Breaking down the problem.

Samadrita Guin, Staff Writer

So, I’m sure that you’ve heard of the ongoing European financial crisis. If you have no idea what I’m talking about, let me give you a quick recap:

 1. In the mid 2000’s Greece enjoyed much growth, and the Greek economy was one of the fastest growing in the Eurozone. The government took advantage of this and spent extravagantly, running a large structural deficit. (What is a deficit, you ask? A deficit occurs when the government outlays exceed government revenues. In other words when the taxes you pay are not enough to cover the government’s expenditures). When deficits increase, the government starts acquiring debt in order to finance the country’s operations. With a steeply rising deficit, outstanding debts grew exponentially.

 2. In October 2009, George Papandreou followed in the footsteps of his family to become the Greek prime minister. After coming into position, he learned that Greece had been understating its debt numbers for years.

 3. Greece had joined the European Monetary Union (EMU) by downplaying its debt numbers in order to comply with the necessary requirements. Once it was accepted, membership meant more ease in borrowing money.

4. When the numbers were publicized, and the truth was available for the entire world to see, the country’s credit rating downgraded from an A- to a BBB+. With an increased likelihood of a Greek default, investors demanded a higher yield on the Greek bonds they had purchased. This pushed up the cost of borrowing even further, thus creating an inescapable cycle.

[pullquote]Using the bailout money as a solution made Greece worse off, because of the fact that solving a debt crisis by acquiring more debt is simply a recipe for disaster[/pullquote]5. These bonds were far spread and wide. If the Greek economy defaulted, it would be taking down all of Europe along with it. Many global banks in various countries were also being affected since they held a significant portion of the debt. (German Banks = $22.6bn, French banks=$15bn, UK banks = $3.4bn.) Also, many private investors – including pension funds – hold an additional $14.6bn. London, being at the centre of this financial crisis, also stood in the middle of any banking crisis.

6. So what was the solution to all this mayhem? Well, the only thing that could be done at this point was to bailout Greece. Even though a bailout usually means that the money comes “no-strings-attached,” it actually came in the form of huge loans from a specifically created fund called the European Financial Stability Facility (EFSF). On May 2010, a bailout for €110 billion was approved, and last week, another bailout for €130 billion was formalized.

 7. In return for the bailout money, Greece had to initiate some measures that were severely harmful to the economy as a whole. €530 million from health and pension funds, €400 million from defense, €50 million from doctors’ overtime pay, and €80 million from education budgets were cut. The effect of these measures has led to a current unemployment rate of an astounding 21%, with a severe scarcity of jobs.

 8. This has led to riots on a regular basis on the streets of Greece. Overall, the Greek economy is not doing so well. If Greek defaults on the bailout loans, it might lead to a major financial downturn in all of Europe, which could drag the Americas down with it, due to the globalization of assets.

So, after getting a glimpse of the entire situation, what do you think went wrong? What were the core problems that slowly led to a booming country turning into one where petrol bombs are thrown at the Parliament house on a regular basis? The problem was, that the Greek government overindulged during the economy’s expansion in the mid 2000’s, into spending money it didn’t have, on public welfare. It is always nice of the government to try and be as generous to the citizens as possible, but the problem arises when they start spending money they neither have nor have the capacity to repay.

Also, tax evasion is vastly present in Greece. With an increase in government spending, but a lower tax collection rate, debts will obviously continue to build! Moreover, hiding the truth in terms of concealing the debt figures was what made matters worse. If the debt numbers had been out in the open since the very beginning, other preventative measures could have been suggested by either the UN World Bank, or by other nations.

Finally, using the bailout money as a solution made Greece worse off, because of the fact that solving a debt crisis by acquiring more debt is simply a recipe for disaster.  The only way this problem could have been solved safely was if the Greek GDP was to grow exponentially, but that would take many years to happen, and in order for GDP to grow, they would need investments, which can only be acquired through more debt. Greece was caught in a vicious cycle that could not be solved unless they used the bailout money, which ironically, simply worsened the situation. All that can be done for the future is to hope that somehow Greece can get back on its feet safe and sound, in about a few years from now.

ARB Team
Arbitrage Magazine
Business News with BITE.

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