problem. According to Cinzia Alcidi, an analyst at the Center for European Policy Studies, "In Spain, there seemed to be an eff ort to smooth out the pace of activity, rather than face the shock, as Ireland did. " Mr. Zapa- tero had several opportunities to clean up the bank- ing system when government fi nancing costs were lower, but dragged his feet. Th e clean-up has been leſt for the new government of Mr. Mariano Rajoy, which recently took $125 billion in order to bail out its fail- ing fi nancial institutions. Th e current problem is that the bailout does not break the feedback loop, through which Spain and its banks are making things worse for each other. Italy, the third largest euro-zone economy is seen as the next domino at risk, aſt er the EU deal to lend Spain $125 billion in bank bailout funds. With private investors unwilling to risk their capital in Italy, the country has no choice but to lean on the EU. In Italy, as in Spain, the government and banking system have an unhealthy interdependence. During the last 12 months, according to the Bank of Italy, Italian bank IDA UNIVERSAL July-August 2012