Subprime Mortgage Crisis and Eurozone Crisis

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Subprime mortgage crisis
and eurozone crisis
Contents
Articles
European sovereign-debt crisis 1
Subprime mortgage crisis 55
References
Article Sources and Contributors 100
Image Sources, Licenses and Contributors 101
Article Licenses
License 103
European sovereign-debt crisis
1
Long-term interest rates (secondary market yields of government
bonds with maturities of close to ten years) of all eurozone
countries except Estonia
[1]
A yield of 6% or more indicates that
financial markets have serious doubts about credit-worthiness.
[2]
The European sovereign debt crisis (often referred to
as the Eurozone crisis) is an ongoing financial crisis that
has made it difficult or impossible for some countries in
the euro area to repay or re-finance their government
debt without the assistance of third parties.
[3]
From late 2009, fears of a sovereign debt crisis
developed among investors as a result of the rising
private and government debt levels around the world
together with a wave of downgrading of government
debt in some European states. Causes of the crisis varied
by country. In several countries, private debts arising
from a property bubble were transferred to sovereign
debt as a result of banking system bailouts and
government responses to slowing economies
post-bubble. In Greece, unsustainable public sector wage
and pension commitments drove the debt increase.
[4]
The
structure of the Eurozone as a monetary union (i.e., one
currency) without fiscal union (e.g., different tax and
public pension rules) contributed to the crisis and harmed
the ability of European leaders to respond.
[5][6]
European
banks own a significant amount of sovereign debt, such
that concerns regarding the solvency of banking systems
or sovereigns are negatively reinforcing.
[7]
Concerns intensified in early 2010 and thereafter,
[8][9]
leading European nations to implement a series of financial
support measures such as the European Financial Stability Facility (EFSF) and European Stability Mechanism.
Beside of all the political measures and bailout programmes being implemented to combat the European sovereign
debt crisis, the European Central Bank (ECB) has also done its part by lowering interest rates and providing cheap
loans of more than one trillion Euros to maintain money flows between European banks. On 6 September 2012, the
ECB also calmed financial markets by announcing free unlimited support for all eurozone countries involved in a
sovereign state bailout/precautionary programme from EFSF/ESM, through some yield lowering Outright Monetary
Transactions (OMT).
[10]
The crisis did not only introduce adverse economic effects for the worst hit countries, but also had a major political
impact on the ruling governments in 8 out of 17 eurozone countries, leading to power shifts in Greece, Ireland, Italy,
Portugal, Spain, Slovenia, Slovakia, and the Netherlands.
2
Causes
Public debt $ and %GDP (2010) for selected European countries
Government debt of Eurozone, Germany and crisis countries
compared to Eurozone GDP
The European sovereign debt crisis resulted from a
combination of complex factors, including the
globalization of finance; easy credit conditions during
the 20022008 period that encouraged high-risk lending
and borrowing practices; the 20072012 global financial
crisis; international trade imbalances; real-estate bubbles
that have since burst; the 20082012 global recession;
fiscal policy choices related to government revenues and
expenses; and approaches used by nations to bail out
troubled banking industries and private bondholders,
assuming private debt burdens or socializing losses.
[4][11]
One narrative describing the causes of the crisis begins
with the significant increase in savings available for
investment during the 20002007 period when 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.
[12]
The temptation offered by such readily available savings
overwhelmed the policy and regulatory control
mechanisms in country after country, as lenders and
borrowers put these savings to use, 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.
[4]
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 wage and pension benefits, with the former doubling in real terms over
10 years.
[5]
Iceland's banking system grew enormously, creating debts to global investors (external debts) several
times GDP.
[4][13]
The interconnection in the global financial system means that if one nation defaults on its sovereign debt or enters
into recession putting some of the external private debt at risk, 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.
[7][14]
Another factor contributing to
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 CDSs can be purchased on the same security, it is unclear what exposure each country's banking
system now has to CDS.
[15]
3
Greece hid its growing debt and deceived EU officials with the help of derivatives designed by major
banks.
[16][17][18][19][20][21]
Although some financial institutions clearly profited from the growing Greek government
debt in the short run,
[16]
there was a long lead-up to the crisis.
Rising household and government debt levels
Public debt as a percent of GDP (2010)
In 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, failing to abide
by their own internal guidelines, sidestepping best
practice and ignoring internationally agreed
standards.
[22]
This allowed the sovereigns to mask their
deficit and debt levels through a combination of
techniques, including inconsistent accounting,
off-balance-sheet transactions
[22]
as well as the use of complex currency and credit derivatives structures.
[23][24]
The
complex structures were designed by prominent U.S. investment banks, who received substantial fees in return for
their services.
[16]
Convergence of interest rates in Eurozone countries
The adoption of the euro led to many Eurozone countries
of different credit worthiness receiving similar and very
low interest rates for their bonds and private credits
during years preceding the crisis, which author Michael
Lewis referred to as "a sort of implicit Germany
guarantee."
[5]
As a result, creditors in countries with
originally weak currencies (and higher interest rates)
suddenly enjoyed much more favorable credit terms,
which spurred private and government spending and led
to an economic boom. In some countries such as Ireland
and Spain low interest rates also led to a housing bubble, which burst at the height of the financial crisis.
[25][26]
A number of economists have dismissed the popular belief that the debt crisis was caused by excessive social
welfare spending. According to their analysis, increased debt levels were mostly 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.
[27]
US economist Paul Krugman named
Greece as the only country where fiscal irresponsibility is at the heart of the crisis.
[28]
British economic historian
Robert Skidelsky added that it was indeed excessive lending by banks, not deficit spending that created this crisis.
Government's mounting debts are a response to the economic downturn as spending rises and tax revenues fall, not
its cause.
[29]
4
Government deficit of Eurozone compared to USA and UK
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."
[30][31]
The budget deficit for the euro area as a
whole (see graph) 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. Moreover,
private-sector indebtedness across the euro area is
markedly lower than in the highly leveraged
Anglo-Saxon economies.
[30]
Trade imbalances
Current account balances relative to GDP (2010)
Commentator and Financial Times journalist Martin
Wolf has asserted that 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.
[32][33]
Whereas
German trade surpluses increased as a percentage of
GDP after 1999, the deficits of Italy, France and Spain
all worsened.
Paul Krugman wrote in 2009 that a trade deficit by
definition requires a corresponding inflow of capital to
fund it, which can drive down interest rates and stimulate the creation of bubbles: "For a while, the inrush of capital
created the illusion of wealth in these countries, just as it did for American homeowners: asset prices were rising,
currencies were strong, and everything looked fine. But bubbles always burst sooner or later, and yesterdays miracle
economies have become todays basket cases, nations whose assets have evaporated but whose debts remain all too
real."
[34]
A trade deficit can also be affected by changes in relative labor costs, which made southern nations less competitive
and increased trade imbalances. Since 2001, Italy's unit labor costs rose 32% relative to Germany's.
[35][36]
Greek unit
labor costs rose much faster than Germany's during the last decade.
[37]
However, most EU nations had increases in
labor costs greater than Germany's.
[38]
Those nations that allowed "wages to grow faster than productivity" lost
competitiveness.
[33]
Germany's restrained labor costs, while a debatable factor in trade imbalances,
[38]
are an
important factor for its low unemployment rate.
[39]
More recently, Greece's trading position has improved;
[40]
in the
period 2011 to 2012, imports dropped 20.9% while exports grew 16.9%, reducing the trade deficit by 42.8%.
[40]
Simon Johnson explains the hope for convergence in the Euro-zone and what went wrong. The euro locks countries
into an exchange rate amounting to very big bet that their economies would converge in productivity. If not,
workers would move to countries with greater productivity. Instead the opposite happened: the gap between German
5
and Greek productivity increased resulting in a large current account surplus financed by capital flows. The capital
flows could have been invested to increase productivity in the peripheral nations. Instead capital flows were
squandered in consumption and consumptive investments.
[41]
Further, Eurozone countries with sustained trade surpluses (i.e., Germany) do not see their currency appreciate
relative to the other Eurozone nations due to a common currency, keeping their exports artificially cheap. Germany's
trade surplus within the Eurozone declined in 2011 as its trading partners were less able to find financing necessary
to fund their trade deficits, but Germany's trade surplus outside the Eurozone has soared as the euro declined in value
relative to the dollar and other currencies.
[42]
Structural problem of Eurozone system
There is a structural contradiction within the euro system, namely that there is a monetary union (common currency)
without a fiscal union (e.g., common taxation, pension, and treasury functions).
[43]
In the Eurozone system, the
countries are required to follow a similar fiscal path, but they do not have common treasury to enforce it. That is,
countries with the same monetary system have freedom in fiscal policies in taxation and expenditure. So, even
though there are some agreements on monetary policy and through European Central Bank, countries may not be
able to or would simply choose not to follow it. This feature brought fiscal free riding of peripheral economies,
especially represented by Greece, as it is hard to control and regulate national financial institutions. Furthermore,
there is also a problem that the euro zone system has a difficult structure for quick response. Eurozone, having 17
nations as its members, require unanimous agreement for a decision making process. This would lead to failure in
complete prevention of contagion of other areas, as it would be hard for the Eurozone to respond quickly to the
problem.
[44]
In addition, as of June 2012 there was no "banking union" meaning that there was no Europe-wide approach to bank
deposit insurance, bank oversight, or a joint means of recapitalization or resolution (wind-down) of failing banks.
[45]
Bank deposit insurance helps avoid bank runs. Recapitalization refers to injecting money into banks so that they can
meet their immediate obligations and resume lending, as was done in 2008 in the U.S. via the Troubled Asset Relief
Program.
[46]
Columnist Thomas L. Friedman wrote in June 2012: "In Europe, hyperconnectedness both exposed just how
uncompetitive some of their economies were, but also how interdependent they had become. It was a deadly
combination. When countries with such different cultures become this interconnected and interdependent when
they share the same currency but not the same work ethics, retirement ages or budget discipline you end up with
German savers seething at Greek workers, and vice versa."
[47]
Monetary policy inflexibility
Membership in the Eurozone established a single monetary policy, preventing individual member states from acting
independently. In particular they cannot create Euros in order to pay creditors and eliminate their risk of default.
Since they share the same currency as their (eurozone) trading partners, they cannot devalue their currency to make
their exports cheaper, which in principle would lead to an improved balance of trade, increased GDP and higher tax
revenues in nominal terms.
[48]
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 Pound Sterling, locked in to euro exchange rates, had suffered an approximate 30
percent cut in the repayment value of this debt.
[49]
6
Loss of confidence
Sovereign CDS prices of selected European countries
(20102012). The left axis is in basis points; a level of 1,000
means it costs $1million to protect $10million of debt for
five years.
Prior 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.
[50]
The loss of confidence is marked by rising
sovereign CDS prices, indicating market expectations about
countries' creditworthiness (see graph).
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" and the result of the fact that the euro area is
not supported by the institutional paraphernalia (and mutual
bonds of solidarity) of a state.
[30]
Heavy bank withdrawals
have occurred in weaker Eurozone states such as Greece and Spain.
[51]
Bank deposits in the Eurozone are insured,
but by agencies of each member government. If banks fail, it is unlikely the government will be able to fully and
promptly honor their commitment, at least not in euros, and there is the possibility that they might abandon the euro
and revert to a national currency; thus, euro deposits are safer in Dutch, German, or Austrian banks than they are in
Greece or Spain.
[52]
As of June, 2012, many European banking systems were under significant stress, particularly Spain. A series of
"capital calls" or notices that banks required capital contributed to a freeze in funding markets and interbank lending,
as investors worried that banks might be hiding losses or were losing trust in one another.
[53][54]
In June 2012, as the euro hit new lows, there were reports that the wealthy were moving assets out of the
Eurozone
[55]
and within the Eurozone from the South to the North. Between June 2011 and June 2012 Spain and
Italy alone have lost 286 bn and 235 bn euros. Altogether Mediterranean countries have lost assets worth ten percent
of GDP since capital flight started in end of 2010.
[56]
Mario Draghi, president of the European Central Bank, has
called for an integrated European system of deposit insurance which would require European political institutions
craft effective solutions for problems beyond the limits of the power of the European Central Bank.
[57]
As of June 6,
2012, closer integration of European banking appeared to be under consideration by political leaders.
[58]
Interest on long term sovereign debt
In June, 2012, following negotiation of the Spanish bailout line of credit interest on long-term Spanish and Italian
debt continued to rise rapidly, casting doubt on the efficacy of bailout packages as anything more than a stopgap
7
measure. The Spanish rate, over 6% before the line of credit was approved, approached 7%, a rough rule of thumb
indicator of serious trouble.
[59]
Rating agency views
On 5 December 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."
[60]
Evolution of the crisis
The 2009 annual budget deficit and public debt both relative to
GDP, for selected European countries. In the eurozone, the
following number of countries were: SGP-limit compliant (3),
Unhealthy (1), Critical (12), and Unsustainable (1).
In the first few weeks of 2010, there was renewed
anxiety about excessive national debt, with lenders
demanding ever higher interest rates from several
countries with higher debt levels, deficits and current
account deficits. This in turn made it difficult for some
governments to finance further budget deficits and
service existing debt, particularly when economic growth
rates were low, and when a high percentage of debt was
in the hands of foreign creditors, as in the case of Greece
and Portugal.
[61]
To fight the crisis some governments have focused on
austerity measures (e.g., higher taxes and lower
expenses) which has contributed to social unrest and
significant debate among economists, many of whom
advocate greater deficits when economies are struggling.
Especially in countries where budget deficits and
sovereign debts have increased sharply, a crisis of confidence has emerged with the widening of bond yield spreads
and risk insurance on CDS between these countries and other EU member states, most importantly Germany.
[62]
By
the end of 2011, Germany was estimated to have made more than 9 billion out of the crisis as investors flocked to
safer but near zero interest rate German federal government bonds (bunds).
[63]
By July 2012 also the Netherlands,
Austria and Finland benefited from zero or negative interest rates. Looking at short-term government bonds with a
maturity of less than one year the list of beneficiaries also includes Belgium and France.
[64]
While Switzerland (and
Denmark)
[64]
equally benefited from lower interest rates, the crisis also
8
The 2012 annual budget deficit and public debt both relative to
GDP, for all eurozone countries and UK. In the eurozone, the
following number of countries were: SGP-limit compliant (3),
Unhealthy (5), Critical (8), and Unsustainable (1).
Debt profile of Eurozone countries
harmed its export sector due to a substantial influx of
foreign capital and the resulting rise of the Swiss franc.
In September 2011 the Swiss National Bank surprised
currency traders by pledging that "it will no longer
tolerate a euro-franc exchange rate below the minimum
rate of 1.20 francs", effectively weakening the Swiss
franc. This is the biggest Swiss intervention since
1978.
[65]
Despite of sovereign debt only having rose substantially
in a few eurozone countries, with the three most affected
countries Greece, Ireland and Portugal collectively only
accounting for 6% of the eurozone's gross domestic
product (GDP),
[66]
it has become a perceived problem
for the area as a whole,
[67]
leading to speculation of
further contagion of other European countries and a
possible breakup of the Eurozone.
However, in Mid 2012, due to successful fiscal
consolidation and implementation of structural reforms
in the countries being most at risk and various policy
measures taken by EU leaders and the ECB (see below),
financial stability in the Eurozone has improved
significantly and interest rates have steadily fallen. This
has also greatly diminished contagion risk for other
eurozone countries. As of October 2012 only 3 out of 17
eurozone countries, namely Greece, Portugal and Cyprus
still battled with long term interest rates above 6%.
[68]
By the end of 2012, the debt crisis forced five out 17
Eurozone countries to seek help from other nations.
[3]
9
Greece
Greece's debt percentage since 1999 compared to the average of
the eurozone.
100,000 people protest against the harsh austerity measures in front
of parliament building in Athens, 29 May 2011
In the early mid-2000s, Greece's economy was one of the
fastest growing in the eurozone and was associated with
a large structural deficit.
[69]
As the world economy was
hit by the global financial crisis 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. The government spent
heavily to keep the economy functioning and the
country's debt increased accordingly.
On 23 April 2010, the Greek government requested an
initial loan of 45 billion from the EU and International
Monetary Fund (IMF), to cover its financial needs for the
remaining part of 2010.
[70][71]
A few days later Standard
& Poor's slashed Greece's sovereign debt rating to BB+
or "junk" status amid fears of default,
[72]
in which case
investors were liable to lose 3050% of their money.
[72]
Stock markets worldwide and the euro currency declined
in response to the downgrade.
[73]
On 1 May 2010, the Greek government announced a
series of austerity measures
[74]
to secure a three year
110 billion loan.
[75]
This was met with great anger by
the Greek public, leading to massive protests, riots and
social unrest throughout Greece.
[76]
The Troika (EC,
ECB and IMF), offered Greece a second bailout loan
worth 130 billion in October 2011, but with the
activation being conditional on implementation of further
austerity measures and a debt restructure agreement. A
bit surprisingly, the Greek prime minister George
Papandreou first answered that call, by announcing a
December 2011 referendum on the new bailout
plan,
[77][78]
but had to back down amidst strong pressure
from EU partners, who threatened to withhold an overdue 6 billion loan payment that Greece needed by
mid-December.
[77][79]
On 10 November 2011 Papandreou instead opted to resign, following an agreement with the
New Democracy party and the Popular Orthodox Rally, to appoint non-MP technocrat Lucas Papademos as new
prime minister of an interim national union government, with responsibility for implementing the needed austerity
measures to pave the way for the second bailout loan.
[80][81]
All the implemented austerity measures, have so far helped Greece bring down its primary deficit - i.e. fiscal deficit
before interest payments - from 24.7bn (10.6% of GDP) in 2009 to just 5.2bn (2.4% of GDP) in 2011,
[82][83]
but
as a side-effect they also contributed to a worsening of the Greek recession, which began in October 2008 and only
became worse in 2010 and 2011.
[84]
The austerity relies primarily on tax increases which harms the private sector
and economy.
[85]
Overall the Greek GDP had its worst decline in 2011 with 6.9%,
[86]
a year where the seasonal
adjusted industrial output ended 28.4% lower than in 2005,
[87][88]
and with 111,000 Greek companies going
bankrupt (27% higher than in 2010).
[89][90]
As a result, the seasonal adjusted unemployment rate also grew from
7.5% in September 2008 to a record high of 19.9% in November 2011, while the Youth unemployment rate during
10
the same time rose from 22.0% to as high as 48.1%.
[91][92]
Youth unemployment ratio hit 13 percent in 2011.
[93][94]
Overall the share of the population living at "risk of poverty or social exclusion" did not increase noteworthily during
the first 2 years of the crisis. The figure was measured to 27.6% in 2009 and 27.7% in 2010 (only being slightly
worse than the EU27-average at 23.4%),
[95]
but for 2011 the figure was now estimated to have risen sharply above
33%.
[96]
In February 2012, an IMF official negotiating Greek austerity measures admitted that excessive spending
cuts were harming Greece.
[82]
Some economic experts argue that the best option for Greece and the rest of the EU, would be to engineer an
orderly default, allowing Athens to withdraw simultaneously from the eurozone and reintroduce its national
currency the drachma at a debased rate.
[97][98]
However, if Greece were to leave the euro, the economic and political
consequences would be devastating. According to Japanese financial company Nomura an exit would lead to a 60%
devaluation of the new drachma. Analysts at French bank BNP Paribas added that the fallout from a Greek exit
would wipe 20% off Greece's GDP, increase Greece's debt-to-GDP ratio to over 200%, and send inflation soaring to
40%-50%.
[99]
Also UBS warned of hyperinflation, a bank run and even "military coups and possible civil war that
could afflict a departing country".
[100][101]
Eurozone National Central Banks (NCBs) may lose up to 100bn in debt
claims against the Greek national bank through the ECB's TARGET2 system. The Deutsche Bundesbank alone may
have to write off 27bn.
[102]
To prevent all this from happening, the troika (EC, IMF and ECB) eventually agreed in February 2012 to provide a
second bailout package worth 130 billion,
[103]
conditional on the implementation of another harsh austerity
package, reducing the Greek spendings with 3.3bn in 2012 and another 10bn in 2013 and 2014.
[83]
For the first
time, the bailout deal also included a debt restructure agreement with the private holders of Greek government bonds
(banks, insurers and investment funds), to "voluntarily" accept a bond swap with a 53.5% nominal write-off, partly
in short-term EFSF notes, partly in new Greek bonds with lower interest rates and the maturity prolonged to 1130
years (independently of the previous maturity).
[104]
The deal implies that previous Greek bond holders are being
given, for 1000 of previous notional, 150 in PSI payment notes issued by the EFSF and 315 in New Greek
Bonds issued by the Hellenic Republic, including a GDP-linked security. The latter represents a marginal coupon
enhancement in case the Greek growth meets certain conditions. While the market price of the portfolio proposed in
the exchange is of the order of 21% of the original face value (15% for the two EFSF PSI notes 1 and 2 years
and 6% for the New Greek Bonds 11 to 30 years), the duration of the set of New Greek Bonds is slightly below 10
years.
[105]
On 9 March 2012 the International Swaps and Derivatives Association (ISDA) issued a communiqu calling the debt
restructuring deal with its private sector involvement (PSI) a "Restructuring Credit Event" which will trigger
payment of credit default swaps. According to Forbes magazine Greeces restructuring represents a default.
[106][107]
It is the world's biggest debt restructuring deal ever done, affecting some 206 billion of Greek government
bonds.
[108]
The debt write-off had a size of 107 billion, and caused the Greek debt level to fall from roughly
350bn to 240bn in March 2012, with the predicted debt burden now showing a more sustainable size equal to
117% of GDP by 2020,
[109]
somewhat lower than the target of 120.5% initially outlined in the signed Memorandum
with the Troika.
[83][110][111]
Critics such as the director of LSE's Hellenic Observatory
[112]
argue that the billions of taxpayer euros are not
saving Greece but financial institutions,
[113]
as "more than 80 percent of the rescue package is going to
creditorsthat is to say, to banks outside of Greece and to the ECB."
[114]
The shift in liabilities from European
banks to European taxpayers has been staggering. One study found that the public debt of Greece to foreign
governments, including debt to the EU/IMF loan facility and debt through the eurosystem, increased from 47.8bn
to 180.5bn (+132,7bn) between January 2010 and September 2011,
[115]
while the combined exposure of foreign
banks to (public and private) Greek entities was reduced from well over 200bn in 2009 to around 80bn (-120bn)
by mid-February 2012.
[116]
11
Mid May 2012 the crisis and impossibility to form a new government after elections led to strong speculations
Greece would have to leave the Eurozone shortly due.
[117][118][119][120]
This phenomenon became known as "Grexit"
and started to govern international market behaviour.
[121][122]
The center-right's narrow victory in the June 17th
election gives hope that a coalition will enable Greece to stay in the Euro-zone.
[123]
A victory by the anti-austerity
axis could have been "an excuse to cut Greece out of the euro zone" according to the Wall Street Journal.
[124]
Ireland
Ireland's debt percentage compared to Eurozone average since
1995
The 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,
Finance Minister Brian Lenihan, Jnr issued a two-year
guarantee to the banks' depositors and bond-holders.
[126]
The guarantees were subsequently renewed for new
deposits and bonds in a slightly different manner. In
2009, an National Asset Management Agency (NAMA),
was created to acquire large property-related loans from
the six banks at a market-related "long-term economic
value".
[127]
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. The economy collapsed during
2008. Unemployment rose from 4% in 2006 to 14% by
2010, while the national budget went from a surplus in
2007 to a deficit of 32% GDP in 2010, the highest in the history of the eurozone, despite austerity measures.
[4][128]
With Ireland's credit rating falling rapidly in the face of mounting estimates of the banking losses, guaranteed
depositors and bondholders cashed in during 2009-10, and especially after August 2010. (The necessary funds were
borrowed from the central bank.) With yields on Irish Government debt rising rapidly it was clear that the
Government would have to seek assistance from the EU and IMF, resulting in a 67.5 billion "bailout" agreement of
29 November 2010
[129][130]
Together with additional 17.5 billion coming from Ireland's own reserves and
pensions, the government received 85 billion,
[131]
of which up to 34 billion was to be used to support the
country's ailing financial sector (only about half of this was used in that way following stress tests conducted in
2011).
[132]
In return the government agreed to reduce its budget deficit to below three percent by 2015.
[132]
In
12
Irish government deficit compared to other European countries and
the United States (20002013)
[125]
April 2011, despite all the measures taken, Moody's
downgraded the banks' debt to junk status.
[133]
In July 2011 European leaders agreed to cut the interest
rate that Ireland was 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 was expected to
save the country between 600700 million euros per
year.
[134]
On 14 September 2011, in a move to further
ease Ireland's difficult financial situation, the European
Commission announced it would 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.
[135]
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.
[136]
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, has already fallen substantially since its record high at 12% in mid July 2011 (see the
graph "Long-term Interest Rates"). At 24 July 2012 it was down at a sustainable 6.3%,
[137]
and it is expected to fall
even further to a level of only 4% by 2015.
[138]
On 26 July 2012, for the first time since September 2010, Ireland was able to return to the financial markets selling
over 5 billion in long-term government debt, with an interest rate of 5.9% for the 5-year bonds and 6.1% for the
8-year bonds at sale.
[139]
13
Portugal
Portugal's debt percentage compared to Eurozone average since
1999
According to a report by the Dirio de Notcias
[140]
Portugal had allowed considerable slippage in
state-managed public works and inflated top
management and head officer bonuses and wages in the
period between the Carnation Revolution in 1974 and
2010. Persistent and lasting recruitment policies boosted
the number of redundant public servants. Risky credit,
public debt creation, and European structural and
cohesion funds were mismanaged across almost four
decades.
[141]
When the global crisis disrupted the
markets and the world economy, together with the US
credit crunch and the European sovereign debt crisis,
Portugal was one of the first and most affected
economies to succumb.
In the summer of 2010, Moody's Investors Service cut
Portugal's sovereign bond rating,
[3][142]
which led to
increased pressure on Portuguese government bonds.
[143]
In the first half of 2011, Portugal requested a 78 billion
IMF-EU bailout package in a bid to stabilise its public finances.
[144]
These measures were put in place as a direct
result of decades-long governmental overspending and an over bureaucratised civil service. After the bailout was
announced, the Portuguese government headed by Pedro Passos Coelho managed to implement measures to improve
the State's financial situation and the country started to be seen as moving on the right track. However, this also lead
to a strong increase of the unemployment rate to over 15 percent in the second quarter 2012 and it is expected to rise
even further in the near future.
[145]
Portugals debt was in September 2012 forecast by the Troika to peak at around 124% of GDP in 2014, followed by
a firm downward trajectory after 2014. Previously the Troika had predicted it would peak at 118.5% of GDP in
2013, so the developments proved to be a bit worse than first anticipated, but the situation was described as fully
sustainable and progressing well. As a result from the slightly worse economic circumstances, the country has been
given one more year to reduce the budget deficit to a level below 3% of GDP, moving the target year from 2013 to
2014. The budget deficit for 2012 has been forecast to end at 5%. The recession in the economy is now also
projected to last until 2013, with GDP declining 3% in 2012 and 1% in 2013; followed by a return to positive real
growth in 2014.
[146]
As part of the bailout programme, Portugal is required to regain complete access to financial markets starting from
September 2013. The first step has been successfully completed on 3 October 2012, when the country managed to
regain partly market access. Once Portugal regains complete access it is expected to benefit from interventions by
the ECB, which announced support in the form of some yield-lowering bond purchases (OMTs),
[146]
to bring
governmental interest rates down to sustainable levels. A peak for the Portuguese 10-year governmental interest rates
happened on 30 January 2012, where it reached 17.3% after the rating agencies had cut the governments credit rating
to "non-investment grade" (also referred to as "junk").
[147]
As of 24 November 2012, it has been more than halved to
only 7.9%.
[148]
14
Spain
Spain's debt percentage compared to Eurozone average since 1999
Spain had a comparatively low debt level among
advanced economies prior to the crisis.
[149]
It'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.
[150][151]
Debt was largely avoided by the ballooning tax revenue
from the housing bubble, which helped accommodate a
decade of increased government spending without debt
accumulation.
[152]
When the bubble burst, Spain spent
large amounts of money on bank bailouts. In May 2012,
Bankia received a 19 billion euro bailout,
[153]
on top of
the previous 4.5 billion euros to prop up Bankia.
[154]
Questionable accounting methods disguised bank
losses.
[155]
During September 2012, regulators indicated
that Spanish banks required 59 billion (USD $77
billion) in additional capital to offset losses from real
estate investments.
[156]
The bank bailouts and the economic downturn increased the country's deficit and debt levels and led to a substantial
downgrading of its credit rating. To build up trust in the financial markets, the government began to introduce
austerity measures and it 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.
[157][158]
As one of the
largest eurozone economies (larger than Greece, Portugal and Ireland combined
[159]
) the condition of Spain's
economy is of particular concern to international observers. Under pressure from the United States, the IMF, other
European countries and the European Commission
[160][161]
the Spanish governments eventually succeeded in
trimming the deficit from 11.2% of GDP in 2009 to an expected 5.4% in 2012.
[159]
Nevertheless, in June 2012, Spain became a prime concern for the Euro-zone
[162]
when interest on Spains 10-year
bonds reached the 7% level and it faced difficulty in accessing bond markets. This led the Eurogroup on 9 June 2012
to grant Spain a financial support package of up to 100 billion.
[163]
The funds will not go directly to Spanish banks,
but be transferred to a governmently owned Spanish fund responsible to conduct the needed bank recapitalisations
(FROB), and thus it will be counted for as additional sovereign debt in Spain's national account.
[164][165][166]
An
economic forecast in June 2012highlighted the need for the arranged bank recapitalisation support package, as the
outlook promised a negative growth rate of 1.7%, unemployment rising to 25%, and a continued declining trend for
housing prices.
[159]
In September 2012 the ECB removed some of the pressure from Spain on financial markets,
when it announced its "unlimited bond-buying plan", to be initiated if Spain would sign a new sovereign bailout
package with EFSF/ESM.
[167][168]
As of October 2012, the Troika (EC, ECB and IMF) is indeed in negotiations with Spain to establish an economic
recovery program, which is required if the country should request a bailout package for the sovereign state from
ESM. Reportedly Spain, in addition to the 100bn "bank recapitalisation" package arranged for in June 2012,
[169]
now also seeks sovereign financial support from a "Precautionary Conditioned Credit Line" (PCCL) package.
[170]
If
Spain receives a PCCL package, irrespective to what extent it subsequently decides to draw on this established credit
line, Spain would immediately qualify to receive "free" additional financial support from ECB, in the form of some
unlimited yield-lowering bond purchases (OMT).
[171][172]
According to recent statements by the Prime Minister, the
country as of December 2012 still consider perhaps to request a PCCL sovereign bailout package in 2013, but only if
15
developments at financial markets will promise Spain a significant financial advantage of doing so. As of 7
December 2012, the yield of 10-year government bonds had declined to 5.4%.
[173]
According to the latest debt sustainability analysis published by the European Commission in October 2012, the
fiscal outlook for Spain, if assuming the country will stick to the fiscal consolidation path and targets outlined by the
country's current EDP programme, will result in a debt-to-GDP ratio reaching its maximum at 110% in 2018 -
followed by a declining trend in subsequent years. In regards of the structural deficit the same outlook has promised,
that it will gradually decline to comply with the maximum 0.5% level required by the Fiscal Compact in
2022/2027.
[174]
Policy reactions
EU emergency measures
The table below provides an overview of the financial composition of all bailout programs being initiated for EU
member states, since the financial crisis erupted in September 2008. Member states outside the eurozone (marked
with yellow in the table) have no access to the funds provided by EFSF/ESM, but can be covered with rescue loans
from EU's Balance of Payments programme (BoP), IMF and other funds.
EU
member
Time span
IMF
[169][175][176][177]
(billion )
World
Bank
[177]
(billion )
EIB / EBRD
(billion )
Bilateral
loans
[169]
(billion )
BoP
[177]
(billion
)
GLF
[175]
(billion )
EFSM
[169]
(billion )
EFSF
[169]
(billion )
ESM
[169]
(billion )
Bailout in
total
(billion )
Cyprus Jan.2013-Dec.2015
(negotiates)
1 - - - - - - -
(negotiates)
1
(negotiates)
1
Greece May 2010-Mar.2016 48.1 (20.1+19.8+8.2) - - - - 52.9 - 144.6 -
245.6
2
Hungary Nov.2008-Oct.2010
9.1 out of 12.5
[178][179] 1.0 - - 5.5 out of
6.5
- - - -
15.6 out of
20.0
3
Ireland Nov.2010-Dec.2013 22.5 - - 4.8 - - 22.5 17.7 -
67.5
4
Latvia Dec.2008-Dec.2011
1.1 out of 1.7
[180][181]
0.4
[180][181]
0.1
[180][181]
0.0 out of
2.2
[180][181]
2.9 out of
3.1
- - - -
4.5 out of
7.5
5
Portugal May 2011-May
2014
26 - - - - - 26 26 - 78
Romania
I
May 2009-June
2011
12.6 out of 13.6
[182][183] 1.0 1.0 - 5.0 - - - -
19.6 out of
20.6
6
Romania
II
Mar 2011-Mar 2013
0.0 out of 3.7
[184][185] - - - 0.0 out of
1.4
- - - -
0.0 out of
5.1
7
Spain I July 2012-Dec.2013 - - - - - - - -
60 out of
100
[174]
60 out of
100
8
Spain II Perhaps in 2013 (negotiates) - - - - - - - (negotiates)
(negotiates)
9
Total
payment
Nov.2008-Mar.2016 119.4 2.4 1.1 4.8 13.4 52.9 48.5 188.3 60 490.8
1
Negotiations between the Troika and Cyprus is ongoing.
[186]
PIMCO will submit the final evaluation report of Cypriot banks in January
2013.
[187]
It is currently estimated the overall bailout package will have a size of 17.5bn, comprising 10bn for bank recapitalisation and
6.0bn for refinancing maturing debt plus 1.5bn to cover budget deficits in 2013+2014+2015. If the entire bank recapitalisation is paid through
the state to the banks (as required by current rules), this entire bailout package is expected to increase the Cypriot debt-to-GDP ratio to around
140%.
[188]
16
2
Many sources list the first bailout was 110bn followed by the second on 130bn. When you deduct 2.7bn due to Ireland+Portugal+Slovakia
opting out as creditors for the first bailout, and add the extra 8.2bn IMF has promised to pay Greece for the years in 2015-16, the total amount of
bailout funds sums up to 245.6bn.
[175]
3
Hungary recovered faster than expected, and thus did not receive the remaining 4.4bn bailout support scheduled for October 2009-October
2010.
[177][189]
IMF paid in total 7.6 out of 10.5 billion SDR,
[178]
equal to 9.1bn out of 12.5bn at current exchange rates.
[179]
4
In Ireland the National Treasury Management Agency also paid 17.5bn for the program on behalf of the Irish government, increasing the
bailout total to 85bn.
[169]
5
Latvia recovered faster than expected, and thus did not receive the remaining 3.0bn bailout support originally scheduled for 2011.
[180][181]
6
Romania recovered faster than expected, and thus did not receive the remaining 1.0bn bailout support originally scheduled for 2011.
[182][183]
7
Romania had a precautionary credit line with 5.1bn available for two years (Mar 2011-Mar 2013) to draw money from if needed; but entirely
avoided to draw on it.
[177]
8
Spain's first 100bn support package has been earmarked only for recapitalisation of the financial sector.
[190]
Initially an emergency account
with 30bn was available, but nothing was drawed, and it was cancelled again in November.
[191]
The first recapitalisation tranch of 39.5bn was
approved 28 November,
[192][193]
and transferred to the bank recapitalisation fund of the Spanish government (FROB) on 12 December
2012.
[191]
Approvement of a second tranch for "category 2" banks has been scheduled for the end of December 2012, while "category 3" banks
will be subject for a possible third tranch in June 2013. All in all, it has been estimated maximum 60bn will be needed for the three
tranches.
[174]
The support package's remaining 40bn will most likely not be needed, but will stay available as precautionary reserve until 31
December 2013.
[190]
9
Spain currently negotiates and consider to accept signing a MoU to get a Precautionary Conditioned Credit Line or an Enhanced Conditioned
Credit Line. If the line is created, Spain plan not to draw any money from it, and are only interested to get it for precautionary reasons (to calm
down markets; and to enable ECB to perform a yield lowering OMT).
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
[194]
aiming at preserving financial stability in Europe by providing financial assistance to eurozone states
in difficulty. The EFSF can issue bonds or other debt instruments on the market with the support of the German Debt
Management Office to raise the funds needed to provide loans to eurozone countries in financial troubles,
recapitalize banks or buy sovereign debt.
[195]
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 (reliant on funds raised by the European Commission using
the EU budget as collateral) and up to 250 billion from the International Monetary Fund (IMF) to obtain a financial
safety net up to 750 billion.
[196]
The EFSF issued 5 billion of five-year bonds in its inaugural benchmark issue 25 January 2011, attracting an order
book of 44.5 billion. This amount is a record for any sovereign bond in Europe, and 24.5 billion more than the
European Financial Stabilisation Mechanism (EFSM), a separate European Union funding vehicle, with a 5 billion
issue in the first week of January 2011.
[197]
On 29 November 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 EFSFs firepower to intervene in primary and secondary bond markets.
[198]
Reception by financial markets
Stocks surged worldwide after the EU announced the EFSF's creation. The facility eased fears that the Greek debt
crisis would spread,
[199]
and this led to some stocks rising to the highest level in a year or more.
[200]
The euro made
its biggest gain in 18 months,
[201]
before falling to a new four-year low a week later.
[202]
Shortly after the euro rose
17
again as hedge funds and other short-term traders unwound short positions and carry trades in the currency.
[203]
Commodity prices also rose following the announcement.
[204]
The dollar Libor held at a nine-month high.
[205]
Default swaps also fell.
[206]
The VIX closed down a record almost
30%, after a record weekly rise the preceding week that prompted the bailout.
[207]
The agreement is interpreted as
allowing the ECB to start buying government debt from the secondary market which is expected to reduce bond
yields.
[208]
As a result Greek bond yields fell sharply from over 10% to just over 5%.
[209]
Asian bonds yields also
fell with the EU bailout.
[210]
)
Usage of EFSF funds
The EFSF only raises funds after an aid request is made by a country.
[211]
As of the end of July 2012, it has been
activated various times. In November 2010, it financed 17.7 billion of the total 67.5 billion rescue package for
Ireland (the rest was loaned from individual European countries, the European Commission and the IMF). In May
2011 it contributed one third of the 78 billion package for Portugal. As part of the second bailout for Greece, the
loan was shifted to the EFSF, amounting to 164 billion (130bn new package plus 34.4bn remaining from Greek
Loan Facility) throughout 2014.
[212]
On 20 July 2012, European finance ministers sanctioned the first tranche of a
partial bail-out worth up to 100 billion for Spanish banks.
[213]
This leaves the EFSF with 148 billion
[213]
or an
equivalent of 444 billion in leveraged firepower.
[214]
The EFSF is set to expire in 2013, running some months parallel to the permanent 500 billion rescue funding
program called the European Stability Mechanism (ESM), which will start operating as soon as member states
representing 90% of the capital commitments have ratified it. (see section: ESM)
On 13 January 2012, Standard & Poors downgraded France and Austria from AAA rating, lowered Spain, Italy (and
five other
[215]
) euro members further, and maintained the top credit rating for Finland, Germany, Luxembourg, and
the Netherlands; shortly after, S&P also downgraded the EFSF from AAA to AA+.
[215][216]
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.
[217]
It runs under the supervision of the
Commission
[218]
and aims at preserving financial stability in Europe by providing financial assistance to EU member
states in economic difficulty.
[219]
The Commission fund, backed by all 27 European Union members, has the
authority to raise up to 60 billion
[220]
and is rated AAA by Fitch, Moody's and Standard & Poor's.
[221][222]
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%.
[223]
Like the EFSF, the EFSM will also be replaced by the permanent rescue funding programme ESM, which is due to
be launched in July 2012.
[224]
Brussels agreement and aftermath
On 26 October 2011, leaders of the 17 eurozone countries met in Brussels and agreed on a 50% write-off of Greek
sovereign debt held by banks, a fourfold increase (to about 1 trillion) in bail-out funds held under the European
Financial Stability Facility, an increased mandatory level of 9% for bank capitalisation within the EU and a set of
commitments from Italy to take measures to reduce its national debt. Also pledged was 35 billion in "credit
enhancement" to mitigate losses likely to be suffered by European banks. Jos Manuel Barroso characterised the
package as a set of "exceptional measures for exceptional times".
[225][226]
The package's acceptance was put into doubt on 31 October when Greek Prime Minister George Papandreou
announced that a referendum would be held so that the Greek people would have the final say on the bailout,
upsetting financial markets.
[227]
On 3 November 2011 the promised Greek referendum on the bailout package was
withdrawn by Prime Minister Papandreou.
18
In late 2011, Landon Thomas in the New York Times noted that some, at least, European banks were maintaining
high dividend payout rates and none were getting capital injections from their governments even while being
required to improve capital ratios. Thomas quoted Richard Koo, an economist based in Japan, an expert on that
country's banking crisis, and specialist in balance sheet recessions, as saying:
I do not think Europeans understand the implications of a systemic banking crisis.... When all banks are
forced to raise capital at the same time, the result is going to be even weaker banks and an even longer
recession if not depression.... Government intervention should be the first resort, not the last resort.
Beyond equity issuance and debt-to-equity conversion, then, one analyst "said that as banks find it more difficult to
raise funds, they will move faster to cut down on loans and unload lagging assets" as they work to improve capital
ratios. This latter contraction of balance sheets "could lead to a depression, the analyst said.
[228]
Reduced lending
was a circumstance already at the time being seen in a "deepen[ing] crisis" in commodities trade finance in western
Europe.
[229]
Final agreement on the second bailout package
In a marathon meeting on 20/21 February 2012 the Eurogroup agreed with the IMF and the Institute of International
Finance on the final conditions of the second bailout package worth 130 billion. The lenders agreed to increase the
nominal haircut from 50% to 53.5%. EU Member States agreed to an additional retroactive lowering of the interest
rates of the Greek Loan Facility to a level of just 150 basis points above the Euribor. Furthermore, governments of
Member States where central banks currently hold Greek government bonds in their investment portfolio commit to
pass on to Greece an amount equal to any future income until 2020. Altogether this should bring down Greece's debt
to between 117%
[109]
and 120.5% of GDP by 2020.
[110]
European Central Bank
ECB Securities Markets Program (SMP) covering bond purchases
from May 2010 till October 2012.
The European Central Bank (ECB) has taken a series of
measures aimed at reducing volatility in the financial
markets and at improving liquidity.
[230]
In May 2010 it took the following actions:
It began open market operations buying government
and private debt securities,
[231]
reaching 219.5
billion in February 2012,
[232]
though it simultaneously
absorbed the same amount of liquidity to prevent a
rise in inflation.
[233]
According to Rabobank
economist Elwin de Groot, there is a natural limit of
300 billion the ECB can sterilize.
[234]
It reactivated the dollar swap lines
[235]
with Federal
Reserve support.
[236]
It changed its policy regarding the necessary credit
rating for loan deposits, accepting as collateral all
outstanding and new debt instruments issued or
guaranteed by the Greek government, regardless of the nation's credit rating.
The move took some pressure off Greek government bonds, which had just been downgraded to junk status, making
it difficult for the government to raise money on capital markets.
[237]
On 30 November 2011, the ECB, the U.S. Federal Reserve, the central banks of Canada, Japan, Britain and the
Swiss National Bank provided global financial markets with additional liquidity to ward off the debt crisis and to
support the real economy. The central banks agreed to lower the cost of dollar currency swaps by 50 basis points to
come into effect on 5 December 2011. They also agreed to provide each other with abundant liquidity to make sure
19
that commercial banks stay liquid in other currencies.
[238]
Long Term Refinancing Operation (LTRO)
Though the ECB's main refinancing operations (MRO) are from repo auctions with a (bi)weekly maturity and
monthly maturation, the ECB now conducts Long Term Refinancing Operations (LTROs), maturing after three
months, six months, 12 months and 36 months. In 2003, refinancing via LTROs amounted to 45 bln euro which is
about 20% of overall liquidity provided by the ECB.
[239]
The ECB's first supplementary longer-term refinancing operation (LTRO) with a six-month maturity was announced
March 2008.
[240]
Previously the longest tender offered was three months. It announced two 3-month and one
6-month full allotment of Long Term Refinancing Operations (LTROs). The first tender was settled 3 April, and was
more than four times oversubscribed. The 25 billion auction drew bids amounting to 103.1 billion, from 177
banks. Another six-month tender was allotted on 9 July, again to the amount of 25 billion.
[240]
The first 12 month
LTRO in June 2009 had close to 1100 bidders.
[241]
On 22 December 2011, the ECB
[242]
started the biggest infusion of credit into the European banking system in the
euro's 13 year history. Under its Long Term Refinancing Operations (LTROs) it loaned 489 billion to 523 banks
for an exceptionally long period of three years at a rate of just one percent.
[243]
Previous refinancing operations
matured after three, six and twelve months.
[241]
The by far biggest amount of 325 billion was tapped by banks in
Greece, Ireland, Italy and Spain.
[244]
This way the ECB tried 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 hoped that banks would use some of the money to buy
government bonds, effectively easing the debt crisis.
[245]
On 29 February 2012, the ECB held a second auction,
LTRO2, providing 800 Eurozone banks with further 529.5 billion in cheap loans.
[246]
Net new borrowing under the
529.5 billion February auction was around 313 billion; out of a total of 256 billion existing ECB lending (MRO
+ 3m&6m LTROs), 215 billion was rolled into LTRO2.
[247]
ECB lending has largely replaced inter-bank lending. Spain has 365 billion and Italy has 281 billion of
borrowings from the ECB (June 2012 data). Germany has 275 billion on deposit.
[248]
Resignations
In September 2011, Jrgen Stark became the second German after Axel A. Weber to resign from the ECB Governing
Council in 2011. Weber, the former Deutsche Bundesbank president, was once thought to be a likely successor to
Jean-Claude Trichet as bank president. He and Stark were both thought to have resigned due to "unhappiness with
the ECBs bond purchases, which critics say erode the banks independence". Stark was "probably the most hawkish"
member of the council when he resigned. Weber was replaced by his Bundesbank successor Jens Weidmann, while
Belgium's Peter Praet took Stark's original position, heading the ECB's economics department.
[249]
Money supply growth
In April, 2012, statistics showed a growth trend in the M1 "core" money supply. Having fallen from an over 9%
growth rate in mid-2008 to negative 1% +/- for several months in 2011, M1 core has built to a 2-3% range in early
2012. "'It is still early days but a further recovery in peripheral real M1 would suggest an end to recessions by late
2012,' said Simon Ward from Henderson Global Investors who collects the data." While attributing the money
supply growth to ECB's LTRO policies, an analysis in The Telegraph said lending "continued to fall across the
eurozone in March [and] ... [t]he jury is out on the ... three-year lending adventure (LTRO)".
[250]
Reorganization of the European banking system
On June 16, 2012 the European Central Bank together with other European leaders hammered out plans for the ECB
to become a bank regulator and to form a deposit insurance program to augment national programs. Other economic
reforms promoting European growth and employment were also proposed.
[251]
Outright Monetary Transactions (OMTs)
20
On 6 September 2012, the ECB announced to offer additional financial support in the form of some yield-lowering
bond purchases (OMT), for all eurozone countries involved in a sovereign state bailout program from EFSF/ESM (at
the point of time where the country regain/posses a complete market access).
[10]
A eurozone country can benefit
from the program if -and for as long as- it is found to suffer from stressed bond yields at excessive levels; but only at
the point of time where the country posses/regain a complete market access -and only if the country still comply with
all terms in the signed Memorandum of Understanding (MoU) agreement.
[10][167]
Countries receiving a
precautionary programme rather than a sovereign bailout, will per definition have complete market access and thus
qualify for OMT support if also suffering from stressed interest rates on its government bonds. In regards of
countries receiving a sovereign bailout (Ireland, Portugal and Greece), they will on the other hand not qualify for
OMT support before they have regained complete market access, which will normally only happen after having
received the last scheduled bailout disbursement.
[10][252]
Despite none OMT programmes were ready to start in
September/October, the financial markets straight away took notice of the additionally planned OMT packages from
ECB, and started slowly to price-in a decline of both short term and long term interest rates in all European countries
previously suffering from stressed and elevated interest levels (as OMTs were regarded as an extra potential
back-stop to counter the frozen liquidity and highly stressed rates; and just the knowledge about their potential
existence in the very near future helped to calm the markets).
If Spain signs a negotiated Memorandum of Understanding with the Troika (EC, ECB and IMF) outlining ESM shall
offer a precautionary programme with credit lines for the Spanish government to potentially draw on if needed
(beside of the bank recapitalisation package they already applied for), this would qualify Spain also to receive the
OMT support from ECB, as the sovereign state would still continue to operate with a complete market access with
the precautionary conditioned credit line. In regards of Ireland, Portugal and Greece, they on the other hand have not
yet regained complete market access, and thus do not yet qualify for OMT support.
[252]
Provided these 3 countries
continue to comply with the programme conditions outlined in their signed Memorandum of Understanding, they
will however qualify to receive OMT at the moment they regain complete market access (until the point of time
where they no longer suffer from elevated/stressed interest rates).
[10]
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
[224]
but it had to
be postponed until after the Federal Constitutional Court of Germany had confirmed the legality of the measures on
12 September 2012.
[253][254]
The permanent bailout fund is now expected to be up and running on 8 October
2012.
[255]
On 16 December 2010 the European Council agreed a two line amendment to the EU Lisbon Treaty to allow for a
permanent bail-out mechanism to be established
[256]
including stronger sanctions. In March 2011, the European
Parliament approved the treaty amendment after receiving assurances that the European Commission, rather than EU
states, would play 'a central role' in running the ESM.
[257][258]
According to this treaty, the ESM will be an
intergovernmental organisation under public international law and will be located in Luxembourg.
[259][260]
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.
21
European Fiscal Compact
Public debt to GDP ratio for selected Eurozone countries and the
UK - 2008 to 2011. Source Data: Eurostat.
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 3% deficit or
the 60% debt rules.
[261][262]
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.
[263][264]
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.
[265]
All other non-eurozone countries apart from the UK are also prepared to join in,
subject to parliamentary vote.
[]
The treaty will enter into force on 1 January 2013, if by that time 12 members of the
euro area have ratified it.
[266]
Originally EU leaders planned to change existing EU treaties but this was blocked by British prime minister David
Cameron, who demanded that the City of London be excluded from future financial regulations, including the
proposed EU financial transaction tax.
[267][268]
By the end of the day, 26 countries had agreed to the plan, leaving
the United Kingdom as the only country not willing to join.
[269]
Cameron subsequently conceded that his action had
failed to secure any safeguards for the UK.
[270]
Britain's refusal to be part of the fiscal compact to safeguard the
eurozone constituted a de facto refusal (PM David Cameron vetoed the project) to engage in any radical revision of
the Lisbon Treaty. John Rentoul of The Independent concluded that "Any Prime Minister would have done as
Cameron did".
[271]
Economic reforms and recovery proposals
Direct loans to banks and banking regulation
On June 28, 2012 Eurozone leaders agreed to permit loans by the European Stability Mechanism to be made directly
to stressed banks rather than through Eurozone states, to avoid adding to sovereign debt. The reform was linked to
plans for banking regulation by the European Central Bank. The reform was immediately reflected by a reduction in
yield of long-term bonds issued by member states such as Italy and Spain and a rise in value of the
Euro.
[272][273][274]
Less austerity, more investment
There has been substantial criticism over the austerity measures implemented by most European nations to counter
this debt crisis. US economist and Nobel laureate Paul Krugman argues that an abrupt return to "'non-Keynesian'
financial policies" is not a viable solution
[275]
Pointing at historical evidence, he predicts that deflationary policies
now being imposed on countries such as Greece and Spain will prolong and deepen their recessions.
[276]
Together
with over 9,000 signatories of "A Manifesto for Economic Sense"
[277]
Krugman also dismissed the belief of austerity
focusing policy makers such as EU economic commissioner Olli Rehn and most European finance ministers
[278]
that
"budget consolidation" revives confidence in financial markets over the longer haul.
[279][280]
In a 2003 study that
analyzed 133 IMF austerity programmes, the IMF's independent evaluation office found that policy makers
22
consistently underestimated the disastrous effects of rigid spending cuts on economic growth.
[281][282]
In early 2012
an IMF official, who negotiated Greek austerity measures, admitted that spending cuts were harming Greece.
[82][82]
In October 2012, the IMF said that its forecasts for countries which implemented austerity programs have been
consistently overoptimistic, suggesting that tax hikes and spending cuts have been doing more damage than
expected, and countries which implemented fiscal stimulus, such as Germany and Austria, did better than
expected.
[283]
Despite years of draconian austerity measures Greece has failed to
reach a balanced budget as public revenues remain low.
According to Keynesian economists "growth-friendly
austerity" relies on the false argument that public cuts
would be compensated for by more spending from
consumers and businesses, a theoretical claim that has
not materialized.
[284]
The case of Greece shows that
excessive levels of private indebtedness and a collapse of
public confidence (over 90% of Greeks fear
unemployment, poverty and the closure of
businesses)
[285]
led the private sector to decrease
spending in an attempt to save up for rainy days ahead.
This led to even lower demand for both products and
labor, which further deepened the recession and made it ever more difficult to generate tax revenues and fight public
indebtedness.
[286]
According to Financial Times chief economics commentator Martin Wolf, "structural tightening
does deliver actual tightening. But its impact is much less than one to one. A one percentage point reduction in the
structural deficit delivers a 0.67 percentage point improvement in the actual fiscal deficit." This means that Ireland
e.g. would require structural fiscal tightening of more than 12% to eliminate its 2012 actual fiscal deficit. A task that
is difficult to achieve without an exogenous eurozone-wide economic boom.
[287]
Austerity is bound to fail if it relies
largely on tax increases
[288]
instead of cuts in government expenditures coupled with encouraging "private
investment and risk-taking, labor mobility and flexibility, an end to price controls, tax rates that encouraged capital
formation ..." as Germany has done in the decade before the crisis.
[289]
Instead of public austerity, a "growth compact" centering on tax increases
[286]
and deficit spending is proposed.
Since struggling European countries lack the funds to engage in deficit spending, German economist and member of
the German Council of Economic Experts Peter Bofinger and Sony Kapoor of the global think tank Re-Define
suggest providing 40 billion in additional funds to the European Investment Bank (EIB), which could then lend ten
times that amount to the employment-intensive smaller business sector.
[286]
The EU is currently planning a possible
10 billion increase in the EIB's capital base. Furthermore the two suggest financing additional public investments
by growth-friendly taxes on "property, land, wealth, carbon emissions and the under-taxed financial sector". They
also called on EU countries to renegotiate the EU savings tax directive and to sign an agreement to help each other
crack down on tax evasion and avoidance. Currently authorities capture less than 1% in annual tax revenue on
untaxed wealth transferred between EU members.
[286]
According to the Tax Justice Network, worldwide, a global
super-rich elite had between $21 and $32 trillion (up to 26,000bn Euros) hidden in secret tax havens by the end of
2010, resulting in a tax deficit of up to $280bn.
[290][291]
Apart from arguments over whether or not austerity, rather than increased or frozen spending, is a macroeconomic
solution,
[292]
union leaders have also argued that the working population is being unjustly held responsible for the
economic mismanagement errors of economists, investors, and bankers. Over 23 million EU workers have become
unemployed as a consequence of the global economic crisis of 20072010, and this has led many to call for
additional regulation of the banking sector across not only Europe, but the entire world.
[293]
In the turmoil of the Global Financial Crisis, the focus across all EU member states has been gradually to implement
austerity measures, with the purpose of lowering the budget deficits to levels below 3% of GDP, so that the debt
level would either stay below -or start decline towards- the 60% limit defined by the Stability and Growth Pact. In
23
order to further restore the confidence in Europe, 23 out of 27 EU countries also agreed on adopting the Euro Plus
Pact, consisting of political reforms to improve fiscal strength and competitiveness; and 25 out of 27 EU countries
also decided to implement the Fiscal Compact which include the commitment of each participating country to
introduce a balanced budget amendment as part of their national law/constitution. The Fiscal Compact is a direct
successor of the previous Stability and Growth Pact, but it is more strict, not only because criteria compliance will be
secured through its integration into national law/constitution, but also because it starting from 2014 will require all
ratifying countries not involved in ongoing bailout programmes, to comply with the new strict criteria of only having
a structural deficit of either maximum 0.5% or 1% (depending on the debt level).
[263][264]
Each of the eurozone
countries being involved in a bailout program (Greece, Portugal and Ireland) was asked both to follow a program
with fiscal consolidation/austerity, and to restore competitiveness through implementation of structural reforms and
internal devaluation, i.e. lowering their relative production costs.
[294]
The measures implemented to restore
competitiveness in the weakest countries are needed, not only to build the foundation for GDP growth, but also in
order to decrease the current account imbalances among eurozone member states.
[295][296]
It has been a long known belief that austerity measures will always reduce the GDP growth in the short term. The
reason why Europe nevertheless chose the path of austerity measures, is because they on the medium and long term
have been found to benefit and prosper GDP growth, as countries with healthy debt levels in return will be rewarded
by the financial markets with higher confidence and lower interest rates. Some economists believing in Keynesian
policies, however criticized the timing and amount of austerity measures being called for in the bailout programmes,
as they argued such extensive measures should not be implemented during the crisis years with an ongoing
recession, but if possible delayed until the years after some positive real GDP growth had returned. In October 2012,
a report published by International Monetary Fund (IMF) also found, that tax hikes and spending cuts during the
most recent decade had indeed damaged the GDP growth more severely, compared to what had been expected and
forecasted in advance (based on the "GDP damage ratios" previously recorded in earlier decades and under different
economic scenarios).
[283]
Already a half year earlier, several European countries as a response to the problem with
subdued GDP growth in the eurozone, likewise had called for the implementation of a new reinforced growth
strategy based on additional public investments, to be financed by growth-friendly taxes on property, land, wealth,
and financial institutions. In June 2012, EU leaders agreed as a first step to moderately increase the funds of the
European Investment Bank, in order to kick-start infrastructure projects and increase loans to the private sector. A
few months later 11 out of 17 eurozone countries also agreed to introduce a new EU financial transaction tax to be
collected from 1 January 2014.
[297]
Progress
In April, 2012, Olli Rehn, the European commissioner for economic and monetary affairs in Brussels,
"enthusiastically announced to EU parliamentarians in mid-April that 'there was a breakthrough before Easter'. He
said the European heads of state had given the green light to pilot projects worth billions, such as building highways
in Greece." Other growth initiatives include "project bonds" wherein the EIB would "provide guarantees that
safeguard private investors. In the pilot phase until 2013, EU funds amounting to 230 million are expected to
mobilize investments of up to 4.6 billion." Der Spiegel also said: "According to sources inside the German
government, instead of funding new highways, Berlin is interested in supporting innovation and programs to
promote small and medium-sized businesses. To ensure that this is done as professionally as possible, the Germans
would like to see the southern European countries receive their own state-owned development banks, modeled after
Germany's [Marshall Plan-era-origin] Kreditanstalt fr Wiederaufbau (KfW) banking group. It's hoped that this will
get the economy moving in Greece and Portugal."
[298]
24
Increase competitiveness
Crisis countries must significantly increase their international competitiveness to generate economic growth and
improve their terms of trade. Indian-American journalist Fareed Zakaria notes in November 2011 that no debt
restructuring will work without growth, even more so as European countries "face pressures from three fronts:
demography (an aging population), technology (which has allowed companies to do much more with fewer people)
and globalization (which has allowed manufacturing and services to locate across the world)."
[299]
In case of economic shocks, policy makers typically try to improve competitiveness by depreciating the currency, as
in the case of Iceland, which suffered the largest financial crisis in 20082011 in economic history but has since
vastly improved its position. However, eurozone countries cannot devalue their currency.
Internal devaluation
Relative change in unit labour costs, 20002011
As a workaround many policy makers try to restore
competitiveness through internal devaluation, a painful
economic adjustment process, where a country aims to
reduce its unit labour costs.
[294][300]
German economist
Hans-Werner Sinn noted in 2012 that Ireland was the
only country that had implemented relative wage
moderation in the last five years, which helped decrease
its relative price/wage levels by 16%. Greece would need
to bring this figure down by 31%, effectively reaching
the level of Turkey.
[301][302]
By 2012, wages in Greece
have been cut to a level last seen in the late 1990s.
Purchasing power dropped even more to the level of
1986.
[303]
Other economists argue that no matter how much Greece
and Portugal drive down their wages, they could never
compete with low-cost developing countries such as China or India. Instead weak European countries must shift their
economies to higher quality products and services, though this is a long-term process and may not bring immediate
relief.
[304]
Fiscal devaluation
Another option would be to implement fiscal devaluation, based on an idea originally developed by John Maynard
Keynes in 1931.
[305][306]
According to this neo-Keynesian logic, policy makers can increase the competitiveness of
an economy by lowering corporate tax burden such as employer's social security contributions, while offsetting the
loss of government revenues through higher taxes on consumption (VAT) and pollution, i.e. by pursuing an
ecological tax reform.
[307][308][309]
Germany has successfully pushed its economic competitiveness by increasing the value added tax (VAT) by three
percentage points in 2007, and using part of the additional revenues to lower employer's unemployment insurance
contribution. Portugal has taken a similar stance
[309]
and also France appears to follow this suit. In November 2012
French president Franois Hollande announced plans to reduce tax burden of the corporate sector by 20 billion
within three years, while increasing the standard VAT from 19.6% to 20% and introducing additional eco-taxes in
2016. To minimize negative effects of such policies on purchasing power and economic activity the French
government will partly offset the tax hikes by decreasing employees' social security contributions by 10 billion and
by reducing the lower VAT for convenience goods (necessities) from 5.5% to 5%.
[310]
Progress
25
Eurozone economic health and adjustment progress 2011 (Source:
Euro Plus Monitor)
[311]
On 15 November 2011, the Lisbon Council published the
Euro Plus Monitor 2011. According to the report most
critical eurozone member countries are in the process of
rapid reforms. The authors note that "Many of those
countries most in need to adjust [...] are now making the
greatest progress towards restoring their fiscal balance
and external competitiveness". Greece, Ireland and Spain
are among the top five reformers and Portugal is ranked
seventh among 17 countries included in the report (see
graph).
[311]
Address current account imbalances
Current account imbalances (19972013)
Regardless of the corrective measures chosen to solve
the current predicament, as long as cross border capital
flows remain unregulated in the euro area,
[312]
current
account imbalances are likely to continue. A country that
runs a large current account or trade deficit (i.e.,
importing more than it exports) must ultimately be a net
importer of capital; this is a mathematical identity called
the balance of payments. In other words, a country that
imports more than it exports must either decrease its
savings reserves or borrow to pay for those imports.
Conversely, Germany's large trade surplus (net export
position) means that it must either increase its savings
reserves or be a net exporter of capital, lending money to
other countries to allow them to buy German goods.
[313]
The 2009 trade deficits for Italy, Spain, Greece, and
Portugal were estimated to be $42.96 billion, $75.31bn
and $35.97bn, and $25.6bn respectively, while
Germany's trade surplus was $188.6bn.
[314]
A similar
imbalance exists in the U.S., which runs a large trade
deficit (net import position) and therefore is a net
borrower of capital from abroad. Ben Bernanke warned
of the risks of such imbalances in 2005, arguing that a
"savings glut" in one country with a trade surplus can drive capital into other countries with trade deficits, artificially
lowering interest rates and creating asset bubbles.
[315][316][317]
A country with a large trade surplus would generally see the value of its currency appreciate relative to other
currencies, which would reduce the imbalance as the relative price of its exports increases. This currency
appreciation occurs as the importing country sells its currency to buy the exporting country's currency used to
purchase the goods. Alternatively, trade imbalances can be reduced if a country encouraged domestic saving by
26
restricting or penalizing the flow of capital across borders, or by raising interest rates, although this benefit is likely
offset by slowing down the economy and increasing government interest payments.
[318]
Either way, many of the countries involved in the crisis are on the euro, so devaluation, individual interest rates and
capital controls are not available. The only solution left to raise a country's level of saving is to reduce budget
deficits and to change consumption and savings habits. For example, if a country's citizens saved more instead of
consuming imports, this would reduce its trade deficit.
[318]
It has therefore been suggested that countries with large
trade deficits (e.g. Greece) consume less and improve their exporting industries. On the other hand, export driven
countries with a large trade surplus, such as Germany, Austria and the Netherlands would need to shift their
economies more towards domestic services and increase wages to support domestic consumption.
[32][319]
Progress
In its spring 2012 economic forecast, the European Commission finds "some evidence that the current-account
rebalancing is underpinned by changes in relative prices and competitiveness positions as well as gains in export
market shares and expenditure switching in deficit countries."
[320]
In May 2012 German finance minister Wolfgang
Schuble has signaled support for a significant increase in German wages to help decrease current account
imbalances within the eurozone.
[321]
Mobilization of credit
A number of proposals were made in the summer of 2012 to purchase the debt of distressed European countries such
as Spain and Italy. Markus Brunnermeier,
[322]
the economist Graham Bishop, and Daniel Gros were among those
advancing proposals. Finding a formula which was not simply backed by Germany is central in crafting an
acceptable and effective remedy.
[323]
Commentary
U.S. President Barack Obama stated in June 2012: "Right now, [Europe's] focus has to be on strengthening their
overall banking system...making a series of decisive actions that give people confidence that the banking system is
solid...In addition, theyre going to have to look at how do they achieve growth at the same time as theyre carrying
out structural reforms that may take two or three or five years to fully accomplish. So countries like Spain and Italy,
for example, have embarked on some smart structural reforms that everybody thinks are necessary -- everything
from tax collection to labor markets to a whole host of different issues. But they've got to have the time and the space
for those steps to succeed. And if they are just cutting and cutting and cutting, and their unemployment rate is going
up and up and up, and people are pulling back further from spending money because they're feeling a lot of pressure
-- ironically, that can actually make it harder for them to carry out some of these reforms over the long term...[I]n
addition to sensible ways to deal with debt and government finances, there's a parallel discussion that's taking place
among European leaders to figure out how do we also encourage growth and show some flexibility to allow some of
these reforms to really take root."
[324]
The Economist wrote in June 2012: "Outside Germany, a consensus has developed on what Mrs. Merkel must do to
preserve the single currency. It includes shifting from austerity to a far greater focus on economic growth;
complementing the single currency with a banking union (with euro-wide deposit insurance, bank oversight and joint
means for the recapitalization or resolution of failing banks); and embracing a limited form of debt mutualization to
create a joint safe asset and allow peripheral economies the room gradually to reduce their debt burdens. This is the
refrain from Washington, Beijing, London and indeed most of the capitals of the euro zone. Why hasnt the
continents canniest politician sprung into action?"
[325]
27
Proposed long-term solutions
European fiscal union
Increased European integration giving a central body increased control over the budgets of member states was
proposed on June 14, 2012 by Jens Weidmann President of the Deutsche Bundesbank,
[326]
expanding on ideas first
proposed by Jean-Claude Trichet, former president of the European Central Bank. Control, including requirements
that taxes be raised or budgets cut, would be exercised only when fiscal imbalances developed.
[327]
This proposal is
similar to contemporary calls by Angela Merkel for increased political and fiscal union which would "allow Europe
oversight possibilities."
[328]
European bank recovery and resolution authority
European banks are estimated to have incurred losses approaching 1 trillion between the outbreak of the financial
crisis in 2007 and 2010. The European Commission approved some 4.5 trillion in state aid for banks between
October 2008 and October 2011, a sum which includes the value of taxpayer-funded recapitalizations and public
guarantees on banking debts.
[329]
This has prompted some economists such as Joseph Stiglitz and Paul Krugman to
note that Europe is not suffering from a sovereign debt crisis but rather from a banking crisis.
[329]
On 6 June 2012, the European Commission adopted a legislative proposal for a harmonized bank recovery and
resolution mechanism. The proposed framework sets out the necessary steps and powers to ensure that bank failures
across the EU are managed in a way which avoids financial instability.
[330]
The new legislation would give member
states the power to impose losses, resulting from a bank failure, on the bondholders to minimize costs for taxpayers.
The proposal is part of a new scheme in which banks will be compelled to bail-in their creditors whenever they
fail, the basic aim being to prevent taxpayer-funded bailouts in the future. The public authorities would also be given
powers to replace the management teams in banks even before the lender fails. Each institution would also be
obliged to set aside at least one per cent of the deposits covered by their national guarantees for a special fund to
finance the resolution of banking crisis starting in 2018.
[329]
Eurobonds
A growing number of investors and economists say Eurobonds would be the best way of solving a debt crisis,
[331]
though their introduction matched by tight financial and budgetary coordination may well require changes in EU
treaties.
[331]
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.
[332][333]
Germany remains largely opposed at least in the short term to a collective takeover of the debt of states that have run
excessive budget deficits and borrowed excessively over the past years, saying this could substantially raise the
country's liabilities.
[334]
European Monetary Fund
On 20 October 2011, the Austrian Institute of Economic Research published an article that suggests transforming 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 all 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 lack of market pressure, the
EMF would operate according to strict rules, providing funds only to countries that meet fiscal and macroeconomic
criteria. Governments lacking sound financial policies would be forced to rely on traditional (national) governmental
28
bonds with less favorable market rates.
[335]
The econometric analysis suggests that "If the short-term and long- term interest rates in the euro area were
stabilized at 1.5% and 3%, respectively, aggregate output (GDP) in the euro area would be 5 percentage points above
baseline in 2015". At the same time sovereign debt levels would be significantly lower with, e.g., Greece's debt level
falling below 110% of GDP, more than 40 percentage points below the baseline scenario with market based interest
levels. Furthermore, banks would no longer be able to unduly benefit from intermediary profits by borrowing from
the ECB at low rates and investing in government bonds at high rates.
[335]
Drastic debt write-off financed by wealth tax
Overall debt levels in 2009 and write-offs necessary in the
Eurozone, UK and U.S. to reach sustainable grounds.
According to the Bank for International Settlements, the
combined private and public debt of 18 OECD countries
nearly quadrupled between 1980 and 2010, and will
likely continue to grow, reaching between 250% (for
Italy) and about 600% (for Japan) by 2040.
[336]
A BIS
study released in June 2012 warns that budgets of most
advanced economies, excluding interest payments,
"would need 20 consecutive years of surpluses exceeding
2 per cent of gross domestic product - starting now - just
to bring the debt-to-GDP ratio back to its pre-crisis
level".
[337]
The same authors found in a previous study
that increased financial burden imposed by aging populations and lower growth makes it unlikely that indebted
economies can grow out of their debt problem if only one of the following three conditions is met:
[338]
government debt is more than 80 to 100 percent of GDP;
non-financial corporate debt is more than 90 percent;
private household debt is more than 85 percent of GDP.
The Boston Consulting Group (BCG) adds that if the overall debt load continues to grow faster than the economy,
then large-scale debt restructuring becomes inevitable. To prevent a vicious upward debt spiral from gaining
momentum the authors urge policy makers to "act quickly and decisively" and aim for an overall debt level well
below 180 percent for the private and government sector. This number is based on the assumption that governments,
nonfinancial corporations, and private households can each sustain a debt load of 60 percent of GDP, at an interest
rate of 5 percent and a nominal economic growth rate of 3 percent per year. Lower interest rates and/or higher
growth would help reduce the debt burden further.
[339]
To reach sustainable levels the Eurozone must reduce its overall debt level by 6.1 trillion. According to BCG this
could be financed by a one-time wealth tax of between 11 and 30 percent for most countries, apart from the crisis
countries (particularly Ireland) where a write-off would have to be substantially higher. The authors admit that such
programs would be "drastic", "unpopular" and "require broad political coordination and leadership" but they
maintain that the longer politicians and central bankers wait, the more necessary such a step will be.
[339]
Instead of a one-time write-off, German economist Harald Spehl has called for a 30 year debt-reduction plan, similar
to the one Germany used after World War II to share the burden of reconstruction and development.
[340]
Similar
calls have been made by political parties in Germany including the Greens and The Left.
[341][342]
29
Controversies
The European bailouts are largely about shifting exposure from banks and others, who otherwise are lined up for
losses on the sovereign debt they have piled up, onto European taxpayers.
[113][343][344][345][346][347]
EU treaty violations
No bail-out clause
The EU's Maastricht Treaty contains juridical language which appears to rule out intra-EU bailouts. First, the no
bail-out clause (Article 125 TFEU) ensures that the responsibility for repaying public debt remains national and
prevents risk premiums caused by unsound fiscal policies from spilling over to partner countries. The clause thus
encourages prudent fiscal policies at the national level.
The European Central Bank's purchase of distressed country bonds can be viewed as violating the prohibition of
monetary financing of budget deficits (Article 123 TFEU). The creation of further leverage in EFSF with access to
ECB lending would also appear to violate the terms of this article.
Articles 125 and 123 were meant to create disincentives for EU member states to run excessive deficits and state
debt, and prevent the moral hazard of over-spending and lending in good times. They were also meant to protect the
taxpayers of the other more prudent member states. By issuing bail-out aid guaranteed by prudent eurozone
taxpayers to rule-breaking eurozone countries such as Greece, the EU and eurozone countries also encourage moral
hazard in the future.
[348]
While the no bail-out clause remains in place, the "no bail-out doctrine" seems to be a thing
of the past.
[349]
Convergence criteria
The EU treaties contain so called convergence criteria, specified in the protocols of the Treaties of the European
Union. Concerning government finance the states have agreed that the annual government budget deficit should not
exceed 3% of the gross domestic product (GDP) and that the gross government debt to GDP should not exceed 60%
of the GDP (see protocol 12 and 13). For eurozone members there is the Stability and Growth Pact which contains
the same requirements for budget deficit and debt limitation but with a much stricter regime. In the past, many
European countries including Greece and Italy have substantially exceeded these criteria over a long period of
time.
[350]
Actors fueling the crisis
Credit rating agencies
Standard & Poor's Headquarters in Lower Manhattan, New York
City
The international U.S.-based credit rating
agenciesMoody's, Standard & Poor's and
Fitchwhich have already been under fire during the
housing bubble
[351][352]
and the Icelandic
crisis
[353][354]
have also played a central and
controversial role
[355]
in the current European bond
market crisis.
[356]
On one hand, the agencies have been
accused of giving overly generous ratings due to
conflicts of interest.
[357]
On the other hand, ratings
agencies have a tendency to act conservatively, and to
take some time to adjust when a firm or country is in
trouble.
[358]
In the case of Greece, the market responded
30
to the crisis before the downgrades, with Greek bonds trading at junk levels several weeks before the ratings
agencies began to describe them as such.
[69]
According to a study by economists at St Gallen University credit rating agencies have fueled rising euro zone
indebtedness by issuing more severe downgrades since the sovereign debt crisis unfolded in 2009. The authors
concluded that rating agencies were not consistent in their judgments, on average rating Portugal, Ireland and Greece
2.3 notches lower than under pre-crisis standards, eventually forcing them to seek international aid.
[359]
European policy makers have criticized ratings agencies for acting politically, accusing the Big Three of bias
towards European assets and fueling speculation.
[360]
Particularly Moody's decision to downgrade Portugal's foreign
debt to the category Ba2 "junk" has infuriated officials from the EU and Portugal alike.
[360]
State owned utility and
infrastructure companies like ANA Aeroportos de Portugal, Energias de Portugal, Redes Energticas Nacionais,
and Brisa Auto-estradas de Portugal were also downgraded despite claims to having solid financial profiles and
significant foreign revenue.
[361][362][363][364]
France too has shown its anger at its downgrade. French central bank chief Christian Noyer criticized the decision of
Standard & Poor's to lower the rating of France but not that of the United Kingdom, which "has more deficits, as
much debt, more inflation, less growth than us". Similar comments were made by high-ranking politicians in
Germany. Michael Fuchs, deputy leader of the leading Christian Democrats, said: "Standard and Poor's must stop
playing politics. Why doesn't it act on the highly indebted United States or highly indebted Britain?", adding that the
latter's collective private and public sector debts are the largest in Europe. He further added: "If the agency
downgrades France, it should also downgrade Britain in order to be consistent."
[365]
Credit rating agencies were also accused of bullying politicians by systematically downgrading eurozone countries
just before important European Council meetings. As one EU source put it: "It is interesting to look at the
downgradings and the timings of the downgradings ... It is strange that we have so many downgrades in the weeks of
summits."
[366]
Regulatory reliance on credit ratings
Think-tanks such as the World Pensions Council (WPC) have criticized European powers such as France and
Germany for pushing for the adoption of the Basel II recommendations, adopted in 2005 and transposed in European
Union law through the Capital Requirements Directive (CRD), effective since 2008. In essence, this forced European
banks and more importantly the European Central Bank, e.g. when gauging the solvency of EU-based financial
institutions, to rely heavily on the standardized assessments of credit risk marketed by only two private US firms-
Moodys and S&P.
[367]
Counter measures
Due to the failures of the ratings agencies, European regulators obtained new powers to supervise ratings
agencies.
[355]
With the creation of the European Supervisory Authority in January 2011 the EU set up a whole range
of new financial regulatory institutions,
[368]
including the European Securities and Markets Authority (ESMA),
[369]
which became the EUs single credit-ratings firm regulator.
[370]
Credit-ratings companies have to comply with the
new standards or will be denied operation on EU territory, says ESMA Chief Steven Maijoor.
[371]
Germany's foreign minister Guido Westerwelle has called for an "independent" European ratings agency, which
could avoid the conflicts of interest that he claimed US-based agencies faced.
[372]
European leaders are reportedly
studying the possibility of setting up a European ratings agency in order that the private U.S.-based ratings agencies
have less influence on developments in European financial markets in the future.
[373][374]
According to German
consultant company Roland Berger, setting up a new ratings agency would cost 300 million. On 30 January 2012,
the company said it was already collecting funds from financial institutions and business intelligence agencies to set
up an independent non-profit ratings agency by mid 2012, which could provide its first country ratings by the end of
the year.
[375]
In April 2012, in a similar attempt, the Bertelsmann Stiftung presented a blueprint for establishing an
international non-profit credit rating agency (INCRA) for sovereign debt, structured in way that management and
31
rating decisions are independent from its financiers.
[376]
But attempts to regulate more strictly credit rating agencies in the wake of the European sovereign debt crisis have
been rather unsuccessful. World Pensions Council (WPC) financial law and regulation experts have argued that the
hastily drafted, unevenly transposed in national law, and poorly enforced EU rule on ratings agencies (Regulation
EC N 1060/2009) has had little effect on the way financial analysts and economists interpret data or on the potential
for conflicts of interests created by the complex contractual arrangements between credit rating agencies and their
clients"
[377]
Media
There has been considerable controversy about the role of the English-language press in regard to the bond market
crisis.
[378][379]
Greek Prime Minister Papandreou is quoted as saying that there was no question of Greece leaving the euro and
suggested that the crisis was politically as well as financially motivated. "This is an attack on the eurozone by certain
other interests, political or financial".
[380]
The Spanish Prime Minister Jos Luis Rodrguez Zapatero has also
suggested that the recent financial market crisis in Europe is an attempt to undermine the euro.
[381][382]
He ordered
the Centro Nacional de Inteligencia intelligence service (National Intelligence Center, CNI in Spanish) to investigate
the role of the "Anglo-Saxon media" in fomenting the crisis.
[383][384][385][386][387][388][389]
So far no results have
been reported from this investigation.
Other commentators believe that the euro is under attack so that countries, such as the U.K. and the U.S., can
continue to fund their large external deficits and government deficits,
[390]
and to avoid the collapse of the
US$.
[391][392][393]
The U.S. and U.K. do not have large domestic savings pools to draw on and therefore are
dependent on external savings e.g. from China.
[394][395]
This is not the case in the eurozone, which is
self-funding.
[396][397][398]
Speculators
Both the Spanish and Greek Prime Ministers have accused financial speculators and hedge funds of worsening the
crisis by short selling euros.
[399][400]
German chancellor Merkel has stated that "institutions bailed out with public
funds are exploiting the budget crisis in Greece and elsewhere."
[401]
The role of Goldman Sachs
[402]
in Greek bond yield increases is also under scrutiny.
[403]
It is not yet clear to what
extent this bank has been involved in the unfolding of the crisis or if they have made a profit as a result of the sell-off
on the Greek government debt market.
In response to accusations that speculators were worsening the problem, some markets banned naked short selling
for a few months.
[404]
Speculation about the breakup of the eurozone
Economists, mostly from outside Europe and associated with Modern Monetary Theory and other post-Keynesian
schools, condemned the design of the euro currency system from the beginning because it ceded national monetary
and economic sovereignty but lacked a central fiscal authority. When faced with economic problems, they
maintained, "Without such an institution, EMU would prevent effective action by individual countries and put
nothing in its place."
[405][406]
US economist Martin Feldstein went so far to call the euro "an experiment that
failed".
[407]
Some non-Keynesian economists, such as Luca A. Ricci of the IMF, contend the eurozone does not
fulfill the necessary criteria for an optimum currency area, though it is moving in that direction.
[311][408]
As the debt crisis expanded beyond Greece, these economists continued to advocate, albeit more forcefully, the
disbandment of the eurozone. If this was not immediately feasible, they recommended that Greece and the other
debtor nations unilaterally leave the eurozone, default on their debts, regain their fiscal sovereignty, and re-adopt
national currencies.
[98][409][410][411][412]
Bloomberg suggested in June 2011 that, if the Greek and Irish bailouts
32
should fail, an alternative would be for Germany to leave the eurozone in order to save the currency through
depreciation
[413]
instead of austerity. The likely substantial fall in the euro against a newly reconstituted Deutsche
Mark would give a "huge boost" to its members' competitiveness.
[414]
Iceland, not part of the EU, is regarded as one of Europe's recovery success stories. It defaulted on its debt and
drastically devalued its currency, which has effectively reduced wages by 50% making exports more
competitive.
[415]
Lee Harris argues that floating exchange rates allows wage reductions by currency devaluations, a
politically easier option than the economically equivalent but politically impossible method of lowering wages by
political enactment.
[416]
Sweden's floating rate currency gives it a short term advantage, structural reforms and
constraints account for longer-term prosperity. Labor concessions, a minimal reliance on public debt, and tax reform
helped to further a pro-growth policy.
[417]
The The Wall Street Journal conjectured as well that Germany could return to the Deutsche Mark,
[418]
or create
another currency union
[419]
with the Netherlands, Austria, Finland, Luxembourg and other European countries such
as Denmark, Norway, Sweden, Switzerland and the Baltics.
[420]
A monetary union of these countries with current
account surpluses would create the world's largest creditor bloc, bigger than China
[421]
or Japan. The Wall Street
Journal added that without the German-led bloc, a residual euro would have the flexibility to keep interest rates
low
[422]
and engage in quantitative easing or fiscal stimulus in support of a job-targeting economic policy
[423]
instead of inflation targeting in the current configuration.
Breakup vs. deeper integration
However, there is opposition in this view. The national exits are expected to be an expensive proposition. The
breakdown of the currency would lead to insolvency of several euro zone countries, a breakdown in intrazone
payments. Having instability and the public debt issue still not solved, the contagion effects and instability would
spread into the system.
[424]
Having that the exit of Greece would trigger the breakdown of the eurozone, this is not
welcomed by many politicians, economists and journalists. According to Steven Erlanger from The New York
Times, a Greek departure is likely to be seen as the beginning of the end for the whole euro zone project, a major
accomplishment, whatever its faults, in the postwar construction of a Europe whole and at peace.
[425]
Likewise, the
two big leaders of the Euro zone, German Chancellor Angela Merkel and former French President Nicolas Sarkozy
have said on numerous occasions that they would not allow the eurozone to disintegrate and have linked the survival
of the Euro with that of the entire European Union.
[426][427]
In September 2011, EU commissioner Joaqun Almunia
shared this view, saying that expelling weaker countries from the euro was not an option: "Those who think that this
hypothesis is possible just do not understand our process of integration".
[428]
The former ECB president Jean-Claude
Trichet also denounced the possibility of a return of the Deutsche Mark.
[429]
The challenges to the speculation about the breakup or salvage of the eurozone is rooted in its innate nature that the
breakup or salvage of eurozone is not only an economic decision but also a critical political decision followed by
complicated ramifications that "If Berlin pays the bills and tells the rest of Europe how to behave, it risks fostering
destructive nationalist resentment against Germany and ....it would strengthen the camp in Britain arguing for an
exita problem not just for Britons but for all economically liberal Europeans.
[430]
Solutions which involve greater
integration of European banking and fiscal management and supervision of national decisions by European umbrella
institutions can be criticized as Germanic domination of European political and economic life.
[431]
According to US
author Ross Douthat "This would effectively turn the European Union into a kind of postmodern version of the old
Austro-Hungarian Empire, with a Germanic elite presiding uneasily over a polyglot imperium and its restive local
populations".
[431]
The Economist provides a somewhat modified approach to saving the euro in that "a limited version of federalization
could be less miserable solution than break-up of the euro."
[430]
The recipe to this tricky combination of the limited
federalization, greatly lies on mutualization for limiting the fiscal integration. In order for overindebted countries to
stabilize the dwindling euro and economy, the overindebted countries require "access to money and for banks to
have a "safe" euro-wide class of assets that is not tied to the fortunes of one country" which could be obtained by
33
"narrower Eurobond that mutualises a limited amount of debt for a limited amount of time."
[430]
The proposition
made by German Council of Economic Experts provides detailed blue print to mutualize the current debts of all
euro-zone economies above 60% of their GDP. Instead of the breakup and issuing new national governments bonds
by individual euro-zone governments, "everybody, from Germany (debt: 81% of GDP) to Italy (120%) would issue
only these joint bonds until their national debts fell to the 60% threshold. The new mutualized-bond market, worth
some 2.3 trillion, would be paid off over the next 25 years. Each country would pledge a specified tax (such as a
VAT surcharge) to provide the cash." However, so far German Chancellor Angela Merkel has opposed to all forms
of mutualization.
[430]
The Hungarian-American business magnate George Soros warns in Does the Euro have a Future? that there is no
escape from the gloomy scenario of a prolonged European recession and the consequent threat to the Eurozones
political cohesion so long as the authorities persist in their current course. He argues that to save the Euro
long-term structural changes are essential in addition to the immediate steps needed to arrest the crisis. The changes
he recommends include even greater economic integration of the European Union.
[432]
Soros writes that a treaty is
needed to transform the European Financial Stability Fund into a full-fledged European Treasury. Following the
formation of the Treasury, European Council could then ask the European Commission Bank to step into the breach
and indemnify the European Commission Bank in advance against potential risks to the Treasurys solvency. Soros
acknowledges that converting the EFSF into a European Treasury will necessitate a radical change of heart. In
particular, he cautions, Germans will be wary of any such move, not least because many continue to believe that they
have a choice between saving the Euro and abandoning it. Soros writes however that a collapse of European Union
would precipitate an uncontrollable financial meltdown and thus the only way to avert another Great Depression
is the formation of a European Treasury.
[432]
The British betting company Ladbrokes stopped taking bets on Greece exiting the Eurozone in May 2012 after odds
fell to 1/3, and reported "plenty of support" for 33/1 odds for a complete disbanding of the Eurozone during
2012.
[433]
Odious debt
Some protesters, commentators such as Libration correspondent Jean Quatremer and the Lige based NGO
Committee for the Abolition of the Third World Debt (CADTM) allege that the debt should be characterized as
odious debt.
[434]
The Greek documentary Debtocracy,
[435]
and a book of the same title and content examine whether
the recent Siemens scandal and uncommercial ECB loans which were conditional on the purchase of military aircraft
and submarines are evidence that the loans amount to odious debt and that an audit would result in invalidation of a
large amount of the debt.
[436]
National statistics
In 1992, members of the European Union signed an agreement known as 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.
[23][24]
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.
[23]
Financial reforms within the U.S. since the financial crisis
have only served to reinforce special protections for derivativesincluding greater access to government
guaranteeswhile minimizing disclosure to broader financial markets.
[437]
The revision of Greeces 2009 budget deficit from a forecast of "68% of GDP" to 12.7% by the new Pasok
Government in late 2009 (a number which, after reclassification of expenses under IMF/EU supervision was further
raised to 15.4% in 2010) has been cited as one of the issues that ignited the Greek debt crisis.
34
This added a new dimension in the world financial turmoil, as the issues of "creative accounting" and manipulation
of statistics by several nations came into focus, potentially undermining investor confidence.
The focus has naturally remained on Greece due to its debt crisis. There has however been a growing number of
reports about manipulated statistics by EU and other nations aiming, as was the case for Greece, to mask the sizes of
public debts and deficits. These have included analyses of examples in several countries
[438][439][440][441]
or have
focused on Italy,
[442]
the United Kingdom,
[443][444][445][446][447][448][449][450]
Spain,
[451]
the United
States,
[452][453][454]
and even Germany.
[455][456]
Collateral for Finland
On 18 August 2011, as requested by the Finnish parliament as a condition for any further bailouts, it became
apparent that Finland would receive collateral from Greece, enabling it to participate in the potential new 109
billion support package for the Greek economy.
[457]
Austria, the Netherlands, Slovenia, and Slovakia responded with
irritation over this special guarantee for Finland and demanded equal treatment across the eurozone, or a similar deal
with Greece, so as not to increase the risk level over their participation in the bailout.
[458]
The main point of
contention was that the collateral is aimed to be a cash deposit, a collateral the Greeks can only give by recycling
part of the funds loaned by Finland for the bailout, which means Finland and the other eurozone countries guarantee
the Finnish loans in the event of a Greek default.
[459]
After extensive negotiations to implement a collateral structure open to all eurozone countries, on 4 October 2011, a
modified escrow collateral agreement was reached. The expectation is that only Finland will utilise it, due to i.a.
requirement to contribute initial capital to European Stability Mechanism in one installment instead of five
installments over time. Finland, as one of the strongest AAA countries, can raise the required capital with relative
ease.
[460]
At the beginning of October, Slovakia and Netherlands were the last countries to vote on the EFSF expansion, which
was the immediate issue behind the collateral discussion, with a mid-October vote.
[461]
On 13 October 2011
Slovakia approved euro bailout expansion, but the government has been forced to call new elections in exchange.
In February 2012, the four largest Greek banks agreed to provide the 880 million in collateral to Finland in order to
secure the second bailout program.
[462]
Finland's recommendation to the crisis countries is to issue asset-backed securities to cover the immediate need, a
tactic successfully used in Finland's early 1990s recession,
[463]
in addition to spending cuts and bad banking.
35
Political impact
Unscheduled change of governments in Euro countries (marked
red) due to crisis
Handling of the ongoing crisis has led to the premature
end of a number of European national governments and
impacted the outcome of many elections:
Republic of Ireland February 2011 After a high
deficit in the governments budget in 2010 and the
uncertainty surrounding the proposed bailout from the
International Monetary Fund, the 30th Dil
(parliament) collapsed the following year, which led
to a subsequent general election, collapse of the
preceding government parties, Fianna Fil and the
Green Party, the resignation of the Taoiseach (PM)
Brian Cowen and the rise of the Fine Gael
parliamentary party, which formed a government
alongside the Labour Party in the 31st Dil, which led
to a change of government and the appointment of
Enda Kenny as Taoiseach.
Portugal March 2011 Following the failure of
parliament to adopt the government austerity
measures, PM Jos Scrates and his government resigned, bringing about early elections in June 2011.
[464][465]
Finland April 2011 The approach to the Portuguese bailout and the EFSF dominated the April 2011 election
debate and formation of the subsequent government.
[466][467]
Spain July 2011 Following the failure of the Spanish government to handle the economic situation, PM Jos
Luis Rodrguez Zapatero announced early elections in November.
[468]
"It is convenient to hold elections this fall
so a new government can take charge of the economy in 2012, fresh from the balloting" he said.
[469]
Following
the elections, Mariano Rajoy became PM.
Slovenia September 2011 Following the failure of June referendums on measures to combat the economic
crisis and the departure of coalition partners, the Borut Pahor government lost a motion of confidence and
December 2011 early elections were set, following which Janez Jana became PM.
[470]
Slovakia October 2011 In return for the approval of the EFSF by her coalition partners, PM Iveta Radiov
had to concede early elections in March 2012, following which Robert Fico became PM.
Italy November 2011 Following market pressure on government bond prices in response to concerns about
levels of debt, the Government of Silvio Berlusconi lost its majority, resigned and was replaced by the
Government of Mario Monti.
[471]
Greece November 2011 After intense criticism from within his own party, the opposition and other EU
governments, for his proposal to hold a referendum on the austerity and bailout measures, PM George Papandreou
of the PASOK party announced his resignation in favour of a national unity government between three parties, of
which only two currently remain in the coalition.
[80]
Following the vote in the Greek parliament on the austerity
and bailout measures, which both leading parties supported but many MPs of these two parties voted against,
Papandreou and Antonis Samaras expelled a total of 44 MPs from their respective parliamentary groups, leading
to PASOK losing its parliamentary majority.
[472]
The early Greek legislative election, 2012 were the first time in
the history of the country, at which the bipartisanship (consisted of PASOK and New Democracy parties), which
ruled the country for over 40 years, collapsed in votes as a punishment for their support to the strict measures
proposed by the country's foreign lenders and the Troika (consisted of the European Commission, the IMF and the
European Central Bank). The popularity of PASOK dropped from 42.5% in 2010 to as low as 7% in some polls in
2012.
[473]
The extreme right-wing, radical left-wing, communist and populist political parties that have opposed
36
the policy of strict measures, won the majority of the votes.
Netherlands - April 2012 - After talks between the VVD, CDA and PVV over a new austerity package of about
14 billion euros failed, the Rutte cabinet collapsed. Early elections were called for 12 September 2012. To prevent
fines from the EU - a new budget was demanded by April 30 - five different parties called the kunduz coalition
forged together an emergency budget for 2013 in just two days.
[474][475]
France - May 2012 - The French presidential election, 2012 became the first time since 1981 that an incumbent
failed to gain a second term, when Nicolas Sarkozy lost to Franois Hollande.
Projections
In 2012 some hedge fund investors with reasonably good track records expect that the crisis will run its course in 3
to 5 years, saying "The perceived risk is greater than the actual risk". However, even they shy away from
investments in Greece, Italy and Spain.
[476]
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54
External links
The EU Crisis Pocket Guide (http:/ / www. tni. org/ briefing/ eu-crisis-pocket-guide) by the Transnational
Institute in English (2012) - Italian (2012) - Spanish (2011)
2011 Dahrendorf Symposium (http:/ / www. dahrendorf-symposium. eu/ ) Changing the Debate on Europe
Moving Beyond Conventional Wisdoms
2011 Dahrendorf Symposium Blog (http:/ / blog. dahrendorf-symposium. eu/ )
Eurostat Statistics Explained: Structure of government debt (http:/ / epp. eurostat. ec. europa. eu/
statistics_explained/ index. php/ Structure_of_government_debt) (October 2011 data)
Interactive Map of the Debt Crisis (http:/ / www. economist. com/ blogs/ dailychart/ 2011/ 02/
europes_economies) Economist Magazine, 9 February 2011
European Debt Crisis (http:/ / topics. nytimes. com/ top/ reference/ timestopics/ subjects/ e/
european_sovereign_debt_crisis/ index. html?ref=global) New York Times topic page updated daily.
Tracking Europe's Debt Crisis (http:/ / www. nytimes. com/ interactive/ business/ global/
european-debt-crisis-tracker. html?ref=europeansovereigndebtcrisis) New York Times topic page, with latest
headline by country (France, Germany, Greece, Italy, Portugal, Spain).
Map of European Debts (http:/ / www. nytimes. com/ interactive/ 2010/ 04/ 06/ business/ global/
european-debt-map. html) New York Times 20 December 2010
Budget deficit from 2007 to 2015 (http:/ / www. eiu. com/ eurodebt) Economist Intelligence Unit 30 March 2011
Protests in Greece in Response to Severe Austerity Measures in EU, IMF Bailout (http:/ / www. democracynow.
org/ 2010/ 5/ 4/ protests_in_greece_in_response_to) video report by Democracy Now!
Diagram of Interlocking Debt Positions of European Countries (http:/ / www. nytimes. com/ interactive/ 2010/ 05/
02/ weekinreview/ 02marsh. html) New York Times 1 May 2010
Argentina: Life After Default (http:/ / www. soundsandcolours. com/ articles/ argentina/
argentina-lessons-learnt-from-the-aftermath-of-default/ ) Sand and Colours 2 August 2010
Google public data (http:/ / www. google. com/ publicdata/ overview?ds=ds22a34krhq5p_): Government Debt
in Europe
Stefan Collignon: Democratic requirements for a European Economic Government (http:/ / library. fes. de/
pdf-files/ id/ ipa/ 07710. pdf) Friedrich-Ebert-Stiftung, December 2010 (PDF 625 KB)
Nick Malkoutzis: Greece A Year in Crisis (http:/ / library. fes. de/ pdf-files/ id/ ipa/ 08208. pdf)
Friedrich-Ebert-Stiftung, Juni 2011
SOME OF ASPECTS OF STATE NATIONAL ECONOMY EVOLUTION IN THE SYSTEM OF THE
INTERNATIONAL ECONOMIC ORDER (http:/ / simon31. narod. ru/ syndromeofsocialism. htm/ )
Rainer Lenz: Crisis in the Eurozone (http:/ / library. fes. de/ pdf-files/ id/ ipa/ 08169. pdf)
Friedrich-Ebert-Stiftung, Juni 2011
Wolf, Martin, "Creditors can huff but they need debtors" (http:/ / www. ft. com/ intl/ cms/ s/ 0/
e71ab1d6-049d-11e1-ac2a-00144feabdc0. html#axzz1cYDHnKg3), Financial Times, 1 November 2011 7:28pm.
More Pain, No Gain for Greece: Is the Euro Worth the Costs of Pro-Cyclical Fiscal Policy and Internal
Devaluation? (http:/ / www. cepr. net/ documents/ publications/ greece-2012-02. pdf) Center for Economic and
Policy Research, February 2012
"Liquidity only buys time" Where are European experts for a long-term and holistic approach? Interview with
Liu Olin: The Euro Crisis. A Chinese Economist's View. (03/2012) (http:/ / 99faces. tv/ liuolin/ ?preview=true&
preview_id=2542& preview_nonce=a5f23749b4)
Michael Lewis-How the Financial Crisis Created a New Third World-October 2011 (http:/ / www. npr. org/
templates/ transcript/ transcript. php?storyId=140948138) NPR, October 2011
This American Life - Continental Breakup (http:/ / www. thisamericanlife. org/ radio-archives/ episode/ 455/
continental-breakup) NPR, January 2012
55
Global Financial Stability Report (http:/ / www. imf. org/ external/ pubs/ ft/ gfsr/ 2012/ 01/ pdf/ text. pdf)
International Monetary Fund, April 2012
OECD Economic Outlook-May 2012 (http:/ / www. oecd. org/ document/ 18/
0,3746,en_2649_33733_20347538_1_1_1_1,00. html)
"Leaving the Euro: A Practical Guide" by Roger Bootle, winner of the 2012 Wolfson Economics Prize (http:/ /
www. policyexchange. org. uk/ images/ WolfsonPrize/ wolfson economics prize winning entry. pdf)
"Breaking the Deadlock: A Path Out of the Crisis" (http:/ / ineteconomics. org/ sites/ inet. civicactions. net/ files/
INET Council on the Euro Zone Crisis - 23-7-12. pdf)
The Eurozone Crisis - Can Austerity Foster Growth? (http:/ / www. cfo-insight. com/ uploads/ media/
Eurozone-Crisis-webinars-20120718. pdf) The World Bank's Chief Economist EMEA, Indermit Gil, about
potential ramifications, CFO Insight Magazine, July 2012
The U.S. subprime mortgage crisis was a set of events and conditions that led to the late-2000s financial crisis,
characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities
backed by said mortgages.
The percentage of new lower-quality subprime mortgages rose from the historical 8% or lower range to
approximately 20% from 2004 to 2006, with much higher ratios in some parts of the U.S.
[1][2]
A high percentage of
these subprime mortgages, over 90% in 2006 for example, were adjustable-rate mortgages.
[3]
These two changes
were part of a broader trend of lowered lending standards and higher-risk mortgage products.
[3][4]
Further, U.S.
households had become increasingly indebted, with the ratio of debt to disposable personal income rising from 77%
in 1990 to 127% at the end of 2007, much of this increase mortgage-related.
[5]
After U.S. house sales prices peaked in mid-2006 and began their steep decline forthwith, refinancing became more
difficult. As adjustable-rate mortgages began to reset at higher interest rates (causing higher monthly payments),
mortgage delinquencies soared. Securities backed with mortgages, including subprime mortgages, widely held by
financial firms, lost most of their value. Global investors also drastically reduced purchases of mortgage-backed debt
and other securities as part of a decline in the capacity and willingness of the private financial system to support
lending.
[1]
Concerns about the soundness of U.S. credit and financial markets led to tightening credit around the
world and slowing economic growth in the U.S. and Europe.
56
Background and timeline of events
Factors contributing to housing bubble.
Domino effect as housing prices declined.
The immediate cause or trigger of the
crisis was the bursting of the United
States housing bubble which peaked in
approximately 20052006.
[6][7]
An
increase in loan incentives such as easy
initial terms and a long-term trend of
rising housing prices had encouraged
borrowers to assume difficult
mortgages in the belief they would be
able to quickly refinance at more
favorable terms. Once interest rates
began to rise and housing prices started
to drop moderately in 20062007 in
many parts of the U.S., refinancing
became more difficult. Defaults and
foreclosure activity increased
dramatically as easy initial terms
expired, home prices failed to go up as
anticipated, and ARM interest rates
reset higher. Falling prices also
resulted in 23% of U.S. homes worth
less than the mortgage loan by
September 2010, providing a financial
incentive for borrowers to enter
foreclosure.
[8]
The ongoing foreclosure
epidemic, of which subprime loans are
one part, that began in late 2006 in the
U.S. continues to be a key factor in the
global economic crisis, because it
drains wealth from consumers and
erodes the financial strength of
banking institutions.
In the years leading up to the crisis,
significant amounts of foreign money
flowed into the U.S. from fast-growing economies in Asia and oil-producing countries. This inflow of funds
combined with low U.S. interest rates from 20022004 contributed to easy credit conditions, which fueled both
housing and credit bubbles. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and
57
U.S. Median Price of Homes Sold
consumers assumed an unprecedented
debt load.
[9][10]
As part of the housing and credit
booms, the amount of financial
agreements called mortgage-backed
securities (MBS), which derive their
value from mortgage payments and
housing prices, greatly increased. Such
financial innovation enabled
institutions and investors around the
world to invest in the U.S. housing
market. As housing prices declined,
major global financial institutions that
had borrowed and invested heavily in
MBS reported significant losses.
Defaults and losses on other loan types
also increased significantly as the crisis
expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S.
dollars globally.
[11]
While the housing and credit bubbles were growing, a series of factors caused the financial system to become
increasingly fragile. Policymakers did not recognize the increasingly important role played by financial institutions
such as investment banks and hedge funds, also known as the shadow banking system. Shadow banks were able to
mask their leverage levels from investors and regulators through the use of complex, off-balance sheet derivatives
and securitizations.
[12]
These instruments also made it virtually impossible to reorganize financial institutions in bankruptcy, and
contributed to the need for government bailouts.
[12]
Some experts believe these institutions had become as important
as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same
regulations.
[13]
These institutions as well as certain regulated banks had also assumed significant debt burdens while
providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or
MBS losses.
[14]
These losses impacted the ability of financial institutions to lend, slowing economic activity. Concerns regarding the
stability of key financial institutions drove central banks to take action to provide funds to encourage lending and to
restore faith in the commercial paper markets, which are integral to funding business operations. Governments also
bailed out key financial institutions, assuming significant additional financial commitments.
The risks to the broader economy created by the housing market downturn and subsequent financial market crisis
were primary factors in several decisions by central banks around the world to cut interest rates and governments to
implement economic stimulus packages. Effects on global stock markets due to the crisis have been dramatic.
Between 1 January and 11 October 2008, owners of stocks in U.S. corporations had suffered about $8 trillion in
losses, as their holdings declined in value from $20 trillion to $12 trillion. Losses in other countries have averaged
about 40%.
[15]
Losses in the stock markets and housing value declines place further downward pressure on consumer spending, a
key economic engine.
[16]
Leaders of the larger developed and emerging nations met in November 2008 and March
2009 to formulate strategies for addressing the crisis.
[17]
A variety of solutions have been proposed by government
officials, central bankers, economists, and business executives.
[18][19][20]
In the U.S., the DoddFrank Wall Street
Reform and Consumer Protection Act was signed into law in July 2010 to address some of the causes of the crisis.
58
Mortgage market
Number of U.S. residential properties subject to foreclosure actions by quarter
(20072012).
Subprime borrowers typically have
weakened credit histories and reduced
repayment capacity. Subprime loans
have a higher risk of default than loans
to prime borrowers.
[21]
If a borrower is
delinquent in making timely mortgage
payments to the loan servicer (a bank
or other financial firm), the lender may
take possession of the property, in a
process called foreclosure.
The value of American subprime
mortgages was estimated at $1.3
trillion as of March 2007,
[22]
with
over 7.5 million first-lien subprime
mortgages outstanding.
[23]
Between
20042006 the share of subprime
mortgages relative to total originations
ranged from 18%21%, versus less
than 10% in 20012003 and during 2007.
[24][25]
The boom in mortgage lending, including subprime lending, was
also driven by a fast expansion of non-bank independent mortgage originators which despite their smaller share
(around 25 percent in 2002) in the market have contributed to around 50 percent of the increase in mortgage credit
between 2003 and 2005.
[26]
In the third quarter of 2007, subprime ARMs making up only 6.8% of USA mortgages
outstanding also accounted for 43% of the foreclosures which began during that quarter.
[27]
By October 2007, approximately 16% of subprime adjustable rate mortgages (ARM) were either 90-days delinquent
or the lender had begun foreclosure proceedings, roughly triple the rate of 2005.
[28]
By January 2008, the
delinquency rate had risen to 21%
[29]
and by May 2008 it was 25%.
[30]
According to RealtyTrac, the value of all outstanding residential mortgages, owed by U.S. households to purchase
residences housing at most four families, was US$9.9 trillion as of year-end 2006, and US$10.6 trillion as of
midyear 2008.
[31]
During 2007, lenders had begun foreclosure proceedings on nearly 1.3 million properties, a 79%
increase over 2006.
[32]
This increased to 2.3 million in 2008, an 81% increase vs. 2007,
[33]
and again to 2.8 million
in 2009, a 21% increase vs. 2008.
[34]
By August 2008, 9.2% of all U.S. mortgages outstanding were either delinquent or in foreclosure.
[35]
By September
2009, this had risen to 14.4%.
[36]
Between August 2007 and October 2008, 936,439 USA residences completed
foreclosure.
[37]
Foreclosures are concentrated in particular states both in terms of the number and rate of foreclosure
filings.
[38]
Ten states accounted for 74% of the foreclosure filings during 2008; the top two (California and Florida)
represented 41%. Nine states were above the national foreclosure rate average of 1.84% of households.
[39]
From September 2008 to September 2012, there were approximately 3.9 million completed foreclosures in the U.S.
As of September 2012, approximately 1.4 million homes, or 3.3% of all homes with a mortgage, were in some stage
of foreclosure compared to 1.5 million, or 3.5%, in September 2011. During September 2012, 57,000 homes
completed foreclosure; this is down from 83,000 the prior September but well above the 2000-2006 average of
21,000 completed foreclosures per month.
[40]
59
Causes
The crisis can be attributed to a number of factors pervasive in both housing and credit markets, factors which
emerged over a number of years. Causes proposed include the inability of homeowners to make their mortgage
payments (due primarily to adjustable-rate mortgages resetting, borrowers overextending, predatory lending, and
speculation), overbuilding during the boom period, risky mortgage products, increased power of mortgage
originators, high personal and corporate debt levels, financial products that distributed and perhaps concealed the
risk of mortgage default, bad monetary and housing policies, international trade imbalances, and inappropriate
government regulation.
[1][41][42][43][44]
Three important catalysts of the subprime crisis were the influx of money from the private sector, the banks entering
into the mortgage bond market and the predatory lending practices of the mortgage lenders, specifically the
adjustable-rate mortgage, 228 loan, that mortgage lenders sold directly or indirectly via mortgage brokers.
[45]
On
Wall Street and in the financial industry, moral hazard lay at the core of many of the causes.
[46]
In its "Declaration of the Summit on Financial Markets and the World Economy," dated 15 November 2008, leaders
of the Group of 20 cited the following causes:
During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade,
market participants sought higher yields without an adequate appreciation of the risks and failed to exercise
proper due diligence. At the same time, weak underwriting standards, unsound risk management practices,
increasingly complex and opaque financial products, and consequent excessive leverage combined to create
vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not
adequately appreciate and address the risks building up in financial markets, keep pace with financial
innovation, or take into account the systemic ramifications of domestic regulatory actions.
[47]
During May 2010, Warren Buffett and Paul Volcker separately described questionable assumptions or judgments
underlying the U.S. financial and economic system that contributed to the crisis. These assumptions included: 1)
Housing prices would not fall dramatically;
[48]
2) Free and open financial markets supported by sophisticated
financial engineering would most effectively support market efficiency and stability, directing funds to the most
profitable and productive uses; 3) Concepts embedded in mathematics and physics could be directly adapted to
markets, in the form of various financial models used to evaluate credit risk; 4) Economic imbalances, such as large
trade deficits and low savings rates indicative of over-consumption, were sustainable; and 5) Stronger regulation of
the shadow banking system and derivatives markets was not needed.
[49]
The U.S. Financial Crisis Inquiry Commission reported its findings in January 2011. It concluded that "the crisis was
avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserves failure to
stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms
acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and
Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the
crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and
ethics at all levels.
[50]
60
Boom and bust in the housing market
Household debt relative to disposable income and GDP.
Existing homes sales, inventory, and months supply, by quarter.
Low interest rates and large inflows of
foreign funds created easy credit
conditions for a number of years prior
to the crisis, fueling a housing market
boom and encouraging debt-financed
consumption.
[51]
The USA home
ownership rate increased from 64% in
1994 (about where it had been since
1980) to an all-time high of 69.2% in
2004.
[52]
Subprime lending was a
major contributor to this increase in
home ownership rates and in the
overall demand for housing, which
drove prices higher.
Between 1997 and 2006, the price of
the typical American house increased
by 124%.
[53]
During the two decades
ending in 2001, the national median
home price ranged from 2.9 to 3.1
times median household income. This
ratio rose to 4.0 in 2004, and 4.6 in
2006.
[54]
This housing bubble resulted
in quite a few homeowners refinancing
their homes at lower interest rates, or
financing consumer spending by taking
out second mortgages secured by the
price appreciation. USA household
debt as a percentage of annual
disposable personal income was 127%
at the end of 2007, versus 77% in
1990.
[5][55]
While housing prices were increasing,
consumers were saving less
[56]
and
both borrowing and spending more.
Household debt grew from $705 billion at yearend 1974, 60% of disposable personal income, to $7.4 trillion at
yearend 2000, and finally to $14.5 trillion in midyear 2008, 134% of disposable personal income.
[57]
During 2008,
the typical USA household owned 13 credit cards, with 40% of households carrying a balance, up from 6% in
1970.
[58]
61
Vicious Cycles in the Housing & Financial Markets.
Free cash used by consumers from
home equity extraction doubled from
$627 billion in 2001 to $1,428 billion
in 2005 as the housing bubble built, a
total of nearly $5 trillion dollars over
the period.
[59][60][61]
U.S. home
mortgage debt relative to GDP
increased from an average of 46%
during the 1990s to 73% during 2008,
reaching $10.5 trillion.
[62]
From 2001
to 2007, U.S. mortgage debt almost
doubled, and the amount of mortgage
debt per household rose more than
63%, from $91,500 to $149,500, with
essentially stagnant wages.
[63]
This credit and house price explosion
led to a building boom and eventually
to a surplus of unsold homes, which caused U.S. housing prices to peak and begin declining in mid-2006.
[64]
Easy
credit, and a belief that house prices would continue to appreciate, had encouraged many subprime borrowers to
obtain adjustable-rate mortgages. These mortgages enticed borrowers with a below market interest rate for some
predetermined period, followed by market interest rates for the remainder of the mortgage's term.
Borrowers who would not be able to make the higher payments once the initial grace period ended, were planning to
refinance their mortgages after a year or two of appreciation. But refinancing became more difficult, once house
prices began to decline in many parts of the USA. Borrowers who found themselves unable to escape higher monthly
payments by refinancing began to default.
As more borrowers stop paying their mortgage payments (this is an on-going crisis), foreclosures and the supply of
homes for sale increases. This places downward pressure on housing prices, which further lowers homeowners'
equity. The decline in mortgage payments also reduces the value of mortgage-backed securities, which erodes the net
worth and financial health of banks. This vicious cycle is at the heart of the crisis.
[65]
By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak.
[66][67]
This
major and unexpected decline in house prices means that many borrowers have zero or negative equity in their
homes, meaning their homes were worth less than their mortgages. As of March 2008, an estimated 8.8 million
borrowers 10.8% of all homeowners had negative equity in their homes, a number that is believed to have risen
to 12 million by November 2008. By September 2010, 23% of all U.S. homes were worth less than the mortgage
loan.
[8]
Borrowers in this situation have an incentive to default on their mortgages as a mortgage is typically nonrecourse
debt secured against the property.
[68]
Economist Stan Leibowitz argued in the Wall Street Journal that although only
12% of homes had negative equity, they comprised 47% of foreclosures during the second half of 2008. He
concluded that the extent of equity in the home was the key factor in foreclosure, rather than the type of loan, credit
worthiness of the borrower, or ability to pay.
[69]
Increasing foreclosure rates increases the inventory of houses offered for sale. The number of new homes sold in
2007 was 26.4% less than in the preceding year. By January 2008, the inventory of unsold new homes was 9.8 times
the December 2007 sales volume, the highest value of this ratio since 1981.
[70]
Furthermore, nearly four million
existing homes were for sale,
[71]
of which almost 2.9 million were vacant.
[72]
62
This overhang of unsold homes lowered house prices. As prices declined, more homeowners were at risk of default
or foreclosure. House prices are expected to continue declining until this inventory of unsold homes (an instance of
excess supply) declines to normal levels.
[73]
A report in January 2011 stated that U.S. home values dropped by 26
percent from their peak in June 2006 to November 2010, more than the 25.9 percent drop between 1928 to 1933
when the Great Depression occurred.
[74]
Homeowner speculation
Speculative borrowing in residential real estate has been cited as a contributing factor to the subprime mortgage
crisis.
[75]
During 2006, 22% of homes purchased (1.65 million units) were for investment purposes, with an
additional 14% (1.07 million units) purchased as vacation homes. During 2005, these figures were 28% and 12%,
respectively. In other words, a record level of nearly 40% of homes purchased were not intended as primary
residences. David Lereah, NAR's chief economist at the time, stated that the 2006 decline in investment buying was
expected: "Speculators left the market in 2006, which caused investment sales to fall much faster than the primary
market."
[76]
Housing prices nearly doubled between 2000 and 2006, a vastly different trend from the historical appreciation at
roughly the rate of inflation. While homes had not traditionally been treated as investments subject to speculation,
this behavior changed during the housing boom. Media widely reported condominiums being purchased while under
construction, then being "flipped" (sold) for a profit without the seller ever having lived in them.
[77]
Some mortgage
companies identified risks inherent in this activity as early as 2005, after identifying investors assuming highly
leveraged positions in multiple properties.
[78]
Nicole Gelinas of the Manhattan Institute described the negative consequences of not adjusting tax and mortgage
policies to the shifting treatment of a home from conservative inflation hedge to speculative investment.
[79]
Economist Robert Shiller argued that speculative bubbles are fueled by "contagious optimism, seemingly impervious
to facts, that often takes hold when prices are rising. Bubbles are primarily social phenomena; until we understand
and address the psychology that fuels them, they're going to keep forming."
[80]
Keynesian economist Hyman Minsky
described how speculative borrowing contributed to rising debt and an eventual collapse of asset values.
[81][82]
Warren Buffett testified to the Financial Crisis Inquiry Commission: "There was the greatest bubble I've ever seen in
my life...The entire American public eventually was caught up in a belief that housing prices could not fall
dramatically."
[48]
63
High-risk mortgage loans and lending/borrowing practices
A mortgage brokerage in the US advertising subprime mortgages in July 2008.
In the years before the crisis, the behavior of
lenders changed dramatically. Lenders
offered more and more loans to higher-risk
borrowers,
[1][83]
including undocumented
immigrants.
[84]
Lending standards
particularly deteriorated in 2004 to 2007, as
the GSEs market share declined and private
securitizers accounted for more than half of
mortgage securitizations.
[1]
Subprime mortgages amounted to $35
billion (5% of total originations) in 1994,
[85]
9% in 1996,
[86]
$160 billion (13%) in
1999,
[85]
and $600 billion (20%) in
2006.
[86][87][88]
A study by the Federal
Reserve found that the average difference
between subprime and prime mortgage
interest rates (the "subprime markup") declined significantly between 2001 and 2007. The combination of declining
risk premiums and credit standards is common to boom and bust credit cycles.
[89]
In addition to considering higher-risk borrowers, lenders had offered increasingly risky loan options and borrowing
incentives. In 2005, the median down payment for first-time home buyers was 2%, with 43% of those buyers making
no down payment whatsoever.
[90]
By comparison, China has down payment requirements that exceed 20%, with
higher amounts for non-primary residences.
[91]
Growth in mortgage loan fraud based upon US Department of the Treasury Suspicious
Activity Report Analysis.
The mortgage qualification guidelines
began to change. At first, the stated
income, verified assets (SIVA) loans
came out. Proof of income was no
longer needed. Borrowers just needed
to "state" it and show that they had
money in the bank. Then, the no
income, verified assets (NIVA) loans
came out. The lender no longer
required proof of employment.
Borrowers just needed to show proof
of money in their bank accounts. The
qualification guidelines kept getting
looser in order to produce more
mortgages and more securities. This led to the creation of NINA. NINA is an abbreviation of No Income No Assets
(sometimes referred to as Ninja loans). Basically, NINA loans are official loan products and let you borrow money
without having to prove or even state any owned assets. All that was required for a mortgage was a credit score.
[92]
Another example is the interest-only adjustable-rate mortgage (ARM), which allows the homeowner to pay just the
interest (not principal) during an initial period. Still another is a "payment option" loan, in which the homeowner can
pay a variable amount, but any interest not paid is added to the principal. Nearly one in 10 mortgage borrowers in
2005 and 2006 took out these option ARM loans, which meant they could choose to make payments so low that
their mortgage balances rose every month.
[63]
An estimated one-third of ARMs originated between 2004 and 2006
64
had "teaser" rates below 4%, which then increased significantly after some initial period, as much as doubling the
monthly payment.
[86]
The proportion of subprime ARM loans made to people with credit scores high enough to qualify for conventional
mortgages with better terms increased from 41% in 2000 to 61% by 2006. However, there are many factors other
than credit score that affect lending. In addition, mortgage brokers in some cases received incentives from lenders to
offer subprime ARM's even to those with credit ratings that merited a conforming (i.e., non-subprime) loan.
[93]
Mortgage underwriting standards declined precipitously during the boom period. The use of automated loan
approvals allowed loans to be made without appropriate review and documentation.
[94]
In 2007, 40% of all subprime
loans resulted from automated underwriting.
[95][96]
The chairman of the Mortgage Bankers Association claimed that
mortgage brokers, while profiting from the home loan boom, did not do enough to examine whether borrowers could
repay.
[97]
Mortgage fraud by lenders and borrowers increased enormously.
[98]
The Financial Crisis Inquiry Commission reported in January 2011 that many mortgage lenders took eager
borrowers qualifications on faith, often with a "willful disregard" for a borrowers ability to pay. Nearly 25% of all
mortgages made in the first half of 2005 were "interest-only" loans. During the same year, 68% of option ARM
loans originated by Countrywide Financial and Washington Mutual had low- or no-documentation requirements.
[63]
So why did lending standards decline? At least one study has suggested that the decline in standards was driven by a
shift of mortgage securitization from a tightly controlled duopoly to a competitive market in which mortgage
originators held the most sway.
[1]
The worst mortgage vintage years coincided with the periods during which
Government Sponsored Enterprises were at their weakest, and mortgage originators and private label securitizers
were at their strongest.
[1]
Why was there a market for these low quality private label securitizations? In a Peabody Award winning program,
NPR correspondents argued that a "Giant Pool of Money" (represented by $70 trillion in worldwide fixed income
investments) sought higher yields than those offered by U.S. Treasury bonds early in the decade. Further, this pool of
money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income generating
investments had not grown as fast. Investment banks on Wall Street answered this demand with financial innovation
such as the mortgage-backed security (MBS) and collateralized debt obligation (CDO), which were assigned safe
ratings by the credit rating agencies.
In effect, Wall Street connected this pool of money to the mortgage market in the U.S., with enormous fees accruing
to those throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks that
funded the brokers, to the giant investment banks behind them. By approximately 2003, the supply of mortgages
originated at traditional lending standards had been exhausted. However, continued strong demand for MBS and
CDO began to drive down lending standards, as long as mortgages could still be sold along the supply chain.
Eventually, this speculative bubble proved unsustainable. NPR described it this way:
[99]
The problem was that even though housing prices were going through the roof, people weren't making any
more money. From 2000 to 2007, the median household income stayed flat. And so the more prices rose, the
more tenuous the whole thing became. No matter how lax lending standards got, no matter how many exotic
mortgage products were created to shoehorn people into homes they couldn't possibly afford, no matter what
the mortgage machine tried, the people just couldn't swing it. By late 2006, the average home cost nearly four
times what the average family made. Historically it was between two and three times. And mortgage lenders
noticed something that they'd almost never seen before. People would close on a house, sign all the mortgage
papers, and then default on their very first payment. No loss of a job, no medical emergency, they were
underwater before they even started. And although no one could really hear it, that was probably the moment
when one of the biggest speculative bubbles in American history popped.
65
Mortgage fraud
In 2004, the Federal Bureau of Investigation warned of an "epidemic" in mortgage fraud, an important credit risk of
nonprime mortgage lending, which, they said, could lead to "a problem that could have as much impact as the S&L
crisis".
[100][101][102][103]
The Financial Crisis Inquiry Commission reported in January 2011 that: "...mortgage fraud...flourished in an
environment of collapsing lending standards and lax regulation. The number of suspicious activity reports reports
of possible financial crimes filed by depository banks and their affiliates related to mortgage fraud grew 20-fold
between 1996 and 2005 and then more than doubled again between 2005 and 2009. One study places the losses
resulting from fraud on mortgage loans made between 2005 and 2007 at $112 billion. Lenders made loans that they
knew borrowers could not afford and that could cause massive losses to investors in mortgage securities."
[63]
New York State prosecutors are examining whether eight banks hoodwinked credit ratings agencies, to inflate the
grades of subprime-linked investments. The Securities and Exchange Commission, the Justice Department, the
United States attorneys office and more are examining how banks created, rated, sold and traded mortgage securities
that turned out to be some of the worst investments ever devised. As of 2010, virtually all of the investigations,
criminal as well as civil, are in their early stages.
[104]
Securitization practices
Borrowing under a securitization structure.
The traditional mortgage model
involved a bank originating a loan to
the borrower/homeowner and retaining
the credit (default) risk. Securitization
is a process whereby loans or other
income generating assets are bundled
to create bonds which can be sold to
investors. The modern version of U.S.
mortgage securitization started in the
1980s, as Government Sponsored
Enterprises (GSEs) began to pool
relatively safe conventional
conforming mortgages, sell bonds to
investors, and guarantee those bonds
against default on the underlying
mortgages.
[1]
A riskier version of securitization also
developed in which private banks
pooled non-conforming mortgages and
generally did not guarantee the bonds against default of the underlying mortgages.
[1]
In other words, GSE
securitization transferred only interest rate risk to investors, whereas private label (investment bank or commercial
bank) securitization transferred both interest rate risk and default risk.
[1]
66
IMF Diagram of CDO and RMBS.
With the advent of securitization, the
traditional model has given way to the
"originate to distribute" model, in
which banks essentially sell the
mortgages and distribute credit risk to
investors through mortgage-backed
securities and collateralized debt
obligations (CDO). The sale of default
risk to investors created a moral hazard
in which an increased focus on
processing mortgage transactions was
incentivized but ensuring their credit
quality was not.
[105][106]
In the mid-2000s, GSE securitization
declined dramatically as a share of
overall securitization, while private
label securitization dramatically
increased.
[1]
Most of the growth in private label securitization was through high-risk subprime and Alt-A
mortgages.
[1]
As private securitization gained market share and the GSEs retreated, mortgage quality declined
dramatically.
[1]
The worst performing mortgages were securitized by the private banks, whereas GSE mortgages
continued to perform better than the rest of the market, including mortgages that were not securitized and were
instead held in portfolio.
[1]
Securitization accelerated in the mid-1990s. The total amount of mortgage-backed securities issued almost tripled
between 1996 and 2007, to $7.3 trillion. The securitized share of subprime mortgages (i.e., those passed to
third-party investors via MBS) increased from 54% in 2001, to 75% in 2006.
[89]
A sample of 735 CDO deals
originated between 1999 and 2007 showed that subprime and other less-than-prime mortgages represented an
increasing percentage of CDO assets, rising from 5% in 2000 to 36% in 2007.
[107]
American homeowners, consumers, and corporations owed roughly $25 trillion during 2008. American banks
retained about $8 trillion of that total directly as traditional mortgage loans. Bondholders and other traditional
lenders provided another $7 trillion. The remaining $10 trillion came from the securitization markets. The
securitization markets started to close down in the spring of 2007 and nearly shut-down in the fall of 2008. More
than a third of the private credit markets thus became unavailable as a source of funds.
[108][109]
In February 2009,
Ben Bernanke stated that securitization markets remained effectively shut, with the exception of conforming
mortgages, which could be sold to Fannie Mae and Freddie Mac.
[110]
A more direct connection between securitization and the subprime crisis relates to a fundamental fault in the way
that underwriters, rating agencies and investors modeled the correlation of risks among loans in securitization pools.
Correlation modeling determining how the default risk of one loan in a pool is statistically related to the default
risk for other loans was based on a "Gaussian copula" technique developed by statistician David X. Li. This
technique, widely adopted as a means of evaluating the risk associated with securitization transactions, used what
turned out to be an overly simplistic approach to correlation. Unfortunately, the flaws in this technique did not
become apparent to market participants until after many hundreds of billions of dollars of ABSs and CDOs backed
by subprime loans had been rated and sold. By the time investors stopped buying subprime-backed securities
which halted the ability of mortgage originators to extend subprime loans the effects of the crisis were already
beginning to emerge.
[111]
Nobel laureate Dr. A. Michael Spence wrote: "Financial innovation, intended to redistribute and reduce risk, appears
mainly to have hidden it from view. An important challenge going forward is to better understand these dynamics as
67
the analytical underpinning of an early warning system with respect to financial instability."
[112]
Others argue that the instruments were understood but risk scenarios weren't properly weighted. Mortgage risks were
underestimated by every institution by failing to give considerable weight to the possibility of falling housing prices.
Probability distributions were based on past history, often using national averages.
[113][114]
Misplaced confidence in
innovation and excessive optimism led to miscalculations by originators, banks, GSEs, rating agencies, regulators,
and academics.
Inaccurate credit ratings
MBS credit rating downgrades, by quarter.
Credit rating agencies are now under
scrutiny for having given
investment-grade ratings to MBSs
based on risky subprime mortgage
loans. These high ratings enabled these
MBSs to be sold to investors, thereby
financing the housing boom. These
ratings were believed justified because
of risk reducing practices, such as
credit default insurance and equity
investors willing to bear the first
losses. However, there are also
indications that some involved in
rating subprime-related securities knew
at the time that the rating process was
faulty.
[115]
Critics allege that the rating agencies
suffered from conflicts of interest, as they were paid by investment banks and other firms that organize and sell
structured securities to investors.
[116]
On 11 June 2008, the SEC proposed rules designed to mitigate perceived
conflicts of interest between rating agencies and issuers of structured securities.
[117]
On 3 December 2008, the SEC
approved measures to strengthen oversight of credit rating agencies, following a ten-month investigation that found
"significant weaknesses in ratings practices," including conflicts of interest.
[118]
Between Q3 2007 and Q2 2008, rating agencies lowered the credit ratings on $1.9 trillion in mortgage-backed
securities. Financial institutions felt they had to lower the value of their MBS and acquire additional capital so as to
maintain capital ratios. If this involved the sale of new shares of stock, the value of the existing shares was reduced.
Thus ratings downgrades lowered the stock prices of many financial firms.
[119]
The Financial Crisis Inquiry Commission reported in January 2011 that: "The three credit rating agencies were key
enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been
marketed and sold without their seal of approval. Investors relied on them, often blindly. In some cases, they were
obligated to use them, or regulatory capital standards were hinged on them. This crisis could not have happened
without the rating agencies. Their ratings helped the market soar and their downgrades through 2007 and 2008
wreaked havoc across markets and firms." The Report further stated that ratings were incorrect because of "flawed
computer models, the pressure from financial firms that paid for the ratings, the relentless drive for market share, the
lack of resources to do the job despite record profits, and the absence of meaningful public oversight."
[63]
68
Governmental policies
U.S. Subprime lending expanded dramatically 20042006.
Government over-regulation, failed
regulation and deregulation have all
been claimed as causes of the crisis.
Increasing home ownership has been
the goal of several presidents including
Roosevelt, Reagan, Clinton and
George W. Bush.
[120]
Decreased regulation of financial
institutions
Several steps were taken to reduce the
regulation applied to banking
institutions in the years leading up to
the crisis. Further, major investment
banks which collapsed during the crisis
were not subject to the regulations
applied to depository banks. In
testimony before Congress both the Securities and Exchange Commission (SEC) and Alan Greenspan claimed
failure in allowing the self-regulation of investment banks.
[121][122]
In 1982, Congress passed the Alternative Mortgage Transactions Parity Act (AMTPA), which allowed non-federally
chartered housing creditors to write adjustable-rate mortgages. This bi-partisan legislation was, according to the
Urban Institute, intended to "increase the volume of loan products that reduced the up-front costs to borrowers in
order to make homeownership more affordable."
[123]
Among the new mortgage loan types created and gaining in
popularity in the early 1980s were adjustable-rate, option adjustable-rate, balloon-payment and interest-only
mortgages. Subsequent widespread abuses of predatory lending occurred with the use of adjustable-rate
mortgages.
[45][124]
Approximately 90% of subprime mortgages issued in 2006 were adjustable-rate mortgages.
[3]
The Glass-Steagall Act was enacted after the Great Depression. It separated commercial banks and investment
banks, in part to avoid potential conflicts of interest between the lending activities of the former and rating activities
of the latter. In 1999 Glass-Steagall was repealed by the Gramm-Leach-Bliley Act. Economist Joseph Stiglitz
criticized the repeal of Glass Steagall because, in his opinion, it created a risk-taking culture of investment banking
dominated the more conservative commercial banking culture, leading to increased levels of risk-taking and leverage
during the boom period.
[125]
President Bill Clinton, who signed the legislation, dismissed its connection to the
subprime mortgage crisis, stating (in 2008): "I don't see that signing that bill had anything to do with the current
crisis."
[126]
The Commodity Futures Modernization Act of 2000 was bi-partisan legislation that formally exempted derivatives
from regulation, supervision, trading on established exchanges, and capital reserve requirements for major
participants. It provided a legal safe harbor for treatment already in effect.
[127]
Concerns that counterparties to
derivative deals would be unable to pay their obligations caused pervasive uncertainty during the crisis. Particularly
relevant to the crisis are credit default swaps (CDS), a derivative in which Party A pays Party B what is essentially
an insurance premium, in exchange for payment should Party C default on its obligations. Warren Buffett famously
referred to derivatives as "financial weapons of mass destruction" in early 2003.
[128][129]
Some analysts believe the subprime mortgage crisis was due, in part, to a 2004 decision of the Securities and
Exchange Commission (SEC) that affected 5 large investment banks. The critics believe that changes in the capital
reserve calculation rules enabled investment banks to substantially increase the level of debt they were taking on,
69
fueling the growth in mortgage-backed securities supporting subprime mortgages. These banks dramatically
increased their risk taking from 2003-2007. By the end of 2007, the largest five U.S. investment banks had over $4
trillion in debt with high ratios of debt to equity, meaning only a small decline in the value of their assets would
render them insolvent.
[130][131]
In an April 9, 2009 speech, Erik Sirri, then Director of the SEC's Division of Trading
and Markets, argued that the regulatory weaknesses in leverage restrictions originated in the late 1970s: "The
Commission did not undo any leverage restrictions in 2004," nor did it intend to make a substantial reduction.
[132]
Policies to promote affordable housing
Several administrations, both Democratic and Republican, advocated affordable housing policies in the years leading
up to the crisis. The Housing and Community Development Act of 1992 established, for the first time, an affordable
housing loan purchase mandate for Fannie Mae and Freddie Mac, a mandate to be regulated by HUD. Initially, the
1992 legislation required that 30 percent or more of Fannies and Freddies loan purchases be related to affordable
housing. However, HUD was given the power to set future requirements, and eventually (under the Bush
Administration) a 56 percent minimum was established.
[133]
To fulfill the requirements, Fannie Mae and Freddie
Mac established programs to purchase $5 trillion in affordable housing loans,
[134]
and encouraged lenders to relax
underwriting standards to produce those loans.
[133]
The National Homeownership Strategy: Partners in the American Dream (Strategy), was compiled in 1995 by
Henry Cisneros, President Clintons HUD Secretary. This 100-page document represented the viewpoints of HUD,
Fannie Mae, Freddie Mac, leaders of the housing industry, various banks, numerous activist organizations such as
ACORN and La Raza, and representatives from several state and local governments.
[135]
In 2001, the independent
research company, Graham Fisher & Company, stated: While the underlying initiatives of the [Strategy] were broad
in content, the main theme was the relaxation of credit standards.
[136]
The Financial Crisis Inquiry Commission (majority report), Federal Reserve Economists, and several academic
researchers have stated that government affordable housing policies were not the major cause of the financial
crisis.
[1][26]
They also state that Community Reinvestment Act loans outperformed other "subprime" mortgages, and
GSE mortgages performed better than private label securitizations.
Community Reinvestment Act
The Community Reinvestment Act (CRA) was originally enacted under President Carter in 1977 in an effort to
encourage banks to halt the practice of lending discrimination. In 1995 the Clinton Administration issued regulations
that added numerical guidelines, urged lending flexibility, and instructed bank examiners to evaluate a banks
responsiveness to community activists (such as ACORN) when deciding whether to approve bank merger or
expansion requests. Critics claim that the 1995 changes to CRA signaled to banks that relaxed lending standards
were appropriate and could minimized potential risk of governmental sanctions.
Conservatives and libertarians have debated the possible effects of the Community Reinvestment Act (CRA), with
detractors claiming that the Act encouraged lending to uncreditworthy borrowers,
[137][138][139][140]
and defenders
claiming a thirty year history of lending without increased risk.
[141][142][143][144]
Detractors also claim that
amendments to the CRA in the mid-1990s, raised the amount of mortgages issued to otherwise unqualified
low-income borrowers, and allowed the securitization of CRA-regulated mortgages, even though a fair number of
them were subprime.
[145][146]
The Financial Crisis Inquiry Commission reported in January 2011 that "the CRA was not a significant factor in
subprime lending or the crisis. Many subprime lenders were not subject to the CRA. Research indicates only 6% of
high-cost loans a proxy for subprime loans had any connection to the law. Loans made by CRA-regulated
lenders in the neighborhoods in which they were required to lend were half as likely to default as similar loans made
in the same neighborhoods by independent mortgage originators not subject to the law."
[63]
Critics claim that the use
of the high-interest-rate proxy distorts results because government programs generally promote low-interest rate
70
loans even when the loans are to borrowers who are clearly subprime.
[147]
Several economist maintain that
Community Reinvestment Act loans outperformed other "subprime" mortgages, and GSE mortgages performed
better than private label securitizations.
[1][26]
State and local governmental programs
As part of the 1995 National Homeownership Strategy, HUD advocated greater involvement of state and local
organizations in the promotion of affordable housing.
[148]
In addition, it promoted the use of low or no-down
payment loans and second, unsecured loans to the borrower to pay their down payments (if any) and closing costs.
[149]
This idea manifested itself in silent second loans that became extremely popular in several states such as
California, and in scores of cities such as San Francisco.
[150]
Using federal funds and their own funds, these states
and cities offered borrowers loans that would defray the cost of the down payment. The loans were called silent
because the primary lender was not supposed to know about them. A Neighborhood Reinvestment Corporation
(affiliated with HUD) publicity sheet explicitly described the desired secrecy: [The NRC affiliates] hold the second
mortgages. Instead of going to the family, the monthly voucher is paid to [the NRC affiliates]. In this way the
voucher is invisible to the traditional lender and the family (emphasis added)
[151]
Mark-to-Market Accounting Rule
Former Federal Deposit Insurance Corporation Chair William Isaac placed much of the blame for the subprime
mortgage crisis on the Securities and Exchange Commission and its fair-value accounting rules, especially the
requirement for banks to mark their assets to market, particularly mortgage-backed securities.
[152]
Whether or not
this is true has been the subject of ongoing debate.
[153][154]
The debate arises because this accounting rule requires companies to adjust the value of marketable securities (such
as the mortgage-backed securities (MBS) at the center of the crisis) to their market value. The intent of the standard
is to help investors understand the value of these assets at a point in time, rather than just their historical purchase
price. Because the market for these assets is distressed, it is difficult to sell many MBS at other than prices which
may (or may not) be reflective of market stresses, which may be below the value that the mortgage cash flow related
to the MBS would merit. As initially interpreted by companies and their auditors, the typically lower sale value was
used as the market value rather than the cash flow value. Many large financial institutions recognized significant
losses during 2007 and 2008 as a result of marking-down MBS asset prices to market value.
Role of Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac are government sponsored enterprises (GSE) that purchase mortgages, buy and sell
mortgage-backed securities (MBS), and guarantee nearly half of the mortgages in the U.S. A variety of political and
competitive pressures resulted in the GSE taking on additional risk, beginning in the mid-1990s and continuing
throughout the crisis and their government takeover in September, 2008.
[155][156]
The majority of the Financial Crisis Inquiry Commission (6 of the 10 members) reported in 2011 that Fannie &
Freddie "contributed to the crisis, but were not a primary cause."
[157][158]
GSE mortgage securities essentially
maintained their value throughout the crisis and did not contribute to the significant financial firm losses that were
central to the financial crisis. The GSEs participated in the expansion of subprime and other risky mortgages, but
they followed rather than led Wall Street and other lenders into subprime lending.
[63]
Critics claim that HUD encouraged Fannie and Freddie to loosen lending standards, and that the two GSEs had a
major role in creating the subprime mortgage crisis. Others say that the two GSEs had a limited role in the crisis,
and/or that they were motivated by profit-seeking rather than affordable housing goals.
[159]
In addition to political pressure to expand purchases of higher-risk affordable housing mortgage types, the GSE were
also under significant competitive pressure from large investment banks and mortgage lenders. For example, some
analysts estimate that Fannie's market share of subprime mortgage-backed securities issued dropped from a peak of
71
44% in 2003 to 22% in 2005, before rising to 33% in 2007.
[160]
By some estimates, more than 84 percent of the subprime mortgages came from private lending institutions in 2006
and the share of subprime loans insured by Fannie Mae and Freddie Mac decreased as the bubble got bigger (from a
high of insuring 48 percent to insuring 24 percent of all subprime loans in 2006).
[161]
Despite conservative criticism
for government lending programs as the main cause of the crisis,
[162][163][164][165]
much of the crisis was
independent of government home loan programs.
Economist Paul Krugman argued in July 2008 that although the GSE are "problematic institutions," they played a
small role in the crisis because they were legally barred from engaging in subprime lending.
[166]
Economist Russell
Roberts has taken issue with Krugman's contention that the GSEs did not engage in subprime lending,
[167]
citing a
June 2008 Washington Post article which stated that "[f]rom 2004 to 2006, the two [GSEs] purchased $434 billion in
securities backed by subprime loans, creating a market for more such lending."
[168]
Furthermore, a 2004 HUD report
admitted that while trading securities that were backed by subprime mortgages was something that the GSEs
officially disavowed, they nevertheless participated in the market.
[169]
However, in 2011, the Federal Reserve, using
statistical comparisons of geographic regions which were and were not subject to GSE regulations finds that GSEs
played no significant role in the subprime crisis.
[170]
Based upon information in the SEC's December 2011 securities
fraud case against 6 ex-executives of Fannie and Freddie, Peter Wallison and Edward Pinto have estimated that, in
2008, Fannie and Freddie held 13 million substandard loans totaling over $2 trillion.
[171]
Economist Paul Krugman argued in January 2010 that the simultaneous growth of the residential and commercial
real estate pricing bubbles and the global nature of the crisis undermines the case made by those who argue that
Fannie Mae, Freddie Mac, CRA, or predatory lending were primary causes of the crisis. In other words, bubbles in
both markets developed even though only the residential market was affected by these potential causes.
[172]
In his Dissent to the Financial Crisis Inquiry Commission, Peter J. Wallison wrote: "It is not true that every
bubbleeven a large bubblehas the potential to cause a financial crisis when it deflates." Wallison notes that other
developed countries had "large bubbles during the 1997-2007 period" but "the losses associated with mortgage
delinquencies and defaults when these bubbles deflated were far lower than the losses suffered in the United States
when the 1997-2007 [bubble] deflated." According to Wallison, the reason the U.S. housing real estate bubble led to
financial crisis was that it was supported by a huge number of substandard loans - generally with low or no
downpayments.
[133]
Some analysts question whether affordable housing mandates were the true motivation behind Fannie's and Freddie's
purchase of substandard loans. In December 2011 the Securities and Exchange Commission charged the former
Fannie Mae and Freddie Mac executives, accusing them of misleading investors about risks of subprime-mortgage
loans.
[173]
According to one analyst, "The SECs facts paint a picture in which it wasnt high-minded government
mandates that did the GSEs wrong, but rather the monomaniacal focus of top management on marketshare. With
marketshare came bonuses and with bonuses came risk-taking, understood or not."
[174]
72
Policies of central banks
Federal Funds Rate and Various Mortgage Rates.
Central banks manage monetary policy
and may target the rate of inflation.
They have some authority over
commercial banks and possibly other
financial institutions. They are less
concerned with avoiding asset price
bubbles, such as the housing bubble
and dot-com bubble. Central banks
have generally chosen to react after
such bubbles burst so as to minimize
collateral damage to the economy,
rather than trying to prevent or stop the
bubble itself. This is because
identifying an asset bubble and
determining the proper monetary
policy to deflate it are matters of
debate among economists.
[175][176]
Some market observers have been concerned that Federal Reserve actions could give rise to moral hazard.
[46]
A
Government Accountability Office critic said that the Federal Reserve Bank of New York's rescue of Long-Term
Capital Management in 1998 would encourage large financial institutions to believe that the Federal Reserve would
intervene on their behalf if risky loans went sour because they were too big to fail.
[177]
A contributing factor to the rise in house prices was the Federal Reserve's lowering of interest rates early in the
decade. From 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%.
[178]
This
was done to soften the effects of the collapse of the dot-com bubble and of the September 2001 terrorist attacks, and
to combat the perceived risk of deflation.
[175]
The Fed believed that interest rates could be lowered safely primarily because the rate of inflation was low; it
disregarded other important factors. Richard W. Fisher, President and CEO of the Federal Reserve Bank of Dallas,
said that the Fed's interest rate policy during the early 2000s (decade) was misguided, because measured inflation in
those years was below true inflation, which led to a monetary policy that contributed to the housing bubble.
[179]
According to Ben Bernanke, now chairman of the Federal Reserve, it was capital or savings pushing into the United
States, due to a world wide "saving glut", which kept long term interest rates low independently of Central Bank
action.
[180]
The Fed then raised the Fed funds rate significantly between July 2004 and July 2006.
[181]
This contributed to an
increase in 1-year and 5-year ARM rates, making ARM interest rate resets more expensive for homeowners.
[182]
This may have also contributed to the deflating of the housing bubble, as asset prices generally move inversely to
interest rates and it became riskier to speculate in housing.
[183][184]
73
Financial institution debt levels and incentives
Leverage Ratios of Investment Banks Increased Significantly 20032007.
The Financial Crisis Inquiry
Commission reported in January 2011
that: "From 1978 to 2007, the amount
of debt held by the financial sector
soared from $3 trillion to $36 trillion,
more than doubling as a share of gross
domestic product. The very nature of
many Wall Street firms changed
from relatively staid private
partnerships to publicly traded
corporations taking greater and more
diverse kinds of risks. By 2005, the 10
largest U.S. commercial banks held
55% of the industrys assets, more than
double the level held in 1990. On the
eve of the crisis in 2006, financial
sector profits constituted 27% of all
corporate profits in the United States, up from 15% in 1980."
[63]
Many financial institutions, investment banks in particular, issued large amounts of debt during 20042007, and
invested the proceeds in mortgage-backed securities (MBS), essentially betting that house prices would continue to
rise, and that households would continue to make their mortgage payments. Borrowing at a lower interest rate and
investing the proceeds at a higher interest rate is a form of financial leverage. This is analogous to an individual
taking out a second mortgage on his residence to invest in the stock market. This strategy proved profitable during
the housing boom, but resulted in large losses when house prices began to decline and mortgages began to default.
Beginning in 2007, financial institutions and individual investors holding MBS also suffered significant losses from
mortgage payment defaults and the resulting decline in the value of MBS.
[185]
A 2004 U.S. Securities and Exchange Commission (SEC) decision related to the net capital rule allowed USA
investment banks to issue substantially more debt, which was then used to purchase MBS. Over 200407, the top
five US investment banks each significantly increased their financial leverage (see diagram), which increased their
vulnerability to the declining value of MBSs. These five institutions reported over $4.1 trillion in debt for fiscal year
2007, about 30% of USA nominal GDP for 2007. Further, the percentage of subprime mortgages originated to total
originations increased from below 10% in 20012003 to between 1820% from 20042006, due in-part to financing
from investment banks.
[24][25]
During 2008, three of the largest U.S. investment banks either went bankrupt (Lehman Brothers) or were sold at fire
sale prices to other banks (Bear Stearns and Merrill Lynch). These failures augmented the instability in the global
financial system. The remaining two investment banks, Morgan Stanley and Goldman Sachs, opted to become
commercial banks, thereby subjecting themselves to more stringent regulation.
[186][187]
In the years leading up to the crisis, the top four U.S. depository banks moved an estimated $5.2 trillion in assets and
liabilities off-balance sheet into special purpose vehicles or other entities in the shadow banking system. This
enabled them to essentially bypass existing regulations regarding minimum capital ratios, thereby increasing
leverage and profits during the boom but increasing losses during the crisis. New accounting guidance will require
them to put some of these assets back onto their books during 2009, which will significantly reduce their capital
ratios. One news agency estimated this amount to be between $500 billion and $1 trillion. This effect was considered
as part of the stress tests performed by the government during 2009.
[188]
74
Martin Wolf wrote in June 2009: "...an enormous part of what banks did in the early part of this decade the
off-balance-sheet vehicles, the derivatives and the 'shadow banking system' itself was to find a way round
regulation."
[189]
The New York State Comptroller's Office has said that in 2006, Wall Street executives took home bonuses totaling
$23.9 billion. "Wall Street traders were thinking of the bonus at the end of the year, not the long-term health of their
firm. The whole system from mortgage brokers to Wall Street risk managers seemed tilted toward taking
short-term risks while ignoring long-term obligations. The most damning evidence is that most of the people at the
top of the banks didn't really understand how those [investments] worked."
[54][190]
The incentive compensation of traders was focused on fees generated from assembling financial products, rather than
the performance of those products and profits generated over time. Their bonuses were heavily skewed towards cash
rather than stock and not subject to "claw-back" (recovery of the bonus from the employee by the firm) in the event
the MBS or CDO created did not perform. In addition, the increased risk (in the form of financial leverage) taken by
the major investment banks was not adequately factored into the compensation of senior executives.
[191]
Credit default swaps
Credit default swaps (CDS) are financial instruments used as a hedge and protection for debtholders, in particular
MBS investors, from the risk of default, or by speculators to profit from default. As the net worth of banks and other
financial institutions deteriorated because of losses related to subprime mortgages, the likelihood increased that those
providing the protection would have to pay their counterparties. This created uncertainty across the system, as
investors wondered which companies would be required to pay to cover mortgage defaults.
Like all swaps and other financial derivatives, CDS may either be used to hedge risks (specifically, to insure
creditors against default) or to profit from speculation. The volume of CDS outstanding increased 100-fold from
1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to
$47 trillion. CDS are lightly regulated, largely because of the Commodities Futures Modernization Act of 2000. As
of 2008, there was no central clearing house to honor CDS in the event a party to a CDS proved unable to perform
his obligations under the CDS contract. Required disclosure of CDS-related obligations has been criticized as
inadequate. Insurance companies such as American International Group (AIG), MBIA, and Ambac faced ratings
downgrades because widespread mortgage defaults increased their potential exposure to CDS losses. These firms
had to obtain additional funds (capital) to offset this exposure. AIG's having CDSs insuring $440 billion of MBS
resulted in its seeking and obtaining a Federal government bailout.
[192]
The monoline insurance companies went out
of business in 20082009.
When investment bank Lehman Brothers went bankrupt in September 2008, there was much uncertainty as to which
financial firms would be required to honor the CDS contracts on its $600 billion of bonds outstanding.
[193][194]
Merrill Lynch's large losses in 2008 were attributed in part to the drop in value of its unhedged portfolio of
collateralized debt obligations (CDOs) after AIG ceased offering CDS on Merrill's CDOs. The loss of confidence of
trading partners in Merrill Lynch's solvency and its ability to refinance its short-term debt led to its acquisition by the
Bank of America.
[195][196]
Economist Joseph Stiglitz summarized how credit default swaps contributed to the systemic meltdown: "With this
complicated intertwining of bets of great magnitude, no one could be sure of the financial position of anyone else-or
even of one's own position. Not surprisingly, the credit markets froze."
[197]
Author Michael Lewis wrote that CDS enabled speculators to stack bets on the same mortgage bonds and CDO's.
This is analogous to allowing many persons to buy insurance on the same house. Speculators that bought CDS
insurance were betting that significant defaults would occur, while the sellers (such as AIG) bet they would not. A
theoretically infinite amount could be wagered on the same housing-related securities, provided buyers and sellers of
the CDS could be found.
[198]
75
In addition, Chicago Public Radio, Huffington Post, and ProPublica reported in April 2010 that market participants,
including a hedge fund called Magnetar Capital, encouraged the creation of CDO's containing low quality
mortgages, so they could bet against them using CDS. NPR reported that Magnetar encouraged investors to purchase
CDO's while simultaneously betting against them, without disclosing the latter bet.
[199][200][201]
Instruments called
synthetic CDO, which are portfolios of credit default swaps, were also involved in allegations by the SEC against
Goldman-Sachs in April 2010.
[202]
The Financial Crisis Inquiry Commission reported in January 2011 that CDS contributed significantly to the crisis.
Companies were able to sell protection to investors against the default of mortgage-backed securities, helping to
launch and expand the market for new, complex instruments such as CDO's. This further fueled the housing bubble.
They also amplified the losses from the collapse of the housing bubble by allowing multiple bets on the same
securities and helped spread these bets throughout the financial system. Companies selling protection, such as AIG,
were not required to set aside sufficient capital to cover their obligations when significant defaults occurred. Because
many CDS were not traded on exchanges, the obligations of key financial institutions became hard to measure,
creating uncertainty in the financial system.
[63]
Globalization, technology and the trade deficit
U.S. Current Account or Trade Deficit as of the year 2010, with a 2011 estimate.
In 2005, Ben Bernanke addressed the
implications of the United States's high
and rising current account deficit,
resulting from U.S. investment
exceeding its savings, or imports
exceeding exports.
[203]
Between 1996
and 2004, the U.S. current account
deficit increased by $650 billion, from
1.5% to 5.8% of GDP. The U.S.
attracted a great deal of foreign
investment, mainly from the emerging
economies in Asia and oil-exporting
nations. The balance of payments
identity requires that a country (such as
the U.S.) running a current account
deficit also have a capital account
(investment) surplus of the same
amount. Foreign investors had these funds to lend, either because they had very high personal savings rates (as high
as 40% in China), or because of high oil prices.
Bernanke referred to this as a "saving glut"
[180]
that may have pushed capital into the United States, a view differing
from that of some other economists, who view such capital as having been pulled into the U.S. by its high
consumption levels. In other words, a nation cannot consume more than its income unless it sells assets to foreigners,
or foreigners are willing to lend to it. Alternatively, if a nation wishes to increase domestic investment in plant and
equipment, it will also increase its level of imports to maintain balance if it has a floating exchange rate.
Regardless of the push or pull view, a "flood" of funds (capital or liquidity) reached the U.S. financial market.
Foreign governments supplied funds by purchasing U.S. Treasury bonds and thus avoided much of the direct impact
of the crisis. American households, on the other hand, used funds borrowed from foreigners to finance consumption
or to bid up the prices of housing and financial assets. Financial institutions invested foreign funds in
mortgage-backed securities. American housing and financial assets dramatically declined in value after the housing
bubble burst.
[204][205]
76
Economist Joseph Stiglitz wrote in October 2011 that the recession and high unemployment of the 20092011
period was years in the making and driven by: unsustainable consumption; high manufacturing productivity
outpacing demand thereby increasing unemployment; income inequality that shifted income from those who tended
to spend it (i.e., the middle class) to those who do not (i.e., the wealthy); and emerging market's buildup of reserves
(to the tune of $7.6 trillion by 2011) which was not spent. These factors all led to a "massive" shortfall in aggregate
demand, which was "papered over" by demand related to the housing bubble until it burst.
[206]
Boom and collapse of the shadow banking system
Securitization markets were impaired during the crisis.
In a June 2008 speech, President of the
NY Federal Reserve Bank Timothy
Geithner, who later became Secretary
of the Treasury, placed significant
blame for the freezing of credit
markets on a "run" on the entities in
the "parallel" banking system, also
called the shadow banking system.
These entities became critical to the
credit markets underpinning the
financial system, but were not subject
to the same regulatory controls as
depository banks. Further, these
entities were vulnerable because they
borrowed short-term in liquid markets
to purchase long-term, illiquid and
risky assets. This meant that
disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at
depressed prices.
[13]
He described the significance of these entities: "In early 2007, asset-backed commercial paper conduits, in structured
investment vehicles, in auction-rate preferred securities, tender option bonds and variable rate demand notes, had a
combined asset size of roughly $2.2 trillion. Assets financed overnight in triparty repo grew to $2.5 trillion. Assets
held in hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the then five major investment
banks totaled $4 trillion. In comparison, the total assets of the top five bank holding companies in the United States
at that point were just over $6 trillion, and total assets of the entire banking system were about $10 trillion." He
stated that the "combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and
credit cycles."
[13]
Nobel laureate Paul Krugman described the run on the shadow banking system as the "core of what happened" to
cause the crisis. "As the shadow banking system expanded to rival or even surpass conventional banking in
importance, politicians and government officials should have realized that they were re-creating the kind of financial
vulnerability that made the Great Depression possible and they should have responded by extending regulations
and the financial safety net to cover these new institutions. Influential figures should have proclaimed a simple rule:
anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated
like a bank." He referred to this lack of controls as "malign neglect."
[207][208]
The securitization markets supported by the shadow banking system started to close down in the spring of 2007 and
nearly shut-down in the fall of 2008. More than a third of the private credit markets thus became unavailable as a
source of funds.
[108]
According to the Brookings Institution, the traditional banking system does not have the capital
to close this gap as of June 2009: "It would take a number of years of strong profits to generate sufficient capital to
77
support that additional lending volume." The authors also indicate that some forms of securitization are "likely to
vanish forever, having been an artifact of excessively loose credit conditions."
[109]
Economist Mark Zandi testified to the Financial Crisis Inquiry Commission in January 2010: "The securitization
markets also remain impaired, as investors anticipate more loan losses. Investors are also uncertain about coming
legal and accounting rule changes and regulatory reforms. Private bond issuance of residential and commercial
mortgage-backed securities, asset-backed securities, and CDOs peaked in 2006 at close to $2 trillion...In 2009,
private issuance was less than $150 billion, and almost all of it was asset-backed issuance supported by the Federal
Reserve's TALF program to aid credit card, auto and small-business lenders. Issuance of residential and commercial
mortgage-backed securities and CDOs remains dormant."
[209]
The Economist reported in March 2010: "Bear Stearns and Lehman Brothers were non-banks that were crippled by a
silent run among panicky overnight "repo" lenders, many of them money market funds uncertain about the quality of
securitized collateral they were holding. Mass redemptions from these funds after Lehman's failure froze short-term
funding for big firms."
[210]
The Financial Crisis Inquiry Commission reported in January 2011: "In the early part of the 20th century, we erected
a series of protections the Federal Reserve as a lender of last resort, federal deposit insurance, ample regulations
to provide a bulwark against the panics that had regularly plagued Americas banking system in the 20th century.
Yet, over the past 30-plus years, we permitted the growth of a shadow banking system opaque and laden with short
term debt that rivaled the size of the traditional banking system. Key components of the market for example, the
multitrillion-dollar repo lending market, off-balance-sheet entities, and the use of over-the-counter derivatives
were hidden from view, without the protections we had constructed to prevent financial meltdowns. We had a
21st-century financial system with 19th-century safeguards."
[63]
Impacts
Impact in the U.S.
Impacts from the Crisis on Key Wealth Measures
Between June 2007 and November
2008, Americans lost more than a
quarter of their net worth. By early
November 2008, a broad U.S. stock
index, the S&P 500, was down 45
percent from its 2007 high. Housing
prices had dropped 20% from their
2006 peak, with futures markets
signaling a 3035% potential drop.
Total home equity in the United States,
which was valued at $13 trillion at its
peak in 2006, had dropped to $8.8
trillion by mid-2008 and was still
falling in late 2008.
[211]
Total retirement assets, Americans'
second-largest household asset,
dropped by 22 percent, from $10.3
trillion in 2006 to $8 trillion in mid-2008. During the same period, savings and investment assets (apart from
retirement savings) lost $1.2 trillion and pension assets lost $1.3 trillion. Taken together, these losses total $8.3
trillion.
[211]
78
Members of USA minority groups received a disproportionate number of subprime mortgages, and so have
experienced a disproportionate level of the resulting foreclosures.
[212][213][214]
Recent research shows that complex
mortgages were chosen by prime borrowers with high income levels seeking to purchase expensive houses relative
to their incomes. Borrowers with complex mortgages experienced substantially higher default rates than borrowers
with traditional mortgages with similar characteristics.
[215]
The crisis had a devastating effect on the U.S. auto
industry. New vehicle sales, which peaked at 17 million in 2005, recovered to only 12 million by 2010.
[216]
Financial market impacts, 2007
FDIC Graph U.S. Bank & Thrift Profitability By Quarter.
The crisis began to affect the financial
sector in February 2007, when HSBC,
the world's largest (2008) bank, wrote
down its holdings of subprime-related
MBS by $10.5 billion, the first major
subprime related loss to be
reported.
[217]
During 2007, at least 100
mortgage companies either shut down,
suspended operations or were sold.
[218]
Top management has not escaped
unscathed, as the CEOs of Merrill
Lynch and Citigroup resigned within a
week of each other in late 2007.
[219]
As the crisis deepened, more and more
financial firms either merged, or
announced that they were negotiating
seeking merger partners.
[220]
During 2007, the crisis caused panic in financial markets and encouraged investors to take their money out of risky
mortgage bonds and shaky equities and put it into commodities as "stores of value".
[221]
Financial speculation in
commodity futures following the collapse of the financial derivatives markets has contributed to the world food price
crisis and oil price increases due to a "commodities super-cycle."
[222][223]
Financial speculators seeking quick returns
have removed trillions of dollars from equities and mortgage bonds, some of which has been invested into food and
raw materials.
[224]
Mortgage defaults and provisions for future defaults caused profits at the 8533 USA depository institutions insured
by the Federal Deposit Insurance Corporation to decline from $35.2 billion in 2006 Q4 to $646 million in the same
quarter a year later, a decline of 98%. 2007 Q4 saw the worst bank and thrift quarterly performance since 1990. In all
of 2007, insured depository institutions earned approximately $100 billion, down 31% from a record profit of $145
billion in 2006. Profits declined from $35.6 billion in 2007 Q1 to $19.3 billion in 2008 Q1, a decline of
46%.
[225][226]
79
Financial market impacts, 2008
The TED spread an indicator of credit risk increased dramatically during September
2008.
As of August 2008, financial firms
around the globe have written down
their holdings of subprime related
securities by US$501 billion.
[227]
The
IMF estimates that financial
institutions around the globe will
eventually have to write off $1.5
trillion of their holdings of subprime
MBSs. About $750 billion in such
losses had been recognized as of
November 2008. These losses have
wiped out much of the capital of the
world banking system. Banks
headquartered in nations that have
signed the Basel Accords must have so
many cents of capital for every dollar
of credit extended to consumers and
businesses. Thus the massive reduction
in bank capital just described has reduced the credit available to businesses and households.
[228]
When Lehman Brothers and other important financial institutions failed in September 2008, the crisis hit a key
point.
[229]
During a two day period in September 2008, $150 billion were withdrawn from USA money funds. The
average two day outflow had been $5 billion. In effect, the money market was subject to a bank run. The money
market had been a key source of credit for banks (CDs) and nonfinancial firms (commercial paper). The TED spread
(see graph above), a measure of the risk of interbank lending, quadrupled shortly after the Lehman failure. This
credit freeze brought the global financial system to the brink of collapse. The response of the USA Federal Reserve,
the European Central Bank, and other central banks was immediate and dramatic. During the last quarter of 2008,
these central banks purchased US$2.5 trillion of government debt and troubled private assets from banks. This was
the largest liquidity injection into the credit market, and the largest monetary policy action, in world history. The
governments of European nations and the USA also raised the capital of their national banking systems by $1.5
trillion, by purchasing newly issued preferred stock in their major banks.
[228]
However, some economists state that Third-World economies, such as the Brazilian and Chinese ones, will not suffer
as much as those from more developed countries.
[230]
However, other analysts have seen Brazil as entering their own
sub-prime crisis.
[231]
The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic
assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from
200710. U.S. banks losses were forecast to hit $1 trillion and European bank losses will reach $1.6 trillion. The
IMF estimated that U.S. banks were about 60 percent through their losses, but British and eurozone banks only 40
percent.
[232]
80
Sustained effects
U.S. Changes in Employment for Selected Time Periods
In Spring, 2011 there were about a million
homes in foreclosure in the United States,
several million more in the pipeline, and
872,000 previously foreclosed homes in the
hands of banks. Sales were slow;
economists estimated that it would take
three years to clear the backlogged
inventory. According to Mark Zandi, of
Moodys Analytics, home prices were
falling and could be expected to fall further
during 2011. However, the rate of new
borrowers falling behind in mortgage
payments had begun to decrease.
[233]
The crisis had a significant and long-lasting
impact on U.S. employment. During the
Great Recession, 8.5 million jobs were lost
from the peak employment in early 2008 of approximately 138 million to the trough in February 2010 of 129
million, roughly 6% of the workforce. From February 2010 to September 2012, approximately 4.3 million jobs were
added, offsetting roughly half the losses.
[234][235]
Research indicates recovery from financial crises can be protracted, with lengthy periods of high unemployment and
substandard economic growth.
[236]
Economist Carmen Reinhart stated in August 2011: "Debt de-leveraging
[reduction] takes about seven years...And in the decade following severe financial crises, you tend to grow by 1 to
1.5 percentage points less than in the decade before, because the decade before was fueled by a boom in private
borrowing, and not all of that growth was real. The unemployment figures in advanced economies after falls are also
very dark. Unemployment remains anchored about five percentage points above what it was in the decade
before.
[237]
Savings surplus or investment deficit
81
U.S. savings and investment; savings less investment is the private sector financial
surplus
During the crisis and ensuing recession,
U.S. consumers increased their savings as
they paid down debt ("deleveraged") but
corporations simultaneously were reducing
their investment. In a healthy economy,
private sector savings placed into the
banking system is borrowed and invested by
companies. This investment is one of the
major components of GDP. A private sector
financial deficit from 2004 to 2008
transitioned to a large surplus of savings
over investment that exceeded $1 trillion by
early 2009 and remained above $800 billion
as of September 2012. Part of this
investment reduction related to the housing
market, a major component of investment in
the GDP computation. This surplus explains
how even significant government deficit spending would not increase interest rates and how Federal Reserve action
to increase the money supply does not result in inflation, because the economy is awash with savings with no place
to go.
[238]
Economist Richard Koo described similar effects for several of the developed world economies in December 2011:
"Today private sectors in the U.S., the U.K., Spain, and Ireland (but not Greece) are undergoing massive
deleveraging in spite of record low interest rates. This means these countries are all in serious balance sheet
recessions. The private sectors in Japan and Germany are not borrowing, either. With borrowers disappearing and
banks reluctant to lend, it is no wonder that, after nearly three years of record low interest rates and massive liquidity
injections, industrial economies are still doing so poorly. Flow of funds data for the U.S. show a massive shift away
from borrowing to savings by the private sector since the housing bubble burst in 2007. The shift for the private
sector as a whole represents over 9 percent of U.S. GDP at a time of zero interest rates. Moreover, this increase in
private sector savings exceeds the increase in government borrowings (5.8 percent of GDP), which suggests that the
government is not doing enough to offset private sector deleveraging."
[239]
Responses
Various actions have been taken since the crisis became apparent in August 2007. In September 2008, major
instability in world financial markets increased awareness and attention to the crisis. Various agencies and
regulators, as well as political officials, began to take additional, more comprehensive steps to handle the crisis.
To date, various government agencies have committed or spent trillions of dollars in loans, asset purchases,
guarantees, and direct spending. For a summary of U.S. government financial commitments and investments related
to the crisis, see CNN Bailout Scorecard
[240]
.
82
Federal Reserve and central banks
The central bank of the USA, the Federal Reserve, in partnership with central banks around the world, has taken
several steps to address the crisis. Federal Reserve Chairman Ben Bernanke stated in early 2008: "Broadly, the
Federal Reserve's response has followed two tracks: efforts to support market liquidity and functioning and the
pursuit of our macroeconomic objectives through monetary policy."
[29]
The Fed has:
Lowered the target for the Federal funds rate from 5.25% to 2%, and the discount rate from 5.75% to 2.25%. This
took place in six steps occurring between 18 September 2007 and 30 April 2008;
[241][242]
In December 2008, the
Fed further lowered the federal funds rate target to a range of 00.25% (25 basis points).
[243]
Undertaken, along with other central banks, open market operations to ensure member banks remain liquid. These
are effectively short-term loans to member banks collateralized by government securities. Central banks have also
lowered the interest rates (called the discount rate in the USA) they charge member banks for short-term
loans;
[244]
Created a variety of lending facilities to enable the Fed to lend directly to banks and non-bank institutions, against
specific types of collateral of varying credit quality. These include the Term Auction Facility (TAF) and Term
Asset-Backed Securities Loan Facility (TALF).
[245]
In November 2008, the Fed announced a $600 billion program to purchase the MBS of the GSE, to help lower
mortgage rates.
[246]
In March 2009, the Federal Open Market Committee decided to increase the size of the Federal Reserves balance
sheet further by purchasing up to an additional $750 billion of government-sponsored enterprise mortgage-backed
securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its
purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help
improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of
longer-term Treasury securities during 2009.
[247]
According to Ben Bernanke, expansion of the Fed balance sheet means the Fed is electronically creating money,
necessary "...because our economy is very weak and inflation is very low. When the economy begins to recover, that
will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure
that we have a recovery that does not involve inflation."
[248]
Economic stimulus
On 13 February 2008, President George W. Bush signed into law a $168 billion economic stimulus package, mainly
taking the form of income tax rebate checks mailed directly to taxpayers.
[249]
Checks were mailed starting the week
of 28 April 2008. However, this rebate coincided with an unexpected jump in gasoline and food prices. This
coincidence led some to wonder whether the stimulus package would have the intended effect, or whether consumers
would simply spend their rebates to cover higher food and fuel prices.
On 17 February 2009, U.S. President Barack Obama signed the American Recovery and Reinvestment Act of 2009,
an $787 billion stimulus package with a broad spectrum of spending and tax cuts.
[250]
Over $75 billion of which was
specifically allocated to programs which help struggling homeowners. This program is referred to as the Homeowner
Affordability and Stability Plan.
[251]
83
Bank solvency and capital replenishment
Common Equity to Total Assets Ratios for Major USA Banks.
Losses on mortgage-backed securities
and other assets purchased with
borrowed money have dramatically
reduced the capital base of financial
institutions, rendering many either
insolvent or less capable of lending.
Governments have provided funds to
banks. Some banks have taken
significant steps to acquire additional
capital from private sources.
The U.S. government passed the
Emergency Economic Stabilization
Act of 2008 (EESA or TARP) during
October 2008. This law included $700
billion in funding for the "Troubled
Assets Relief Program" (TARP),
which was used to lend funds to banks
in exchange for dividend-paying preferred stock.
[252][253]
Another method of recapitalizing banks is for government and private investors to provide cash in exchange for
mortgage-related assets (i.e., "toxic" or "legacy" assets), improving the quality of bank capital while reducing
uncertainty regarding the financial position of banks. U.S. Treasury Secretary Timothy Geithner announced a plan
during March 2009 to purchase "legacy" or "toxic" assets from banks. The Public-Private Partnership Investment
Program involves government loans and guarantees to encourage private investors to provide funds to purchase toxic
assets from banks.
[254]
For a summary of U.S. government financial commitments and investments related to the crisis, see CNN Bailout
Scorecard
[240]
.
For a summary of TARP funds provided to U.S. banks as of December 2008, see Reuters-TARP Funds
[255]
.
Bailouts and failures of financial firms
84
People queuing outside a Northern Rock bank branch in
Birmingham, United Kingdom on September 15, 2007, to withdraw
their savings because of the subprime crisis.
Several major financial institutions either failed, were
bailed-out by governments, or merged (voluntarily or
otherwise) during the crisis. While the specific
circumstances varied, in general the decline in the value
of mortgage-backed securities held by these companies
resulted in either their insolvency, the equivalent of
bank runs as investors pulled funds from them, or
inability to secure new funding in the credit markets.
These firms had typically borrowed and invested large
sums of money relative to their cash or equity capital,
meaning they were highly leveraged and vulnerable to
unanticipated credit market disruptions.
[256]
The five largest U.S. investment banks, with combined
liabilities or debts of $4 trillion, either went bankrupt
(Lehman Brothers), were taken over by other
companies (Bear Stearns and Merrill Lynch), or were bailed-out by the U.S. government (Goldman Sachs and
Morgan Stanley) during 2008.
[257]
Government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac either
directly owed or guaranteed nearly $5 trillion in mortgage obligations, with a similarly weak capital base, when they
were placed into receivership in September 2008.
[258]
For scale, this $9 trillion in obligations concentrated in seven
highly leveraged institutions can be compared to the $14 trillion size of the U.S. economy (GDP)
[259]
or to the total
national debt of $10 trillion in September 2008.
[260]
Major depository banks around the world had also used financial innovations such as structured investment vehicles
to circumvent capital ratio regulations.
[261]
Notable global failures included Northern Rock, which was nationalized
at an estimated cost of 87 billion ($150 billion).
[262]
In the U.S., Washington Mutual (WaMu) was seized in
September 2008 by the USA Office of Thrift Supervision (OTS).
[263]
This would be followed by the shotgun
wedding of Wells Fargo & Wachovia after it was speculated that without the merger Wachovia was also going to
fail. Dozens of U.S. banks received funds as part of the TARP or $700 billion bailout.
[264]
The TARP funds gained
some controversy after PNC Financial Services received TARP money, only to turn around hours later and purchase
the struggling National City Corp., which itself had become a victim of the subprime crisis.
As a result of the financial crisis in 2008, twenty-five U.S. banks became insolvent and were taken over by the
FDIC.
[265]
As of August 14, 2009, an additional 77 banks became insolvent.
[266]
This seven month tally surpasses
the 50 banks that were seized in all of 1993, but is still much smaller than the number of failed banking institutions
in 1992, 1991, and 1990.
[267]
The United States has lost over 6 million jobs since the recession began in December
2007.
[268]
The FDIC deposit insurance fund, supported by fees on insured banks, fell to $13 billion in the first quarter of
2009.
[269]
That is the lowest total since September, 1993.
[269]
According to some, the bailouts could be traced directly to Alan Greenspan's efforts to reflate the stock market and
the economy after the tech stock bust, and specifically to a February 23, 2004 speech Mr. Greenspan made to the
Mortgage Bankers Association where he suggested that the time had come to push average American borrowers into
more exotic loans with variable rates, or deferred interest.
[270]
This argument suggests that Mr. Greenspan sought to
enlist banks to expand lending and debt to stimulate asset prices and that the Federal Reserve and US Treasury
Department would back any losses that might result. As early as March 2007 some commentators predicted that a
bailout of the banks would exceed $1 trillion, at a time when Ben Bernanke, Alan Greenspan and Henry Paulson all
claimed that mortgage problems were "contained" to the subprime market and no bailout of the financial sector
would be necessary.
[270]
85
Homeowner assistance
Both lenders and borrowers may benefit from avoiding foreclosure, which is a costly and lengthy process. Some
lenders have offered troubled borrowers more favorable mortgage terms (i.e., refinancing, loan modification or loss
mitigation). Borrowers have also been encouraged to contact their lenders to discuss alternatives.
[271]
The Economist described the issue this way: "No part of the financial crisis has received so much attention, with so
little to show for it, as the tidal wave of home foreclosures sweeping over America. Government programmes have
been ineffectual, and private efforts not much better." Up to 9 million homes may enter foreclosure over the
20092011 period, versus one million in a typical year.
[272]
At roughly U.S. $50,000 per foreclosure according to a
2006 study by the Chicago Federal Reserve Bank, 9 million foreclosures represents $450 billion in losses.
[273]
A variety of voluntary private and government-administered or supported programs were implemented during
20072009 to assist homeowners with case-by-case mortgage assistance, to mitigate the foreclosure crisis engulfing
the U.S. One example is the Hope Now Alliance, an ongoing collaborative effort between the US Government and
private industry to help certain subprime borrowers.
[274]
In February 2008, the Alliance reported that during the
second half of 2007, it had helped 545,000 subprime borrowers with shaky credit, or 7.7% of 7.1 million subprime
loans outstanding as of September 2007. A spokesperson for the Alliance acknowledged that much more must be
done.
[275]
During late 2008, major banks and both Fannie Mae and Freddie Mac established moratoriums (delays) on
foreclosures, to give homeowners time to work towards refinancing.
[276][277][278]
Critics have argued that the case-by-case loan modification method is ineffective, with too few homeowners assisted
relative to the number of foreclosures and with nearly 40% of those assisted homeowners again becoming delinquent
within 8 months.
[279][280][281]
In December 2008, the U.S. FDIC reported that more than half of mortgages modified
during the first half of 2008 were delinquent again, in many cases because payments were not reduced or mortgage
debt was not forgiven. This is further evidence that case-by-case loan modification is not effective as a policy
tool.
[282]
In February 2009, economists Nouriel Roubini and Mark Zandi recommended an "across the board" (systemic)
reduction of mortgage principal balances by as much as 2030%. Lowering the mortgage balance would help lower
monthly payments and also address an estimated 20 million homeowners that may have a financial incentive to enter
voluntary foreclosure because they are "underwater" (i.e., the mortgage balance is larger than the home
value).
[283][284]
A study by the Federal Reserve Bank of Boston indicated that banks were reluctant to modify loans. Only 3% of
seriously delinquent homeowners had their mortgage payments reduced during 2008. In addition, investors who hold
MBS and have a say in mortgage modifications have not been a significant impediment; the study found no
difference in the rate of assistance whether the loans were controlled by the bank or by investors. Commenting on
the study, economists Dean Baker and Paul Willen both advocated providing funds directly to homeowners instead
of banks.
[285]
The L.A. Times reported the results of a study that found homeowners with high credit scores at the time of entering
the mortgage are 50% more likely to "strategically default" abruptly and intentionally pull the plug and abandon
the mortgage compared with lower-scoring borrowers. Such strategic defaults were heavily concentrated in
markets with the highest price declines. An estimated 588,000 strategic defaults occurred nationwide during 2008,
more than double the total in 2007. They represented 18% of all serious delinquencies that extended for more than
60 days in the fourth quarter of 2008.
[286]
86
Homeowners Affordability and Stability Plan
On 18 February 2009, U.S. President Barack Obama announced a $73 billion program to help up to nine million
homeowners avoid foreclosure, which was supplemented by $200 billion in additional funding for Fannie Mae and
Freddie Mac to purchase and more easily refinance mortgages. The plan is funded mostly from the EESA's $700
billion financial bailout fund. It uses cost sharing and incentives to encourage lenders to reduce homeowner's
monthly payments to 31 percent of their monthly income. Under the program, a lender would be responsible for
reducing monthly payments to no more than 38 percent of a borrowers income, with government sharing the cost to
further cut the rate to 31 percent. The plan also involves forgiving a portion of the borrowers mortgage balance.
Companies that service mortgages will get incentives to modify loans and to help the homeowner stay
current.
[287][288][289]
Regulatory proposals and long-term solutions
President Barack Obama and key advisers introduced a series of regulatory proposals in June 2009. The proposals
address consumer protection, executive pay, bank financial cushions or capital requirements, expanded regulation of
the shadow banking system and derivatives, and enhanced authority for the Federal Reserve to safely wind-down
systemically important institutions, among others.
[290][291][292]
The DoddFrank Wall Street Reform and Consumer
Protection Act was signed into law in July 2010 to address some of the causes of the crisis.
U.S. Treasury Secretary Timothy Geithner testified before Congress on October 29, 2009. His testimony included
five elements he stated as critical to effective reform:
1. Expand the Federal Deposit Insurance Corporation bank resolution mechanism to include non-bank financial
institutions;
2. 2. Ensure that a firm is allowed to fail in an orderly way and not be "rescued";
3. 3. Ensure taxpayers are not on the hook for any losses, by applying losses to the firm's investors and creating a
monetary pool funded by the largest financial institutions;
4. 4. Apply appropriate checks and balances to the FDIC and Federal Reserve in this resolution process;
5. Require stronger capital and liquidity positions for financial firms and related regulatory authority.
[293]
Law investigations, judicial and other responses
Significant law enforcement action and litigation is resulting from the crisis. The U.S. Federal Bureau of
Investigation was looking into the possibility of fraud by mortgage financing companies Fannie Mae and Freddie
Mac, Lehman Brothers, and insurer American International Group, among others.
[294]
New York Attorney General
Andrew Cuomo is suing Long Island based Amerimod, one of the nation's largest loan modification corporations for
fraud, and has issued 14 subpoenas to other similar companies.
[295]
The FBI also assigned more agents to
mortgage-related crimes and its caseload has dramatically increased.
[296][297]
The FBI began a probe of Countrywide
Financial in March 2008 for possible fraudulent lending practices and securities fraud.
[298]
Over 300 civil lawsuits were filed in federal courts during 2007 related to the subprime crisis. The number of filings
in state courts was not quantified but is also believed to be significant.
[299]
87
Implications
VOA Special English Economics Report from
Oct 2010 describing how millions of foreclosed
homes were seized by banks.
Estimates of impact have continued to climb. During April 2008,
International Monetary Fund (IMF) estimated that global losses for
financial institutions would approach $1 trillion.
[300]
One year later, the
IMF estimated cumulative losses of banks and other financial
institutions globally would exceed $4 trillion.
[301]
Francis Fukuyama has argued that the crisis represents the end of
Reaganism in the financial sector, which was characterized by lighter
regulation, pared-back government, and lower taxes. Significant
financial sector regulatory changes are expected as a result of the
crisis.
[302]
Fareed Zakaria believes that the crisis may force Americans and their
government to live within their means. Further, some of the best minds
may be redeployed from financial engineering to more valuable business activities, or to science and technology.
[303]
Roger Altman wrote that "the crash of 2008 has inflicted profound damage on [the U.S.] financial system, its
economy, and its standing in the world; the crisis is an important geopolitical setback...the crisis has coincided with
historical forces that were already shifting the world's focus away from the United States. Over the medium term, the
United States will have to operate from a smaller global platform while others, especially China, will have a
chance to rise faster."
[228]
GE CEO Jeffrey Immelt has argued that U.S. trade deficits and budget deficits are unsustainable. America must
regain its competitiveness through innovative products, training of production workers, and business leadership. He
advocates specific national goals related to energy security or independence, specific technologies, expansion of the
manufacturing job base, and net exporter status.
[304]
"The world has been reset. Now we must lead an aggressive
American renewal to win in the future." Of critical importance, he said, is the need to focus on technology and
manufacturing. Many bought into the idea that America could go from a technology-based, export-oriented
powerhouse to a services-led, consumption-based economy and somehow still expect to prosper, Jeff said. That
idea was flat wrong.
[305]
Economist Paul Krugman wrote in 2009: "The prosperity of a few years ago, such as it was profits were terrific,
wages not so much depended on a huge bubble in housing, which replaced an earlier huge bubble in stocks. And
since the housing bubble isnt coming back, the spending that sustained the economy in the pre-crisis years isnt
coming back either."
[306]
Niall Ferguson stated that excluding the effect of home equity extraction, the U.S. economy
grew at a 1% rate during the Bush years.
[307]
Microsoft CEO Steve Ballmer has argued that this is an economic reset
at a lower level, rather than a recession, meaning that no quick recovery to pre-recession levels can be expected.
[308]
The U.S. Federal government's efforts to support the global financial system have resulted in significant new
financial commitments, totaling $7 trillion by November, 2008. These commitments can be characterized as
investments, loans, and loan guarantees, rather than direct expenditures. In many cases, the government purchased
financial assets such as commercial paper, mortgage-backed securities, or other types of asset-backed paper, to
enhance liquidity in frozen markets.
[309]
As the crisis has progressed, the Fed has expanded the collateral against
which it is willing to lend to include higher-risk assets.
[310]
The Economist wrote in May 2009: "Having spent a fortune bailing out their banks, Western governments will have
to pay a price in terms of higher taxes to meet the interest on that debt. In the case of countries (like Britain and
America) that have trade as well as budget deficits, those higher taxes will be needed to meet the claims of foreign
creditors. Given the political implications of such austerity, the temptation will be to default by stealth, by letting
their currencies depreciate. Investors are increasingly alive to this danger..."
[311]
88
The crisis has cast doubt on the legacy of Alan Greenspan, the Chairman of the Federal Reserve System from 1986
to January 2006. Senator Chris Dodd claimed that Greenspan created the "perfect storm".
[312]
When asked to
comment on the crisis, Greenspan spoke as follows:
[175]
The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely
liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home
equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for
residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the
crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally,
will be able to get back to business.
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98
Further reading
Fengbo Zhang (2008): 1. Perspective on the United States Sub-prime Mortgage Crisis (http:/ / sites. google. com/
site/ fengbozhang/ m), 2. Accurately Forecasting Trends of the Financial Crisis (http:/ / sites. google. com/ site/
forecastfinancialcrisis/ ), 3. Stop Arguing about Socialism versus Capitalism (https:/ / sites. google. com/ site/
usatoday2008/ ).
Archaya and Richardson. Financial Stability: How to Repair a Failed System NYU Stern Project-Executive
Summaries of 18 Crisis-Related Papers (http:/ / media. wiley. com/ assets/ 1706/ 87/
NYU_Stern_Executive_Summaries. pdf)
Committee for a Responsible Federal Budget " Stimulus Watch, (http:/ / www. usbudgetwatch. org/ stimulus)"
(Updated Regularly).
Blackburn, Robin (2008) " The Subprime Mortgage Crisis, (http:/ / www. newleftreview. org/ ?view=2715)" New
Left Review 50 (MarchApril).
Demyanyk, Yuliya (FRB St. Louis), and Otto Van Hemert (NYU Stern School) (2008) " Understanding the
Subprime Mortgage Crisis, (http:/ / papers. ssrn. com/ sol3/ papers. cfm?abstract_id=1020396)" Working paper
circulated by the Social Science Research Network.
DiMartino, D., and Duca, J. V. (2007) " The Rise and Fall of Subprime Mortgages, (http:/ / www. dallasfed. org/
assets/ documents/ research/ eclett/ 2007/ el0711. pdf)" Federal Reserve Bank of Dallas Economic Letter 2(11).
Dominique Doise, Subprime: Price of infringements/Subprime : le prix des transgressions (http:/ / www.
alerionavocats. com/ fr/ expertise/ publications/ subprime-le-prix-des-transgressions-price-of-infringements/ ),
Revue de droit des affaires internationales (RDAI) / International Business Law Journal (IBLJ), N 4, 2008
Ely, Bert (2009) Bad Rules Produce Bad Outcomes: Underlying Public-Policy Causes of the U.S. Financial
Crisis, (http:/ / www. cato. org/ pubs/ journal/ cj29n1/ cj29n1-8. pdf) Cato Journal 29(1).
Don Tapscott, 2010. Macrowikinomics, Publisher Atlantic Books
Gold, Gerry, and Feldman, Paul (2007) A House of Cards From fantasy finance to global crash. London, Lupus
Books. ISBN 978-0-9523454-3-5
Michael Lewis, " The End, (http:/ / www. portfolio. com/ news-markets/ national-news/ portfolio/ 2008/ 11/ 11/
The-End-of-Wall-Streets-Boom)" Portfolio Magazine (November 11, 2008).
Lewis, Michael (2010). The Big Short: Inside the Doomsday Machine. London: Allen Lane.
ISBN0-393-07223-1.
Liebowitz, Stan (2009) " Anatomy of a Train Wreck: Causes of the Mortgage Meltdown (http:/ / www.
independent. org/ pdf/ policy_reports/ 2008-10-03-trainwreck. pdf)" in Randall Holcombe and B. W. Powell, eds.,
Housing America: Building out of a Crisis (http:/ / www. independent. org/ store/ book_detail. asp?bookID=76).
Oakland CA: The Independent Institute.
Muolo, Paul, and Padilla, Matthew (2008). Chain of Blame: How Wall Street Caused the Mortgage and Credit
Crisis. Hoboken, NJ: John Wiley and Sons. ISBN978-0-470-29277-8.
Woods, Thomas E. (2009) Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy
Tanked, and Government Bailouts Will Make Things Worse / Washington DC: Regnery Publishing ISBN
1-59698-587-9
Reinhart, Carmen M., and Kenneth Rogoff (2008) " Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An
International Historical Comparison, (http:/ / www. economics. harvard. edu/ faculty/ rogoff/ files/
Is_The_US_Subprime_Crisis_So_Different. pdf)" Harvard University working paper.
Stewart, James B., "Eight Days: the battle to save the American financial system", The New Yorker magazine,
September 21, 2009.
Clark, Kenneth E. Legacy of Greed: The Story Behind the Mortgage and Housing Meltdown, Publisher: Author
Solutions ISBN 978-1-4520-5439-1 http:/ / www. kennetheclark. com
Review of Mark Zandi's book Financial Shock: A 360 Look at the Subprime Mortgage Implosion, and How to
Avoid the Next Financial Crisis (http:/ / www. nybooks. com/ articles/ 22280) from The New York Review of
99
Books
Zandi, Mark Book Excerpt: Financial Shock-Chapter 1 (http:/ / www. economy. com/ mark-zandi/
financial-shock/ financial-shock. pdf)
External links
Financial Crisis Inquiry Commission Homepage (http:/ / www. fcic. gov/ )
Report of Financial Crisis Inquiry Commission-January 2011 (http:/ / www. gpo. gov/ fdsys/ pkg/ GPO-FCIC/
pdf/ GPO-FCIC. pdf)
Reuters: Times of Crisis (http:/ / widerimage. reuters. com/ timesofcrisis) multimedia interactive charting the
year of global change
PBS Frontline Inside the Meltdown (http:/ / www. pbs. org/ wgbh/ pages/ frontline/ meltdown/ )
PBS - What You Need to Know About the Crisis (http:/ / www. pbs. org/ wgbh/ pages/ frontline/
business-economy-financial-crisis/ money-power-wall-street/
dig-deeper-what-you-need-to-know-about-the-financial-crisis/ )
"Government warned of mortgage meltdown Regulators ignored warnings about risky mortgages, delayed
regulations on the industry" (http:/ / money. cnn. com/ 2008/ 12/ 01/ news/ ignored_warnings. ap/ index. htm).
CNN. December 1 2008. Retrieved 2010-05-24.
"The US sub-prime crisis in graphics" (http:/ / news. bbc. co. uk/ 2/ hi/ business/ 7073131. stm). BBC. 21
November 2007.
CNN Scorecard of Bailout Funds at CNN Bailout Allocations & Payments (http:/ / money. cnn. com/ news/
specials/ storysupplement/ bailout_scorecard/ index. html)
Barth, Li, Lu, Phumiwasana and Yago. 2009. The Rise and Fall of the U.S. Mortgage and Credit Markets: A
Comprehensive Analysis of the Market Meltdown. Amazon (http:/ / www. amazon. com/ dp/ 0470477245)
Financial Times In depth: Subprime fall-out (http:/ / www. ft. com/ indepth/ subprime)
The Crisis of Credit Visualized Infographic by Jonathan Jarvis (http:/ / vimeo. com/ 3261363)
The Economic Crisis: Its Origins and the Way Forward (http:/ / www. bu. edu/ phpbin/ buniverse/ videos/ view/
?id=346) Video of lecture given by Marshall Carter, chairman of the New York Stock Exchange, at Boston
University, April 15, 2009
The True American Dream (http:/ / 72. 5. 117. 181/ economica/ stories/ viewStory?storyid=3667) Home
Ownership, the Subprime Lending Crisis, and Financial Instability by Masum Momaya International Museum
of Women
The Financial Crisis: What Happened and Why Lecture 2 (http:/ / www. aynrand. org/ site/
PageServer?pagename=arc_financial_crisis) Video of lecture given in July 2009, by Yaron Brook, professor of
finance and executive director of the Ayn Rand Center for Individual Rights
Lectures by Ben Bernanke to an economics class at George Washington University March, 2012
"Chairman Ben Bernanke Lecture Series Part 1" (http:/ / www. ustream. tv/ recorded/ 21242022) Recorded
live on March 20, 2012 10:35am MST
"Chairman Ben Bernanke Lecture Series Part 3" (http:/ / www. ustream. tv/ recorded/ 21404362) Recorded
live on March 27, 2012 10:38am MST
Article Sources and Contributors
100
Article Sources and Contributors
European sovereign-debt crisis Source: http://en.wikipedia.org/w/index.php?oldid=528739070 Contributors: 4pq1injbok, ABMvandeBult, Adaniels85, Aid85, Ajfweb, Albicor, Alcea setosa,
Alex1011, Alinor, Allens, Andi47, Andrewlp1991, Anna Lincoln, AnonMoos, Anothroskon, Arnoutf, Art LaPella, Arthur Rubin, Athenean, B.Andersohn, BD2412, BIL, Bdell555, Belchman,
Bender235, Benjamin M. Anderson, Benjamin9832, Bentery, Billinghurst, Binksternet, Blaisorblade, Bomazi, Boson, Brandmeister, Branlon, Breein1007, Brenont, Briaboru, CYYK,
CactusWriter, Caeruleancentaur, Capedia, Carachi, Cassowary, Cattus, CecilWard, Cerebellum, Che829, Chiton magnificus, Chris the speller, ChrisGualtieri, Circeus, Ckatz, Clithering, Cogiati,
Connolly15, CopperSquare, CorvetteZ51, CouchRambo, Creedence, Crnorizec, Cs32en, CultureArchitect, Curb Chain, Cybercobra, DaLeBu, Damac, Dan Guan, DanielRigal, Danish Expert,
Datastat, Daveopen, Davepoth, De Administrando Imperio, Dearieme, Deenoe, Deltabeignet, Delusion23, Denisarona, Devourer09, Dewritech, Dimboukas, Dinkytown, Doctorhawkes,
Dolescum, Dondervogel 2, Dr.K., Dreamer5656, DriveMySol, Drpickem, Dumelow, Eastlaw, Eco84, Edward, El Duende, Elatanatari, Eleassar, ElfMage, Emanuel Kingsley, Enok, Erathouis,
Erget2005, Espoo, Eug.galeotti, Eumolpo, Ewawer, Exok, Facts707, Falcon9x5, Farcaster, Farzaneh, Faustbol, Fayries, FeydHuxtable, FinHits, FormerIP, Fred Bauder, Friginator, Funandtrvl,
Gammondog, Gareth E Kegg, Gcruzlop, Georgeloy, Gfcvoice, Gniniv, Gposes01, Green-ops, Greenshed, Gregkaye, Ground Zero, Grrr81, Gsarwa, Guyphillips, HJ Mitchell, Hairgelmare,
Halsteadk, Happolati, Hari akku, Haslaki, Haukep19, Henry4444, Hideokun, Hmains, Holy Santa, HonorTheKing, Hooiwind, Hugo999, Hvn0413, Hydrox, Ianare, Iloveandrea, Imperial
Monarch, Impru20, Inhumanfat, Insilvis, InverseHypercube, Ipafes, Ipigott, Its snowing in East Asia, Ivibee, J intela, JaGa, Jason from nyc, Jax 0677, Jethro B, Jnn0810, Jo3sampl, John, John
Ericson, John Z, JohnC, JohnGH, Johnmccoll, JokerXtreme, Jollyr, Jph, Jprw, Jpvandijk, Keenan Pepper, Keith D, Kilopi, Kintetsubuffalo, Kittybrewster, Kozuch, Kris1912, Ktr101, Kuru, Ky23,
L1A1 FAL, LMB, Lady Pablo, Lawrencekhoo, Lenartwiki, Leotohill, Lex Pecunia, Lihaas, Lillyallenrocks, LittleWink, Luisldq, MER-C, MSkriver, Majorbolz, Malekhanif, Mansmokingacigar,
Marek69, Mark t young, MathewTownsend, Mecanismo, Megiddo1013, Mens Sana, Menswear, Mephistophelian, Mgiganteus1, Michael Zimmermann, Mike Young, Mild Bill Hiccup, Miltimj,
Mimihitam, Mistakefinder, Mjs1991, Mk5384, Moe Epsilon, Molh394, Moorehaus, Moriori, Mporter, MrOllie, Mrfebruary, Mulder1982, Mw0001, Myriamrobin, Naccy5122, Narayanese,
NativeClient, Nbarth, Neumannk, Neun-x, Nhb2011, Nheilmann, Noclador, Nopetro, Nsk92, Nunocordeiro, Oakley77, Ohconfucius, Ohnoitsjamie, Oneiros, Onepebble, Opera hat, Oreo Priest,
Paris1127, Paul Pieniezny, Paul White, Pauli133, Paum89, Pavlos03, PedroPVZ, Peregrine981, Pgreenfinch, Phalinshah, Philly boy92, Piotrus, Planetary Chaos Redux, Plankto, Platinumshore,
Pointillist, Polisciasu, Pontificalibus, Professionalgeek, ProgRockLover, Psinu, Pufferfish101, Pyrotec, Quest for Truth, Quest09, Rannphirt anaithnid, Rcsprinter123, Red Hurley, Red King,
Redrose64, Redthoreau, Reidlos, Renewolf, Rich Farmbrough, Richardbourke, Rick AUT, Rickyrab, Rinconsoleao, Rizalninoynapoleon, Rjwilmsi, Robo Cop, Rod57, Ronanmurphy98, RoyBoy,
Rubinkumar, Rye1967, S.rvarr.S, Samofi, Sandstein, Sardath, Saurael, Schrdinger's Neurotoxin, SchuminWeb, Seemorr, SelectSplat, Sfan00 IMG, Shadowmorph, Shattered, Shawnc,
ShoWPiece, Shokioto22, Shrike, SimonP, Skartsis, Skogkatten, Skookum1, Slaterino, Sligocki, Sm8900, Smallbones, Smocking, Smsagro, Smyth, Snow storm in Eastern Asia, Solferino, Spitzl,
Sreyan, Stanjourdan, Staticshakedown, Statisfactions, StephenDawson, SteveSoho, Stifynsemons, Strike Eagle, Student7, Sulmues, Sun Creator, Suomi Finland 2009, Supreme Deliciousness,
Surv1v4l1st, Sustainlogic, Swliv, SylviaStanley, Tco03displays, Tech56, Tenth Plague, TerraFrost, ThaddeusB, The Celestial City, The Gnome, Theyenguy, Tim!, TimidGuy, Tophat13,
Tpbradbury, Treybien, Trinitresque, Ubernot, Uditichopra, Uxejn, Van Vidrine, Vanakaris, Vcirulli, Velho, Vgy7ujm, Vitacore, Volgar, VsevolodKrolikov, Vuo, Vvarkey, Walter Grlitz,
Wasbeer, Wasell, Watercolor merger, Waterdorf, Wavelength, Welshleprechaun, WhisperToMe, WikiWikiPhil, Wikibioecoeros, Wikidea, Wikireader41, Will Beback, Williameis, Wipsenade,
Wolftengu, Woohookitty, Wportre, WriterHound, Wwoods, Xaliqen, Y256, YechezkelZilber, Yellowdesk, Ykliu, Ylee, Yug, Zachlipton, Zidonuke, 678 anonymous edits
Subprime mortgage crisis Source: http://en.wikipedia.org/w/index.php?oldid=529114124 Contributors: 03md, 155ws, 164CL, 17Drew, 2ArgArg, ABF, ALL HAIL MEGATRON!, Aaron
Schulz, Abouyamourn, AceFactFinder, Acerimusdux, Aecis, Afelton, Agnaramasi, Agnistus, AgnosticPreachersKid, Airplaneman, Aitias, Akadonnew, Akrabbim, Alan.chatham,
AlbertaSunwapta, Alcator, Aldaron, Alethiareg, Alex1011, Alexgeorgeka, Allsaint25, Altenmann, Amads, American2, Amiyatosh, Ancheta Wis, Andersonbd1, AndrewHowse, Andrewkreid,
Andrewpmk, Aneeshwiki, Angusmclellan, Anisrectorum357, Antandrus, Anthony, Anthony Appleyard, Arie, Arknascar44, Art LaPella, Artoasis, Asthma bronchiale, Astor14, Astrotrain,
Atomicdor, Atoric, Auntof6, Ave Caesar, Avenue, Awakeatmidnight, B.d.mills, BURNyA, BandieraRossa, BanyanTree, Barryob, Bdarbs, Beano, Beardo, Bearian, Beland, Belowenter,
BenKovitz, Benbest, Bender235, Bennyfactor, Berny, BigK HeX, Binh Giang, BioPupil, Bkell, Blablablob, Black-Velvet, Bleekblock, BoH, Bobo192, Bobsharps, Bonadea, Bondwonk,
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CTho, Calatayudboy, Calvin 1998, CambridgeBayWeather, Can't sleep, clown will eat me, Canterbury Tail, Capnmarko, Capnquackenbush, Capricorn42, Captain-tucker, Carolmooredc,
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smith, CliffC, Clinevol98, Closedmouth, CoJaBo, Codem01, ConradPino, Cornellrockey, CosineKitty, Crayon101, Creativethinker85, Cretog8, CrimsonEye78, Critical Chris, Cruane, Cskor,
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Drcwright, Dustman81, Dvink, Dwight666, EJSawyer, Eastlaw, EconomistBR, Eddiet19, Edward, Edward Vielmetti, Eka k, El T, Elenseel, Entoaggie09, Epbr123, Epstein's Mother, Erc,
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Hapsala, Hello32020, Heron, Hgd4th, HitchensDennett, Hmains, Hobawido, HolyT, Horace.wk.chan, Horatio, Hu12, Husk1919, Hypnosadist, Hypnotic180, I.pezzuto, ILikeHowMuch, IW.HG,
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Peterlewis, Peterxyz, Pgreenfinch, Philip Trueman, PhilipO, Phl, Phoenixauthor, Photomy, Physics-fan3.14, Pink Piggy Banke, Piquant, Plymouthpictures, Pnm, Pocopocopocopoco,
Potatoswatter, Prk166, Professor marginalia, ProfessorPaul, Proofreader77, Psemmusa, Puchiko, QTCaptain, Quasirandom, QueenofBattle, Quigonpaj, R'n'B, R8o6d4e0d0, RHB, RL0919, Radio
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File:Fed Funds Rate & Mortgage Rates 2001 to 2008.png Source: http://en.wikipedia.org/w/index.php?title=File:Fed_Funds_Rate_&_Mortgage_Rates_2001_to_2008.png License: Creative
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