European sovereign debt crisis

The Beginning

the crisis begins with the significant increase in savings available for investment during the 2000–2007 period. During this time, the global pool of fixed income securities increased from approximately $36 trillion in 2000 to $70 trillion by 2007. This "Giant Pool of Money" increased as savings from high-growth developing nations entered global capital markets. Investors searching for higher yields than those offered by U.S. Treasury bonds sought alternatives globally. The temptation offered by this readily available savings overwhelmed the policy and regulatory control mechanisms in country after country as global fixed income investors searched for yield, generating bubble after bubble across the globe. While these bubbles have burst causing asset prices (e.g., housing and commercial property) to decline, the liabilities owed to global investors remain at full price, generating questions regarding the solvency of governments and their banking systems.

How each European country involved in this crisis borrowed and invested the money varies.

For example:

Ireland's banks lent the money to property developers, generating a massive property bubble. When the bubble burst, Ireland's government and taxpayers assumed private debts.

In Greece, the government increased its commitments to public workers in the form of extremely generous pay and pension benefits.

Iceland's banking system grew enormously, creating debts to global investors ("external debts") several times GDP.

The interconnection in the global financial system means that if one nation defaults on its sovereign debt or enters into recession that places some of the external private debt at risk as well, the banking systems of creditor nations face losses. For example: in October 2011 Italian borrowers owed French banks $366 billion (net).

Should Italy be unable to finance itself, the French banking system and economy could come under significant pressure, which in turn would affect France's creditors and so on. This is referred to as financial contagion.

Further creating interconnection is the concept of debt protection. Institutions entered into contracts called credit default swaps (CDS) that result in payment should default occur on a particular debt instrument (including government issued bonds). But, since multiple CDS can be purchased on the same security, it is unclear what exposure each country's banking system now has to CDS.

in insurance you can insure only that thing which you own, but in case of cds you can insure something which is owned by someone else there by creating multiple insurance on one thing. Thus loss of that one thing will result in claim by many creating pressure on insurer.

Some politicians, notably Angela Merkel, have sought to attribute some of the blame for the crisis to hedge funds and other speculators stating that "institutions bailed out with public funds are exploiting the budget crisis in Greece and elsewhere“.

Rising government debt levelsIn 1992 members of the European Union signed the Maastricht Treaty, under which they pledged to limit their deficit spending and debt levels. However, a number of EU member states, including Greece and Italy, were able to circumvent these rules and mask their deficit and debt levels through the use of complex currency and credit derivatives structures. The structures were designed by prominent U.S. investment banks, who received substantial fees in return for their services and who took on little credit risk themselves thanks to special legal protections for derivatives counterparties.

A number of "appalled economists" have condemned the popular notion in the media that rising debt levels of European countries were caused by excess government spending. According to their analysis increased debt levels are due to the large bailout packages provided to the financial sector during the late-2000s financial crisis, and the global economic slowdown thereafter.

The average fiscal deficit in the euro area in 2007 was only 0.6% before it grew to 7% during the financial crisis. In the same period the average government debt rose from 66% to 84% of GDP.

The authors also stressed that fiscal deficits in the euro area were stable or even shrinking since the early 1990s. US economist Paul Krugman named Greece as the only country, where fiscal irresponsibility is at the heart of the crisis.(see the graph)

Either way, high debt levels alone may not explain the crisis. According to The Economist Intelligence Unit, the position of the euro area looked "no worse and in some respects, rather better than that of the US or the UK." The budget deficit for the euro area as a whole is much lower and the euro area's government debt/GDP ratio of 86% in 2010 was about the same level as that of the US.

Greece's debt percentage between 1999 and 2010 compared to the average of the eurozone

Trade imbalancesCommentators such as Financial Times journalist Martin Wolf have asserted the root of the crisis was growing trade imbalances. He notes in the run-up to the crisis, from 1999 to 2007, Germany had a considerably better public debt and fiscal deficit relative to GDP than the most affected eurozone members. In the same period, these countries (Portugal, Ireland, Italy and Spain) had far worse balance of payments positions. Whereas German trade surpluses increased as a percentage of GDP after 1999, the deficits of Italy, France and Spain all worsened.

More recently, Greece's trading position has improved; in the period November 2010 to October 2011 imports dropped 12% while exports grew 15% (40% to non-EU countries in comparison to October 2010).

Monetary policy inflexibilitySince membership of the eurozone establishes a single monetary policy individual member states can no longer act independently. Paradoxically, this situation creates a higher default risk than faced by smaller non-eurozone economies, like the United Kingdom, which are able to "print money" in order to pay creditors and ease their risk of default. (Such an option is not available to a state such as France.) By "printing money" a country's currency is devalued relative to its (eurozone) trading partners, making it exports cheaper, in principle leading to an improving balance of trade, increased GDP and higher tax revenues in nominal terms. In the reverse direction moreover, assets held in a currency which has devalued suffer losses on the part of those holding them. For example by the end of 2011, following a 25 percent fall in the rate of exchange and 5 percent rise in inflation, eurozone investors in Sterling, locked in to Euro exchanges rates, had suffered an approximate 30 percent cut in the repayment value of this debt.

Loss of confidencePrior to development of the crisis it was assumed by both regulators and banks that sovereign debt from the eurozone was safe. Banks had substantial holdings of bonds from weaker economies such as Greece which offered a small premium and seemingly were equally sound.

As the crisis developed it became obvious that Greek, and possibly other countries', bonds offered substantially more risk. Contributing to lack of information about the risk of European sovereign debt was conflict of interest by banks that were earning substantial sums underwriting the bonds. The loss of confidence is marked by rising sovereign CDS prices, indicating market expectations about countries' creditworthiness (see graph).

Sovereign CDS prices of selected European countries (2010–2011). The left axis is in basis points; a level of 1,000 means it costs $1 million to protect $10 million of debt for five

years.

Furthermore, investors have doubts about the possibilities of policy makers to quickly contain the crisis. Since countries that use the Euro as their currency have fewer monetary policy choices (e.g., they cannot print money in their own currencies to pay debt holders), certain solutions require multi-national cooperation. Further, the European Central Bank has an inflation control mandate but not an employment mandate, as opposed to the U.S. Federal Reserve, which has a dual mandate. According to the Economist, the crisis "is as much political as economic" .

Rating agency viewsOn December 5, 2011 S&P placed its long-term sovereign ratings on 15 members of the eurozone on "CreditWatch" with negative implications; S&P wrote this was due to "systemic stresses from five interrelated factors: 1) Tightening credit conditions across the eurozone; 2) Markedly higher risk premiums on a growing number of eurozone

sovereigns including some that are currently rated 'AAA';3) Continuing disagreements among European policy makers on how to

tackle the immediate market confidence crisis and, longer term, how to ensure greater economic, financial, and fiscal convergence among eurozone members;

4) High levels of government and household indebtedness across a large area of the eurozone; and

5) The rising risk of economic recession in the eurozone as a whole in 2012. Currently, we expect output to decline next year in countries such as Spain,

Portugal and Greece, but we now assign a 40% probability of a fall in output for the eurozone as a whole."

What did they do to save themselves

GreeceIn the early-mid 2000s, Greece's economy was strong and the government took advantage by running a large deficit, partly due to high defense spending amid historic enmity to Turkey. As the world economy cooled in the late 2000s, Greece was hit especially hard because its main industries—shipping and tourism—were especially sensitive to changes in the business cycle. As a result, the country's debt began to pile up rapidly. In early 2010, as concerns about Greece's national debt grew, policy makers suggested that emergency bailouts might be necessary.On 23 April 2010, the Greek government requested that the EU/IMF bailout package be activated, with an initial loan package of €45 billion ($61 billion). A few days later Standard & Poor's slashed Greece's sovereign debt rating to BB+ or "junk" status amid fears of default, in which case investors were thought to lose 30–50% of their money. Stock markets worldwide and the Euro currency declined in response to this announcement.

On 1 May 2010, the Greek government announced a series of austerity measures to persuade Germany, the last remaining holdout, to sign on to a larger EU/IMF loan package. The next day the eurozone countries and the International Monetary Fund agreed to a three year €110 billion loan retaining relatively high interest rates of 5.5%, conditional on the implementation of harsh austerity measures. Credit rating agencies immediately downgraded Greek governmental bonds to an even lower junk status. This was followed by an announcement of the ECB on 3 May that it will still accept as collateral all outstanding and new debt instruments issued or guaranteed by the Greek government, regardless of the nation's credit rating, in order to maintain banks' liquidity. The new austerity package was met with great anger by the Greek public, leading to massive protests, riots and social unrest throughout Greece. On 5 May 2010, a national strike was held in opposition to the planned spending cuts and tax increases. In Athens some protests turned violent, killing three people.

still €110 billion loan did not help as it was found that the process of re-establishing Greek access to private capital markets by 2012, would take even much longer.The November 2010 revisions of 2009 deficit and debt levels made accomplishment of the 2010 targets even harder, and indications signaled a recession harsher than originally feared. In May 2011 it became evident that due to the severe economic crisis tax revenues were lower than expected, making it even harder for Greece to meet its fiscal goals.

Following the findings of a bilateral EU-IMF audit in June, which called for even further austerity measures, Standard and Poor's downgraded Greece's sovereign debt rating to CCC, the lowest in the world.

To ensure the release of the next 12 billion euros from the eurozone bail-out package (without which Greece would have had to default on loan repayments in mid-July), the government proposed additional spending cuts worth €28 billion over five years.

EU emergency measures continued at an extraordinary summit on 21 July 2011 in Brussels, where euro area leaders agreed to extend Greek (as well as Irish and Portuguese) loan repayment periods from 7 years to a minimum of 15 years and to cut interest rates to 3.5%. They also approved a new €109 billion support package, conditional on large privatization efforts. In the early hours of 27 October 2011, eurozone leaders and the IMF also came to an agreement with banks to accept a 50% write-off of (some part of) Greek debt, the equivalent of €100 billion, to reduce the country's debt level from €340bn to €240bn or 120% of GDP by 2020.

The unprecedented austerity measures have helped Greece bring down its primary deficit from €24.7bn (15.8% of GDP) in 2009 to just over €5bn (9.3%) in 2011 but they also dragged the country into five consecutive years of recession.

Industrial output is more than 28% lower than in 2005 and unemployment rates are hitting a record high reaching almost 20 percent by 2011. Youth unemployment reached 48%, up from 22.4% back in 2008 when the financial crisis began. By 2011 more than a third of the nation had fallen into poverty and the number of 111,000 Greek companies that went bankrupt was 27% higher than one year before.

Some of the economic experts argued in 2010, that the best option for Greece and the rest of the EU, would be to engineer an “orderly default” on Greece’s public debt, which would allow Athens to withdraw simultaneously from the eurozone and reintroduce its national currency the drachma at a debased rate.However, if Greece were to leave the euro, the economic and political impact would be devastating. According to Japanese financial company Nomura an exit would lead to a 60 percent devaluation of the new drachma. UBS warned of "hyperinflation, military coups and possible civil war that could afflict a departing country".

In February 2012, the second bailout package from July 2011 was extended from €109 billion to €130 billion. The activation of the extended lending package was needed no later than March 20, when a debt burden of €14.4bn had to be refinanced or paid, or else Greece would fall into default.

There were three requirements of the package • finalize an agreement whereby all private holders of governmental bonds

would accept a 50% haircut with yields reduced to 3.5%, thus facilitating a €100bn debt reduction for Greece.

• Greece needed to implement another demanding austerity package in order to bring its budget deficit into sustainable territory.

• a majority of the Greek politicians should sign an agreement guaranteeing their continued support for the new austerity package, even after the elections in April 2012.

On February 12, amid riots in Athens and other cities that left stores looted and burned and more than 120 people injured, the Greek parliament approved the austerity package and the post election guarantee.

On 21 February 2012 the Eurogroup finalized the second bailout package. In a marathon meeting in Brussels private holders of governmental bonds accepted a slightly bigger haircut of 53.5% Creditors are invited to swap their Greek bonds into new 3.65% bonds with a maturity of 30 years, thus facilitating a €107bn debt reduction for Greece. EU Member States agreed to an additional retroactive lowering of the bailout interest rates. Furthermore they will pass on to Greece all profits that their central banks made by buying Greek bonds at a debased rate until 2020. Altogether this should bring down Greece's debt to 120.5% by 2020.

IrelandThe Irish sovereign debt crisis was not based on government over-spending, but from the state guaranteeing the six main Irish-based banks who had financed a property bubble. On 29 September 2008 the Finance Minister Brian Lenihan, Jnr issued a one-year guarantee to the banks' depositors and bond-holders. He renewed it for another year in September 2009 soon after the launch of the National Asset Management Agency (NAMA), a body designed to remove bad loans from the six banks.

Irish banks had lost an estimated 100 billion euros, much of it related to defaulted loans to property developers and homeowners made in the midst of the property bubble, which burst around 2007. Ireland could have guaranteed bank deposits and let private bondholders who had invested in the banks face losses, but instead borrowed money from the ECB to pay these bondholders, shifting the losses and debt to its taxpayers.

The economy collapsed during 2008. Unemployment rose from 4% in 2006 to 14% by 2010, while the federal budget went from a surplus in 2007 to a deficit of 32% GDP in 2010

In April 2010, following a marked increase in Irish 2-year bond yields, Ireland's NTMA state debt agency said that it had "no major refinancing obligations" in 2010. Its requirement for €20 billion in 2010 was matched by a €23 billion cash balance, and it remarked: "We're very comfortably circumstanced“. On 18 May the NTMA tested the market and sold a €1.5 billion issue that was three times oversubscribed.

By September 2010 the banks could not raise finance and the bank guarantee was renewed for a third year. This had a negative impact on Irish government bonds, government help for the banks rose to 32% of GDP, and so the government started negotiations with the EU, the IMF and three nations: the United Kingdom, Denmark and Sweden, resulting in a €67.5 billion "bailout" agreement of 29 November 2010

Together with additional €17.5 billion coming from Ireland's own reserves and pensions, the government received €85 billion, of which €34 billion were used to support the country's ailing financial sector. In return the government agreed to reduce its budget deficit to below three percent by 2015. In February the government lost the ensuing Irish general election, 2011. In April 2011, despite all the measures taken, Moody's downgraded the banks' debt to junk status.

In July 2011 European leaders agreed to cut the interest rate that Ireland is paying on its EU/IMF bailout loan from around 6% to between 3.5% and 4% and to double the loan time to 15 years. The move is expected to save the country between 600–700 million euros per year.On 14 September 2011 the European Commission announced to cut the interest rate on its €22.5 billion loan coming from the European Financial Stability Mechanism, down to 2.59 per cent – which is the interest rate the EU itself pays to borrow from financial markets.

The Euro Plus Monitor report from November 2011 attests to Ireland's vast progress in dealing with its financial crisis, expecting the country to stand on its own feet again and finance itself without any external support from the second half of 2012 onwards. According to the Centre for Economics and Business Research Ireland's export-led recovery "will gradually pull its economy out of its trough". As a result of the improved economic outlook, the cost of 10-year government bonds, which has already fallen substantially since mid July 2011 (see the graph "Long-term Interest Rates"), is expected to fall further to 4 per cent by 2015.

Long-term interest rates of all eurozone countries except Estonia (secondary market yields of government bonds with maturities of close to ten years) A yield of 6 % or more indicates that financial

markets have serious doubts about credit-worthiness.

PortugalAccording to A report released in January 2011 by the Diário de Notícias and published in Portugal by Gradiva the democratic Portuguese Republic governments in the period between 1974 and 2010have encouraged over-expenditure and investment bubbles through unclear public-private partnerships and funding of numerous ineffective and unnecessary external consultancy and advisory of committees and firms. This allowed considerable slippage in state-managed public works and inflated top management and head officer bonuses and wages.

Risky credit, public debt creation, and European structural and cohesion funds were mismanaged across almost four decades. The Prime Minister Sócrates's cabinet was not able to forecast or prevent this in 2005, and later it was incapable of doing anything to improve the situation when the country was on the verge of bankruptcy by 2011.

Robert Fishman, in the New York Times article "Portugal's Unnecessary Bailout", points out that Portugal fell victim to successive waves of speculation by pressure from bond traders, rating agencies and speculators. In the first quarter of 2010, before markets pressure, Portugal had one of the best rates of economic recovery in the EU.

On 16 May 2011 the eurozone leaders officially approved a €78 billion bailout package for Portugal, which became the third eurozone country, after Ireland and Greece, to receive emergency funds. The bailout loan will be equally split between the European Financial Stabilisation Mechanism, the European Financial Stability Facility, and the International Monetary Fund. According to the Portuguese finance minister, the average interest rate on the bailout loan is expected to be 5.1 percent. As part of the deal, the country agreed to cut its budget deficit from 9.8 % of GDP in 2010 to 5.9% in 2011, 4.5 percent in 2012 and 3 % in 2013.

On 6 July 2011 the ratings agency Moody's had cut Portugal's credit rating to junk status, Moody's also launched speculation that Portugal may follow Greece in requesting a second bailout.In December 2011 it was reported that Portugal's estimated budget deficit of 4.5 percent in 2011 will be substantially lower than expected, due to a one-off transfer of pension funds.

Despite the fact that the economy is expected to contract by 3 percent in 2011 the IMF expects the country to be able to return to medium and long-term debt sovereign markets by late 2013.

Effect on other European countries

BelgiumIn 2010, Belgium's public debt was 100% of its GDP—the third highest in the eurozone after Greece and Italy and there were doubts about the financial stability of the banks, following the country's major financial crisis in 2008–2009.

However the government deficit of 5% was relatively modest and Belgian government 10-year bond yields in November 2010 of 3.7% were still below those of Ireland (9.2%), Portugal (7%) and Spain (5.2%). Furthermore, thanks to Belgium's high personal savings rate, the Belgian Government financed the deficit from mainly domestic savings, making it less prone to fluctuations of international credit markets. Nevertheless on 25 November 2011, Belgium's long-term sovereign credit rating was downgraded from AA+ to AA by Standard and Poor and 10-year bond yields reached 5.66%. Shortly after Belgian negotiating parties reached an agreement to form a new government. The deal includes spending cuts and tax rises worth about €11 billion, which should bring the budget deficit down to 2.8% of GDP by 2012, and to balance the books in 2015. Following the announcement Belgium 10-year bond yields fell sharply to 4.6%.

FranceFrance's public debt in 2010 was approximately U.S. $2.1 trillion and 83% GDP, with a 2010 budget deficit of 7% GDP. By 16 November 2011, France's bond yield spreads vs. Germany had widened 450% since July, 2011. France's C.D.S. contract value rose 300% in the same period. On 1 December 2011, France's bond yield had retreated and the country successfully auctioned €4.3 billion worth of 10 year bonds at an average yield of 3.18 %, well below the perceived critical level of 7 %

ItalyItaly's deficit of 4.6% of GDP in 2010 was similar to Germany’s at 4.3% and less than that of the U.K. and France. Italy even has a surplus in its primary budget, which excludes debt interest payments. However, its debt has increased to almost 120 % of GDP (U.S. $2.4 trillion in 2010) and economic growth was lower than the EU average for over a decade. This has led investors to view Italian bonds more and more as a risky asset. On the other hand, the public debt of Italy has a longer maturity and a big share of it is held domestically.About 300 billion euros of Italy's 1.9 trillion euro debt is due in 2012, so it must go to the capital markets for significant refinancing in the near-term. On 15 July and 14 September 2011, Italy's government passed austerity measures meant to save €124 billion. Nonetheless, by 8 November 2011 the Italian bond yield was 6.74% for 10-year bonds, climbing above the 7% level. On 11 November 2011, Italian 10-year borrowing costs fell sharply from 7.5 to 6.7% after Italian legislature approved further austerity measures and the formation of an emergency government to replace that of Prime Minister Silvio Berlusconi. The measures include a pledge to raise €15 billion from real-estate sales over the next three years, a two-year increase in the retirement age to 67 by 2026, opening up closed professions within 12 months and a gradual reduction in government ownership of local services.

SpainSpain has a comparatively low debt among advanced economies and it does not face a risk of default. The country's public debt relative to GDP in 2010 was only 60%, more than 20 points less than Germany, France or the US, and more than 60 points less than Italy, Ireland or Greece.As one of the largest eurozone economies the condition of Spain's economy is of particular concern to international observers, and faced pressure from the United States, the IMF, other European countries and the European Commission to cut its deficit more aggressively.shortly after the announcement of the EU's new "emergency fund" for eurozone countries in early May 2010, Spain had to announce new austerity measures designed to further reduce the country's budget deficit, in order to signal financial markets that it was safe to invest in the country.Spain succeeded in trimming its deficit from 11.2% of GDP in 2009 to 9.2% in 2010 and originally expected its 2011 deficit to be at 6%. However, due to the European crisis and over spending by regional governments, the real deficit likely overshoot the latest target reaching between 6.6% and 8%.

To build up additional trust in the financial markets, the government amended the Spanish Constitution in 2011 to require a balanced budget at both the national and regional level by 2020.

The amendment states that public debt can not exceed 60% of GDP, though exceptions would be made in case of a natural catastrophe, economic recession or other emergencies.

The new conservative Spanish government led by Mariano Rajoy aims to cut the deficit further to 4.4 percent in 2012 and 3 percent in 2013.

United Kingdom

According to the Financial Policy Committee "Any associated disruption to bank funding markets could spill over to UK banks.” Bank of England governor Mervyn King declared that the UK is very much at risk from a domino-fall of defaults and called on banks to build up more capital when financial conditions allowed. This is because the UK has the highest gross foreign debt of any European country (€7.3 trillion; €117,580 per person) due in large part to its highly leveraged financial industry, which is closely connected with both the United States and the eurozone.

Where we are now

European Financial Stability Facility (EFSF)

On 9 May 2010, the 27 EU member states agreed to create the European Financial Stability Facility, a legal instrument aiming at preserving financial stability in Europe by providing financial assistance to eurozone states in difficulty.

Emissions of bonds are backed by guarantees given by the euro area member states in proportion to their share in the paid-up capital of the European Central Bank. The €440 billion lending capacity of the Facility is jointly and severally guaranteed by the eurozone countries' governments and may be combined with loans up to €60 billion from the European Financial Stabilisation Mechanism and up to €250 billion from the International Monetary Fund (IMF) to obtain a financial safety net up to €750 billion.

On November 29, 2011 the member state finance ministers agreed to expand the EFSF by creating certificates that could guarantee up to 30% of new issues from troubled euro-area governments and to create investment vehicles that would boost the EFSF’s firepower to intervene in primary and secondary bond markets.

European Financial Stabilisation Mechanism (EFSM)

On 5 January 2011, the European Union created the European Financial Stabilisation Mechanism (EFSM), an emergency funding programme reliant upon funds raised on the financial markets and guaranteed by the European Commission using the budget of the European Union as collateral. It runs under the supervision of the Commission and aims at preserving financial stability in Europe by providing financial assistance to EU member states in economic difficulty. The Commission fund, backed by all 27 European Union members, has the authority to raise up to €60 billion and is rated AAA by Fitch, Moody's and Standard & Poor's.

Under the EFSM, the EU successfully placed in the capital markets a €5 billion issue of bonds as part of the financial support package agreed for Ireland, at a borrowing cost for the EFSM of 2.59%.

ECB interventions

On 22 December 2011, the ECB started the biggest infusion of credit into the European banking system in the euro's 13 year history. It loaned €489 billion to 523 banks for an exceptionally long period of three years at a rate of just one percent. This way the ECB tries to make sure that banks have enough cash to pay off €200 billion of their own maturing debts in the first three months of 2012, and at the same time keep operating and loaning to businesses so that a credit crunch does not choke off economic growth. It also hopes that banks use some of the money to buy government bonds, effectively easing the debt crisis. A second auction will be held on 29 February 2012.

Proposed long-term solutions

European fiscal union and revision of the Lisbon Treaty

In March 2011 a new reform of the Stability and Growth Pact was initiated, aiming at straightening the rules by adopting an automatic procedure for imposing of penalties in case of breaches of either the deficit or the debt rules. By the end of the year, Germany, France and some other smaller EU countries went a step further and vowed to create a fiscal union across the eurozone with strict and enforceable fiscal rules and automatic penalties embedded in the EU treaties.

On 9 December 2011 at the European Council meeting, all 17 members of the eurozone and six countries that aspire to join agreed on a new intergovernmental treaty to put strict caps on government spending and borrowing, with penalties for those countries who violate the limits. All other non-eurozone countries except Great Britain are also prepared to join in, subject to parliamentary vote

Eurobonds

On 21 November 2011, the European Commission suggested that eurobonds issued jointly by the 17 euro nations would be an effective way to tackle the financial crisis. Using the term "stability bonds", Jose Manuel Barroso insisted that any such plan would have to be matched by tight fiscal surveillance and economic policy coordination as an essential counterpart so as to avoid moral hazard and ensure sustainable public finances.

However, Germany remains opposed to take over the debt and interest risk of states that have run excessive budget deficits and borrowed excessively over the past years. The German government sees no point in making borrowing easier for states who have problems borrowing so much that they go into debt crisis. Germany says that Eurobonds, jointly issued and underwritten by all 17 members of the currency bloc, could substantially raise the country's liabilities in a debt crisis.

European Stability Mechanism (ESM)

The European Stability Mechanism (ESM) is a permanent rescue funding programme to succeed the temporary European Financial Stability Facility and European Financial Stabilisation Mechanism in July 2012.

the ESM will be an intergovernmental organisation under public international law and will be located in Luxembourg.

Such a mechanism serves as a "financial firewall." Instead of a default by one country rippling through the entire interconnected financial system, the firewall mechanism can ensure that downstream nations and banking systems are protected by guaranteeing some or all of their obligations. Then the single default can be managed while limiting financial contagion.

European Monetary Fund

On 20 October 2011, the Austrian Institute of Economic Research published an article that suggests to transform the EFSF into a European Monetary Fund (EMF), which could provide governments with fixed interest rate Eurobonds at a rate slightly below medium-term economic growth (in nominal terms). These bonds would not be tradable but could be held by investors with the EMF and liquidated at any time. Given the backing of the entire eurozone countries and the ECB "the EMU would achieve a similarly strong position vis-a-vis financial investors as the US where the Fed backs government bonds to an unlimited extent." To ensure fiscal discipline despite the lack of market pressure, the EMF would operate according to strict rules, providing funds only to countries that meet agreed on fiscal and macroeconomic criteria. Governments that lack sound financial policies would be forced to rely on traditional (national) governmental bonds with less favorable market rates.

Source:

• Wikipedia

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