User:Dearieme

In early 2010, following downgrading by international ratings agencies, fears of a sovereign debt crisis developed concerning some countries in the Euro Area, specifically: Greece, Spain, Italy, and the Republic of Ireland, and Portugal. This led to a crisis of confidence as well as the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other Eurozone members, most importantly Germany.

Concern about rising government deficits and debt levels across the globe together with a wave of downgrading of European Government debt has created alarm on financial markets. In Europe the debt crisis has been mostly centred on recent events in Greece where there is concern about the rising cost of financing Greek Government debt.

Greek government funding crisis

The crisis in Europe began in Greece. Prior to the global financial crisis Greece had both a high current account deficit and a large government debt relative to annual GDP. The global recession led to a further deterioration in the government's finances. Greece government deficit is currently estimated to be 13.6%which one of the highest in the world relative to GDP.

Greek government debt was estimated at €216 billion in January 2010. [1]Accumulated government debt is forecast, according to some estimates, to hit 120% of GDP this year. This is considerably more than the OECD average of circa 80% but less than the debt accumulated by Japan, currently at around 180% of annual GDP. One of the key problems surrounding the Greek government bond market, however, is its reliance on foreign investors with some estimates suggesting that up to 70% of Greek government bonds are held externally.

Greek government bond Auctions have all been over-subscribed in 2010 [2]. According to the Financial Times on January 25, 2010 "Investors placed about €20bn ($28bn, £17bn) in orders for the five-year, fixed-rate bond, four times more than the (Greek) government had reckoned on." In March, again according to the Financial Times, "Athens sold €5bn (£4.5bn) in 10-year bonds and received orders for three times that amount." Similarly in April 2010 the sale of more than 1.5 billion euros ($2 billion) in Treasury bills met with "stronger-than-expected" demand.

Despite strong investor demand, yields have risen and in an attempt to lower its cost of financing and calm bond markets, the Greek government has introduced fiscal austerity and appealed to the EU for assistance in lowering the cost of refinancing its large public debt and in fending off speculative attacks on its bond market.

Global context

Niall Ferguson writes that "the sovereign debt crisis that is unfolding ... is a fiscal crisis of the western world". Financing needs for the Eurozone in 2010 come to a total of €1.6 trillion, while the US is expected to issue US$1.7 trillion more Treasury securities in this period, and Japan has ¥213 trillion of government bonds to roll over. The countries most at risk are those that rely on foreign investors to fund their government sector. According to Ferguson similarities between the U.S. and Greece should not be dismissed.

Rising bond yields in some government bond markets have intensified the fear that the emerging sovereign debt issues could become a global contagion. Given the deterioration in government accounts there is growing concern that this crisis will spread to the United States which has a limited domestic savings pool, a high public sector deficit, and a large accumulated government debt and relies on foreign capital inflows for funding, in contrast to the Euro Area which does not.

Recent U.S. government bond auctions have been very poorly received , both because of the perceived risk associated with a U.S. Dollar depreciation relative to the Chinese RMB and because of the enormous funding requirement of the U.S. government. Some commentators have termed recent U.S. public debt auctions "failures".

Role of credit rating agencies

The international credit rating agencies – Moody's, S&P and Fitch – have played a pivotal and controversial role in the current European bond market crisis. These agencies entered 2010 with their reputations already severely damaged by their consistent failure to identify real risks evident in their failure to downgrade U.S. sub-prime mortgage bonds in 2007 prior to the recent financial crisis. The failures of agencies to accurately identify risk where it exists dates back decades, ratings agencies did not identify Enron as a risk, they failed to predict the bankruptcy of all the largest Icelandic banks in 2008 and the consequent severe financial weakening of Iceland itself, they failed to identify risks in the Newly Industrialised Countries in Asia before the Asian crisis of the 1990s and they failed in Latin America.

The German finance minister has said traders should not take global rating agencies “too seriously” following in the light of downgrades of Greece, Spain and Portugal. Guido Westerwelle, German foreign minister, called for an “independent” European rating agency, which could avoid the conflicts of interest that he claimed US-based agencies faced. According to the Financial Tmes "The latest furore over the agencies’ role in the sovereign debt market" is likely to bring about more supervision of these agencies.

In an effort to limit the damage caused by rating downgrades the European Central Bank has announced that it will keep accepting BBB- rated debt as collateral past the end of the year, ensuring Greek bonds will still be eligible even as the country's credit rating deteriorates. Meanwhile, European leaders are reportedly studying the possibility of setting up a European ratings agency in order that the U.S.-based ratings agencies have less influence on developments in European financial markets in the future. Given what is seen by many as the reckless conduct of the ratings agencies European regulators will be given new powers to supervise ratings agencies. These supervisory powers will come into effect in December 2010.

Controversies

There has been considerable controversy about the role of the English-language press in the regard to the bond market crisis. The Spanish Prime Minister has ordered Spanish intelligence services to investigate the role of the Anglo-Saxon media in fomenting the crisis. No results have so far been reported as a result of this investigation.

According to the Spanish newspaper "El Pais" "the National Intelligence Center (CNI) was investigating "whether investors' attacks and the aggressiveness of some Anglo-Saxon media are driven by market forces and challenges facing the Spanish economy, or whether there is something more behind this campaign."". The Spanish Prime Minister has suggested that the recent financial market crisis in Europe is an attempt to draw international capital away from the Euro in order that countries, such as the U.K. and the U.S. can continue to fund their large external deficits which are matched by large government deficits. The U.S. and U.K. do not have large domestic savings pools to draw on and therefore are dependant on external savings. This is not the case in the Euro Area which is self funding.

The 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".

The role of Goldman Sachs in the Greek bond 'crisis' is also under scrutiny . 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. Speculators and hedge funds engaged in selling Euros have also been accused by both the Spanish and Greek Prime Ministers of worsening the crisis. Angela Merkel has stated that "institutions bailed out with public funds are exploiting the budget crisis in Greece and elsewhere".

Spread beyond Greece

According to the Financial Times: "So far, investors have concentrated their ire on peripheral eurozone economies because of the zone's inability to resolve cleanly the Greek crisis. That is understandable, say many economists, but they add that the focus on continental Europe is unfair."

According to David Mackie of JPMorgan "the euro area has the fiscal capacity to backstop banks across the region and to support the sovereign states of Greece, Spain, Portugal and Ireland, along with some help from the IMF." Jürgen Stark, a European Central Bank executive board member, said restoring sustainability to the public finances was "even harder for the UK, the US and Japan. Given their high budget deficits and the high and rising debt levels". Mr Stark's analysis is not merely an attempt to divert attention from the eurozone. It is identical to that of the IMF.

The fund believes that most advanced economies need to tighten fiscal policy significantly in the next decade to stabilise debt at 60 per cent of national income by 2030. The tightening needed in the US, Japan and the UK is just as bad as that required in Greece.

The crisis has reduced confidence in other Eurozone economies. According to some analysts Ireland, with a government deficit of 14.3 percent of GDP, Spain with 11.2 percent, and Portugal at 9.4 percent are most at risk. In April 2010, following a market increase in Irish 2-year bond yields, Ireland's NTMA state debt agency said that it had "no major refinancing obligations" in 2010. Its requirement for €20 billion in 2010 was matched by a €23 billion cash balance, and it remarked: "We're very comfortably circumstanced".

Since the crisis began yields have risen as rating agencies downgraded debt. S&P's downgraded the sovereign bonds for Portugal two notches to A- and in issuing a negative outlook, warned that further downgrades are likely unless drastic measures towards austerity are taken. As a result of these downgrades, fears were raised over the possible contagion effect to other bond markets in vulnerable Eurozone countries. The focus on government debt has led to a weakening of the euro which was welcomed in Germany, one of the world's leading exporters.

Proposed corrective policies

European Union leaders have made two major proposals for ensuring fiscal stability in the long term. The first proposal is the creation of a common fund responsible for bailing out, with strict conditions, a EU member country in the brink of default. This reactive tool is sometimes dubbed as the European Monetary Fund by the media. The second much older proposal is the construction of single authority responsible for tax policy oversight and government spending coordination of EU member countries. This preventive tool is dubbed as the European Treasury. The monetary fund is to be financially supported, at least initially by EU member governments, and on the other hand, the treasury is to be financially supported by the European Commission. All of the EU proposals involve giving greater power to EU institutions and reducing policy choices of EU member states.

Regardless of the corrective measures chosen to solve the current predicament as long as cross border capital flows remain unregulated in the Euro Area [3], asset bubbles [4] current account imbalances are likely to continue. The suggestion has been made that long term stability in the eurozone requires a common fiscal policy rather than controls on portfolio investment. In exchange for cheaper funding from the EU, Greece and other countries, in addition to having already lost control over monetary policy and foreign exchange policy since the Euro came into being, would therefore also lose control over domestic fiscal policy.

However, strong European Commission oversight in the fields of taxation and budgetary policy and the enforcement mechanisms that go with it have been described as infringements on the sovereignty of eurozone member states and are opposed by key EU nations such as France and Italy, which could jeopardize the establishment of a European Treasury.

Objections to proposed policies

The Greek government bond market sell off is seen as justification for imposing fiscal 'austerity' on Greece in exchange for European funding which would lower borrowing costs for the Greek government. The negative impact of tighter fiscal policy would though offset the positive impact of lower borrowing costs and social disruption could have a significantly negative impact on investment and growth in the longer term.

Fiscal austerity leading to a deeper recession would see Greek bond markets rally and Greek yields fall thus guaranteeing that European holders of Greek government debt would retain the value of their investments at the cost of a severe contraction of the Greek economy. Draconian fiscal policy measures aimed exclusively at lowering Greek bond yields would increase the mark-to-market value of Greek government bonds at the expense of the Greek people. The 'rescue package' proposed by the EU and IMF [5] would simply protect foreign holders of Greek government bonds, who invested in Greek bonds at inflated values, at the expense of the local economy. Such policies have been used frequently by the IMF in recent decades, and have attracted much criticism.

Wilhelm Hankel, emeritus professor of economics at the University of Frankfurt/MainSome, suggested in an article published in the Financial Times, that the preferred solution to the Greek bond 'crisis' is a Greek exit from the Euro followed by a devaluation of the currency. Fiscal austerity or a Euro exit is the alternative to accepting differentiated government bond yields within the Euro Area. If Greece remains in the Euro while accepting higher bond yields, reflecting it's high government deficit, then high interest rates would dampen demand, raise savings and slow the economy. An improved trade performance and less reliance on foreign capital would result.