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March 14 After months of tortuous and tense negotiations, a second bailout for Greece finally became a reality when

euro zone nations formally approved the plan and authorized the release of the first multibillion-euro loan installment. The plan is valued at 130 billion euros ($170 billion). March 9 Greece said that it had clinched a landmark debt restructuring deal with its private sector lenders. The deal clears the way for the release of bailout funds from Europe and the International Monetary Fund that will save the country from imminent default. The Greek finance ministry said that 85.8 percent of private creditors holding 177 billion euros in Greek bonds participated in the bond swap. After invoking collective action clauses, provisions that will force the holdouts to accept the offer, the participation rate would rise to 95 percent and meet the target set by Europe and the I.M.F. for the release of crucial rescue funds. March 2 A European summit meeting that had looked to be surprisingly routine after two years of crisis nevertheless ended with another test for the credibility of the euro zone, as Spain announced that a deepening recession meant it would have to abandon its deficit-reduction targets for 2012. March 1 The International Swaps and Derivatives Association said that based on current evidence the Greek bailout would not prompt payments on the credit-default swaps linked to the countrys bonds. But the organization warned that the situation in Greece was still evolving and such payouts might be necessary in the future as further facts come to light. Feb. 29 The European Central Bank allocated another huge round of cheap, three-year loans to eurozone banks of the kind that have helped avert a crisis. Banks asked to borrow 529.5 billion, or $713 billion, compared to 489 billion in Decembers offer of three-year loans. Feb. 28 The European Central Bank acted to prevent a potential collapse of the Greek banking system, after the country was declared by Standard & Poors to be in selective default, making Greek bonds ineligible as collateral for E.C.B. loans. The E.C.B. said banks could continue to draw cash from national central banks temporarily under a separate program known as emergency liquidity assistance. The central bank said it would accept Greek bonds as collateral again in mid-March, when European Overview Since the fall of 2009, the European Union has been struggling with a slow-moving but unshakable crisis over the enormous debts faced by its weakest economies, such as Greece and Portugal, or those most battered by the global recession, like Ireland. A series of negotiations, bailouts and austerity packages have failed to stop the slide of investor confidence or to restore the growth needed to give struggling countries a way out of their debt traps. By August 2011 European leaders found themselves scrambling once again to intervene in the markets, this time to protect Italy and Spain, two countries seen as too big to bail out.

The crisis has produced the deepest tensions within the union in memory, as Germany in particular has resisted aid to countries it sees as profligate, and has raised questions about whether the euro can survive as a multinational currency, since countries like Greece have been unable to boost their exports by devaluing their own currency. A reluctant, indirect intervention by the European Central Bank in late 2011 led the crisis fever to cool considerably, as it lent vast sums to banks on easy terms to head off a liquidity crunch. But crisis has given way to a grinding reality for Europe of economic stagnation and even, for much of the Continent, the specter of another downturn less than three years after the last recession ended. Many analysts say the belt-tightening demanded by France and Germany as a condition of aid for weaker nations can only push those and other nations further into recession, sap the economies of their European trading partners and do little to address the systemic weaknesses plaguing Europes banks. The economic crisis gradually became a political one as well, leading to the ouster of governments in Ireland, Portugal, Greece, Italy, Spain, Finland and Romania. Protests by traditional interest groups like public sector unions were joined by crowds of young people who camped out in Madrid and Athens in imitation of the Arab Spring demonstrations. Nationalist groups gained in popularity in many countries, and Hungarys conservative government made sweeping changes that the European Union denounced as steps toward autocracy. Fall of 2011: Fears Grow In the fall of 2011, even as European leaders struggled to come up with a new bailout plan for Greece, much larger fears loomed. Interest rates soared for Italy, the continents third largest economy, and rose for France, whose banks hold large amounts of Italian government bonds, and where government finances are strained. The continents economy was teetering on the brink of a second recession. A growing number of economists called for the European Central Bank to step forward as a lender of last resort, as the Federal Reserve has done, to stop the contagion. But the bank, whose mandate is focused solely on preventing inflation, has resisted, saying a political solution is required. As the crisis deepened, banks in Europe began to hoard capital, straining the finances of their counterparts and hurting companies across the globe that depend on them for loans. In December, leaders of the countries that use the euro agreed to an intergovernmental pact adopting tighter fiscal controls. All 17 of the countries that use the euro agreed to join, as did six others. But Britain refused, raising questions about its future in which it has become increasingly isolated. The agreement, which can be adopted more quickly than a change to the European Union treaty — and without Britains consent — would reassert rules limiting deficits to 3 percent of gross domestic product and total debt to 60 percent. Violators would be hit with sanctions unless a majority of other countries agreed.

After the summit, the familiar pattern of market relief followed by new market worries was repeated. But on Dec. 21, banks borrowed more than $600 billion from the European Central Bank at the extraordinarily easy terms of 1 percent interest for a threeyear loan. Analysts suggested that the Bank had hit upon an indirect method of stopping the market spiral threatening Italy, Spain and other governments, by flooding banks with money they could use to lock in guaranteed profits by buying sovereign debt. Greece Dodges Default With a Second Bailout By early 2012, the sense of crisis had returned, as the leaders of France and Germany threatened to withhold the second aid package without further cuts and promises of structural economic changes. At the same time, Greece plunged into meetings with banks and hedge funds about deeper writedowns on its debt up to as much as 70 percent. The proposed austerity package included 20-percent cuts to base pay for workers in private companies and a loosening of public sector job protections. With elections looming as soon as April, the three parties that make up Mr. Papademoss coalition feared that they were essentially being told to commit political suicide to save the country. The European Unions plan of tax increases, spending cuts and now wage cuts has pushed the country into a deep recession; the economy shrunk by almost 12 percent between 2009 and 2011 and is expected to shrink by up to 6 percent in 2012. The crisis also stripped Greeces political center, weak to begin with, of its last shreds of political legitimacy. With unemployment at 21 percent, businesses closing, credit scarce and the proposed new wage cuts expected to further decimate the shrinking middle class, the hard left and extreme right are rising. In early February, Mr. Papademos reached a deal to support the new austerity measures with two of his coalition members, the Socialists and New Democracy, a center right party. The right-wing party, Popular Orthodox Rally, balked, but is too small to block the deal, which includes a 22 percent cut in the benchmark minimum wage and cuts of 150,000 public sector layoffs. Greek workers responded by walking off the job for the second general strike in a week. Street demonstrations in Athens turned violent, and 80,000 people marched in protest the day before Parliament approved the package on Feb. 13. Once the deal was finalized and the measures approved by the Greek Parliament, lenders were expected to begin releasing to Greece the aid it needs to prevent a default when its next debt payment comes due on March 20, 2012. On Feb. 21, after more than 13 hours of talks in Brussels, European finance ministers approved a new bailout of 130 billion euros, or $172 billion, subject to Greece taking immediate steps to put the deep structural changes that they agreed to into effect. Greece must persuade, if not actually force, its private sector bond holders to accept a higher than expected loss of more than 70 percent on their holdings to reduce Greeces debt stock by the targeted amount of 100 billion.

The agreement included a reduction in interest rates on loans from Greeces first rescue in 2010, and European central banks foregoing profit on their Greek bond holdings, that allowed the deal to satisfy a mandate set by the International Monetary Fund that Greeces debt come down to 120.5 percent of gross domestic product by 2020. Though Greece may have dodged a default with its last-minute bailout deal, longer-term doubts over its ability to repay its staggering debts remained, raising questions about whether even more rescue money will eventually be needed. It is uncertain if another round of austerity can bring Greece to a point whereby it generates enough revenue to pay off its obligations even if the private sector debt deal goes through and return to the market on its own. The Debt Deal After months of hardball, high-wire negotiations, Greece announced on March 9, 2012, that it had clinched a landmark debt restructuring deal with its private sector lenders. The deal clears the way for the release of bailout funds from Europe and the International Monetary Fund that will save the country from imminent default. The Greek finance ministry said that 85.8 percent of private creditors holding 177 billion euros in Greek bonds participated in the bond swap. After invoking collective action clauses, provisions that will force the holdouts to accept the offer, the participation rate would rise to 95 percent and meet the target set by Europe and the I.M.F. for the release of crucial rescue funds. The ministry also said that 69 percent of investors holding a category of Greek bonds issued under laws other than Greek law had agreed to the exchange or about 20 billion worth. This figure was much higher than anticipated because many of these investors were expected to either challenge Greece in court or hold out for better terms. For Greece, the better than expected numbers highlights the success of the aggressive legal strategy to force bond holders to take up the exchange even though they would accept a big loss in the process. Seen at first as a risky gambit that could end up badly, the take-it-or-leave-it approach mixed in with tough rhetoric from public officials in Greece and Europe proved to be highly effective as it forced even the most reluctant investors to tender their bonds. The value of Greek 10-year bonds had shortly before hit a record low of 16 cents on the euro. Downgrading Frances Credit Rating On Jan. 13, 2012, Standard & Poors stripped France of its sterling credit rating, downgrading it one notch from AAA to AA+. The ratings agency also cut Portugals credit to junk status and downgraded Italys debt by two steps in a wide-ranging revision of European countries caught in the euro crisis.

The actions, which lowered the ratings of nine countries, would be the strongest signal yet that Europes sovereign debt woes were far from over and would pose fresh political challenges for politicians as they try to stabilize the problem on the Continent. A downgrade by a single ratings agency like Standard & Poors could have an immediate, though not devastating, impact on the countries ability to borrow money. S.& P. warned in December 2011 that the agency was reviewing the credit ratings of 15 European Union countries because of the crisis. Germany and the Netherlands, which were on the original list, did not receive a downgrade. In addition to Italy and Portugal, two nations Spain and Cyprus had their ratings cut by two notches. Austria, Malta, Slovenia and Slovakia, along with France, were lowered by one grade. The ratings of the other countries in the review Belgium, Estonia, Ireland and Luxembourg were unchanged. The ratings revisions came at the end of a week in which Mr. Sarkozy and Prime Minister Mario Monti of Italy warned that the crisis could deepen if steps were not taken to stoke growth. Both delivered their messages to Chancellor Angela Merkel in her offices in Berlin, prompting the German leader to admit for the first time that the harsh program of austerity she has been pushing on the euro zone was not a cure-all for the crisis. An Escalating Spiral of Debt? As difficult as the last two years have been for Europe, 2012 could be even tougher. Each week, countries will need to sell billions of dollars of bonds a staggering $1 trillion in total to replace existing debt and cover their current budget deficits. At any point, should banks, pensions and other big investors balk, anxiety could course through the markets, making government officials feel like they are stuck in a scary financial remake of Groundhog Day. Even if governments attract investors at reasonable interest rates one month, they will have to repeat the process again the next month and signs of skittish buyers could make each sale harder to manage than the previous one. The challenge for Europe is to keep Italy and Spain from ending up like Greece and Portugal, whose borrowing costs rose so high in 2011 that it signaled real likelihood of default, making it impossible for the governments to find buyers for their debt. Since then, Greece and Portugal have been reliant on the financial backing of the European Union and the International Monetary Fund. The intense focus on the sovereign debt auctions and their importance to the broader economy starkly underscores the difference between European and American responses to their crises. Since 2008, there has been almost no private sector interest to buy new United States residential mortgage loans, the financial asset at the root of the countrys crisis. To make

up for that lack of investor demand, the federal government has bought and guaranteed hundreds of billions of dollars of new mortgages. But the crisis response in the United States did not depend solely on government-backed entities like the Federal Reserve to buy housing loans. Banks and investors also took large losses on existing housing debt. While painful, the mortgage debt proved less of a drag on the financial system. So far, Europe has been averse to taking permanent losses on government bonds. Except in the case of Greek debt, European policy makers have shied away from any plan that could mean private holders of government debt get hurt. Such haircuts might seem like the recipe for more instability. But if Europe struggles to find buyers for its debt, more radical options are likely to be considered. Europes debt problem is huge, and the experience in the United States suggests dealing with it may take several, more drastic approaches. In February 2012, Eurostat, the unions statistical agency, said the debt ratios of the 17 euro zone countries as a whole rose to 87.4 percent of G.D.P. from 83.2 percent a year earlier. For all of the 27 European Union nations, the debt ratio rose to 82.2 percent from 78.5 percent. Those averages remain below the roughly 100 percent for the United States and 200 percent for Japan. Among the most indebted euro members, Italys debt ratio rose 0.5 point to 119.6 percent in the third quarter from a year earlier, though it did show progress in shaving 1.6 points from the second quarter of 2011. Portugals debt ratio rose 18.9 points from a year earlier, to 110.1 percent, while Irelands rose more than 16 points, to 104.9 percent. Background The debt crisis first surfaced in Greece in October 2009, when the newly elected Socialist government of Prime Minister George A. Papandreou announced that his predecessor had disguised the size of the countrys ballooning deficit. But its roots of the crisis go back further, beginning with a strong euro and the rockbottom interest rates that prevailed for much of the previous decade. Greece took advantage of this easy money to drive up borrowing by the countrys consumers and its government, which built up $400 billion in debt. In Spain and Ireland, government spending was kept under control, but easy money helped turn real-estate booms there into bubbles a process helped in Irelands case by the aggressive deregulation of its banks that helped draw investment from around the world. After the bubble burst, the Irish government made the banks problems its own by guaranteeing all their liabilities. After the extent of Greek debt was revealed, markets reacted by sending interest rates up not only for its debt, but also for borrowing by Spain, Portugal and Ireland.

In early 2010, the European Union and the International Monetary Fund put together a series of bailout packages for Greece that totalled 110 billion euros ($163 billion) in a process that critics said ended up costing more because European leaders failed to get ahead of the curve. In May, leaders approved a contingency fund of 500 billions euro (about $680 billion) for the union at large. The hope was that the fund would never have to be tapped, as its existence would calm investors. But in the fall of 2010 interest rates began creeping up again, as countries that reduced spending to meet tough deficit targets found themselves falling farther behind, as their economies slowed and revenues declined. In November, European officials arranged a bailout of 85 billion euros (roughly $112 billion) for Ireland, after overcoming the resistance of Irish officials to the move, which they saw an attack on sovereignty. (In fact, news of the deal led Prime Minister Brian Cowen to announce that he would step down after passing a new round of budget cuts, and his party was ousted at the next election). In the spring of 2010, after much hesitation, the European Union and the International Monetary Fund combined first to offer Greece a bailout package of 110 billion euros ($163 billion), followed by a broader contingency fund of 500 billions euro (about $680 billion). The hope was that this show of financial force would reassure markets about the solvency of euro countries. But the new loans, combined with the effect of the austerity measures demanded of Greece, Ireland and Portugal, drove them into recession and did little to ease their debt burden — Greeces debt load even increased. As the debt crisis renewed over the winter of 2010 and spring of 2011 it led to the fall of governments in Ireland and Portugal, and saw unrest rise in Spain, where unemployment remained close to 20 percent. Contagion Fears Return By the summer of 2011, it was clear that Greece would need a second big bailout package, and worries rose again about contagion, as Italy and Spain saw the interest rates charged on its borrowing rise steeply. The European Central Bank responded by buying large amounts of Italian and Spanish bonds, as leaders put together a plan that would increase the powers of the European Financial Stability Facility to head off a run' on governments seen as in danger of default. By September, with growth slowing, stalled or in reverse across the continent, European leaders were increasingly discussing the creation of a central financial authority with powers in areas like taxation, bond issuance and budget approval that could eventually turn the euro zone into something resembling a United States of Europe. But talk of long-term solutions did little to calm markets worried about the weakness of banks in France and elsewhere that held large amounts of debt from Greece and other shaky governments. And the resignation of Jrgen Stark, a top German official at the European Central Bank, highlighted the depth of policy discord among senior policymakers. Mr. Stark, like many German officials, had opposed the banks large-scale purchases of government debt.

Another potential crisis bubbled up in September, as European officials angrily warned Greece that the next installment of its bailout funding would be withheld in October — a step that would lead to certain bankruptcy — unless further radical cuts in government spending were pushed through. Earlier that summer, Greece, which had started the crisis, faced its more dire fiscal emergency, as it stood to run out of cash in August without a new installment of money from the first bailout. European leaders refused to release the funds until a second, more drastic round of austerity measures were adopted, including the sale of $72 billion in state assets. The government of Prime Minister George Papandreou teetered, but the measure was pushed through after days of giant street protests. The basic conflict over the shape of a new bailout plan was between Germanys chancellor, Angela Merkel, who insisted that private banks pay part of the cost by taking losses on Greek bonds, and the European Central Bank, who opposed even a voluntary haircut' for banks, saying it would be seen as a default. July Agreement Falls Behind the Curve The deal reached in late July included $157 billion in new funds for Greece and a modest reduction of its debt burden; private lenders saw their bonds rolled over into longer maturities but also had them guaranteed. And the European Financial Stability Facility, the eurozone rescue fund, saw its contingency fund grow to 440 billion euros, or $632 billion, and was given new, amplified powers and the ability to use the money to bail out Portugal and Ireland if necessary. The response to the package was not what leaders hoped: investors began driving up interest rates in Italy and Spain, economies too large to be bailed out by the new arrangements. At the same time, the fall in confidence threatened to undermine the big banks in those countries, whose large holdings of government bonds began to lose value. On Aug. 7, 2011, the European Central Bank said it would actively implement its bondbuying program to address dysfunctional market segments, a statement interpreted as a sign that it will intervene to prevent borrowing costs for Italy and Spain from becoming unsustainable. Vowing Closer Paths To address the growing debt crisis, Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France met on Aug. 16, 2011 at the lyse Palace in Paris. The leaders promised to take concrete steps toward a closer political and economic union of the 17 countries that use the euro. They called for each nation in the euro zone to enshrine a golden rule into their national constitutions to work toward balanced budgets and debt reduction, a level of discipline well beyond the current, oft-broken commitment. They also pledged to push for a new tax on financial transactions, and for regular summit meetings of the zones members. Both leaders ruled out issuing collective bonds, known as eurobonds, to share responsibility for government debt across member states, and they opposed a further increase in a bailout fund that will not be put into place until late September 2011 at the

earliest. Mrs. Merkel said there was no magic wand to solve all the problems of the euro, arguing that they must be met over time with improved fiscal discipline, competitiveness and economic growth among weaker states. But a growing number of leaders in September began quietly discussing a broader plan for greater fiscal integration — since the alternatives could include the collapse of the euro or increasing conflict over bailouts. Officials said a major overhaul of the way Europe conducts fiscal policy was likely to take a long time and require changes in the treaties governing the euro. But they pointed to the smaller changes that were already taking place as evidence that euro area financial ministries see that they have little choice but to move together if they want to avoid a catastrophic breakdown. Increasing Distress The talks took place against a background of increasing continent-wide distress. Official figures released in August 2011 showed that quarterly growth in the euro zone fell to its lowest rate in two years. Germany the Continents powerhouse slowed almost to a standstill. Most of Europes main stock indexes lost ground after the data suggested that the debt and economic problems in countries like Greece and Italy were infecting the rest of the 17-country euro zone. Meanwhile, leaders groped for a way to expand the effective firepower of the bailout fund, the European Financial Stability Facility, amid a general agreement that the boost agreed to in July was no longer adequate to calm the markets fears about big economies like Spain and Italy. One suggestion, pushed by the Obama administration, was to use the facilitys funds to guarantee loans from the European Central Bank rather than to make loans directly. Also in September, Greece pushed through a hugely unpopular property tax increase as part of a new austerity package needed to keep installments of the first bailout package flowing. And the eurozones members crept through the process of signing off on the July agreement, with crucial votes in favor coming from Germany and Finland, which had threatened to block it unless it got higher levels of collateral on its contribution. Under the fretful gaze of investors, the meandering approval process has revealed ever more fissures, layers of decision making and complexity in Europe that adds up to a worrisome inability to react quickly and decisively to upheaval in fast-moving financial markets.

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(Article) European Debt Crisis: A New Fear of Collapse


Submitted by IASguru on Mon, 2011-01-10 13:36

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European Debt Crisis: A New Fear of Collapse

Fears of a sovereign debt crisis developed In early 2010 concerning some countries in Europe including: Greece, Ireland, Spain, 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 EU members, most importantly Germany. Concern about rising government deficits and debt levels across the globe together with a wave of down grading of European Government debt has created alarm on financial markets. The debt crisis has been mostly centred on recent events in Greece, where there is concern about the rising cost of financing government debt. On 2 May 2010, the Euro zone countries and the International Monetary Fund agreed to a 110 billion loan for Greece, conditional on the implementation of harsh Greek austerity measures. On 9 May 2010, Europe's Finance Ministers approved a comprehensive rescue package worth almost a trillion dollars aimed at ensuring financial stability across Europe.

Stimulates
The Greek economy was one of the fastest growing in the euro zone during the 2000s; from 2000 to 2007 it grew at an annual rate of 4.2% as foreign capital flooded the country. A strong economy and falling bond yields allowed the government of Greece to run large structural deficits. According to an editorial published by the Greek newspaper Kathimerini, large public deficits are one of the features that have marked the Greek social model since the restoration of democracy in 1974. After the removal of the right leaning military junta, the government wanted to bring disenfrachised left leaning portions of the population into the economic mainstream. In order to do so, successive Greek governments have, among other things, run large deficits to finance public sector jobs, pensions, and other social benefits. Initially currency devaluation helped finance the borrowing. After the introduction of the euro Greece was initially able to borrow due the lower interest rates government bonds could command. Since the introduction of the Euro, debt to GDP has remained above 100%. The global financial crisis that began in 2008 had a particularly large effect on Greece. Two of the country's largest industries are tourism and shipping, and both were badly affected by the downturn with revenues falling 15% in 2009. To keep with in the monetary union guidelines, the government of Greece has been found to have consistently and deliberately misreported the country's official economic statistics. In the beginning of 2010, it was discovered that Greece had paid Goldman Sachs and other banks hundreds of millions of dollars in fees since 2001 for arranging transactions that hid the actual level of borrowing. The purpose of these deals made by several subsequent Greek governments was to enable them to spend beyond their means, while hiding the actual deficit from the EU overseers.

In 2009, the government of George Papandreou revised its deficit from an estimated 6% (or 8% if a special tax for building irregularities were not to be applied) to 12.7%. In May 2010, the Greek government deficit was estimated to be 13.6% which is one of the highest in the world relative to GDP. Greek government debt was estimated at 216 billion in January 2010. Accumulated government debt is forecast, according to some estimates, to hit 120% of GDP in 2010. The Greek government bond market is reliant on foreign investors, with some estimates suggesting that up to 70% of Greek government bonds are held externally. Estimated tax evasion costs the Greek government over $20 billion per year. Despite the crisis, Greek government bond auctions have all been over-subscribed in 2010 (as of 26 January). According to the Financial Times on 25 January 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."

Downgrading of Debt
On 27 April 2010, the Greek debt rating was decreased to 'junk' status by Standard& Poor's amidst fears of default by the Greek government. Yields on Greek government two-year bonds rose to 15.3% following the downgrading. Some analysts question Greece's ability to refinance its debt. Standard & Poor's estimates that in the event of default investors would lose 3050% of their money. Stock markets worldwide declined in response to this announcement. Following down gradings by Fitch, Moody's and S&P, Greek bond yields rose in 2010, both in absolute terms and relative to German government bonds. Yields have risen, particularly in the wake of successive ratings downgrading. According to the Wall Street Journal "with only a handful of bonds changing hands, the meaning of the bond move isn't so clear." As of 6 May 2010, Greek 10- year bonds were trading at an effective yield of 11.31%. On 3 May 2010, the European Central Bank suspended its minimum threshold for Greek debt "until further notice", meaning the bonds will remain eligible as collateral even with junk status. The decision will guarantee Greek banks' access to cheap central bank funding, and analysts said its hould also help increase Greek bonds' attractiveness to investors. Following the introduction of these measures the yield on Greek 10-year bonds fell to 8.5%, 550 basis points above German yields, down from 800 basis points earlier.

Austerity and Loan Agreement


On 5 March 2010, the Greek parliament passed the Economy Protection Bill, expected to save 4.8 billion through a number of measures including public sector wage reductions. Passage of the bill occurred amid widespread protests against government austerity measures in the Greek

capital, Athens. On 23 April 2010, the Greek government requested that the EU/IMF bailout package be activated. The IMF has said it was "prepared to move expeditiously on this request". Greece needs some of the money before 19 May, when it faces a debt roll over of $11.3bn. On 2 May 2010, a loan agreement was reached between Greece, the other euro zone countries, and the International Monetary Fund. The deal consists of an immediate 45 billion in low interest loans to be provided in 2010, with more funds available later. A total of 100 billion has been agreed. The interest for the Euro zone loans is 5%, considered to be a rather high level for any bailout loan. The government of Greece agreed to impose a fourth and final round of austerity measures.

These include:

Public Sector limit introduced of 1,000 to biannual bonus, abolished entirely for those earning over 3,000 a month. Cuts of 8% on public sector allowances and 3% pay cut for DEKO (public sector utilities) pay cheques. Freeze on increases in public sector wages for three years. Limit of 800 to 13th and 14th month pension installment. Abolished for those pensioners receiving over 2,500 a month. Return of special tax (LAFKA) on high pensions. Changes planned to the laws governing layoffs and overtime pay. Extraordinary taxes on company profits. Increases in VAT to 23%, 11% and 5.5%. 10% rise in taxes on alcohol, cigarettes, and fuels. 10% increase in luxury taxes. Equalisation of men's and women's pension age limits. General pension age does not change but a mechanism is introduced to scale them to life expectations changes. Creation of a financial stability fund. Average retirement age for public sector workers increased from 61 to 65. Public-owned companies to diminish from 6,000 to 2,000.

On 5 May 2010, a national strike was held in opposition to the planned spending cuts and tax increases. Protest on that date was widespread and turned violent in Athens, killing three people and injuring dozens. According to research published on 5 May 2010, by Citibank, the EMU loans will be pari passu and not senior like those of the IMF. In fact the seniority of the IMF loans themselves has no

legal basis but is respected nonetheless. The amount of the loans will cover Greece's funding needs for the next three years (estimated at 30bn for the rest of 2010 and 40bn each for 2011 and 2012). Citibank finds the fiscal tightening "unexpectedly tough". It will amount to a total of 30 billion (i.e. 12.5% of 2009 Greek GDP) and consist of 5 pp of GDP tightening in 2010 and a further 4 pp tightening in 2011.

Danger of Default
Without a bailout agreement, there was a possibility that Greece would have been forced to default on some of its debt. The premiums on Greek debt had risen to a level that reflected a high chance of a default or restructuring. One analyst gave a 80 to 90% chance of a default or restructuring. Martin Feldstein called a Greek default "inevitable." A default would most likely have taken the form of a restructuring where Greece would pay creditors only a portion of what they were owed, perhaps 50 or 25 percent. This would effectively remove Greece from the euro, as it would no longer have collateral with the European Central Bank. It would also destabilise the Euro Inter bank Offered Rate, which is backed by government securities. Since Greece is on the euro, it cannot print its own currency. This prevents it from inflating away a portion of its obligations or otherwise stimulating its economy with monetary policy. For example, the U.S. Federal Reserve expanded its balance sheet by over $1.3 trillion since the global financial crisis began, essentially printing new money and injecting it into the system by purchasing outstanding debt. The overall effect of Greece being forced off the euro, would itself have been small for the other European economies. Greece represents only 2% of the euro zone economy. The more severe danger is that a default by Greece will cause investors to lose faith in other Euro zone countries. This concern is focused on Portugal and Ireland, all of whom have high debt and deficit issues. Italy also has a high debt, but its budget position is better than the European average, and it is not considered amongst the countries most at risk. Recent rumours raised by speculators about a Spanish bail-out were dismissed by Spanish President Mr. Zapatero as "complete insanity" and "intolerable". Spain has a comparatively low debt amongst advanced economies, at only 53% of GDP in 2010, more than 20 points less than Germany, France or the US, and more than 60 points less than Italy, Ireland or Greece, and it doesn't face a risk of default. Spain and Italy are far larger and more central economies than Greece, both countries have most of their debt controlled internally, and are in a better fiscal situation than Greece and Portugal, making a default unlikely unless the situation gets far more severe.

Objections to Proposed Policies

The crisis is seen as a 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 could 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. Joseph Stiglitz has also criticised the EU for being too slow to help Greece, insufficiently supportive of the new government, lacking the will power to set up sufficient "solidarity and stabilisation framework" to support countries experiencing economic difficulty, and too deferential to bond rating agencies. An alternative to the bailout agreement, would have been Greece leaving the Euro zone. Wilhelm Hankel, professor emeritus of economics at the University of Frankfurt am Main 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 its 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.

EU Emergency Measures
On 9 May 2010, Europe's Finance Ministers approved, in an emergency meeting, a rescue package that could provide 750 billion Euros for crisis aid aimed at ensuring financial stability across Europe. The package announced has three components: The first part expands a 60 billion (US$70 billion) Euro group's stabilisation fund (European Financial Stabilization mechanism). Countries will be able to draw on that fund but activation will be subject to strict conditionalities. It is intended to help any member of the euro zone that is struggling to finance its debts because of high interest rates demanded by the financial markets. All EU countries contribute to this fund on a pro-rata basis, whether they are euro zone countries or not. The second part worth 440 billion (US$570 billion) consists of government-backed loans to improve market confidence. The loans will be issued by a Special purpose vehicle (SPV) managed by the Commission and backed by the explicit guarantee of the EMU member states and the implicit guarantee of the European Central Bank. All euro zone economies will participate in funding this mechanism, while other EU members can choose whether to participate. Sweden and Poland have agreed to participate, while the UK's refusal prompted strong criticism from the French government, along with a threat that euro zone countries would not support the

pound in the case of speculative attacks. Denmark will not contribute despite its participation in the European Exchange Rate Mechanism. Finally the third part consists of 250 billion (US$284 billion), half the size of the EU participation, with additional contribution from the International Monetary Fund. The agreement also allowed the European Central Bank to start buying government debt which is expected to reduce bond yields. (Greek bond yields fell from over 10% to just over 5%; Asian bonds also fell with the EU bailout.) The ECB has also announced a series measures aimed at reducing volatility in the financial markets and at improving liquidity: First, it began open market operations buying government and private debt securities. Second, it announced two 3-month and one 6- month full allotment of Long Term Refinancing Operations (LTRO's). Thirdly, it reactivated the dollar swap lines with Federal Reserve support. Subsequently, the member banks of the European System of Central Banks started buying government debt. Stocks worldwide surged after this announcement as fears that the Greek debt crisis would spread subsided, some rose the most in a year or more. The Euro made its biggest gain in 18 months, before falling to a new four-year low a week later. Commodity prices also rose following the announcement. The dollar Libor held at a nine-month high. Default swaps also fell. The VIX closed down a record almost 30%, after a record weekly rise the preceding week that prompted the bailout. Despite the moves by the EU, the European Commissioner for Economic and Financial Affairs, Olli Rehn, called for "absolutely necessary" deficit cuts by the heavily indebted countries of Spain and Portugal. Private sector bankers and economists also warned that the threat from a double dip recession has not faded. Stephen Roach, chairman of Morgan Stanley Asia, warned about this threat saying "When you have a vulnerable post-crisis economic recovery and crises reverberating in the aftermath of that, you have some very serious risks to the global business cycle. " Nouriel Roubini said the new credit available to the heavily indebted countries did not equate to an immediate revival of economic fortunes: "While money is available now on the table, all this money is conditional on all these countries doing fiscal adjustment and structural reform." After initially falling to a four-year low early in the week following the announcement of the EU guarantee packages, the euro rose as hedge funds and other short-term traders unwound short positions and carry trades in the currency.

Long-Term Solutions
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, an EU member country. This reactive tool is sometimes dubbed as the European Monetary Fund by the media. The second is a single authority responsible for tax policy oversight and government spending coordination of EU member countries. This preventive tool is dubbed the European Treasury. The monetary fund would be supported by EU member governments, and the treasury would be supported by the European Commission. 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 euro zone member states and are opposed by key EU nations such as France and Italy, which could jeopardise the establishment of a European Treasury. Some think-tanks such as the CEE Council have argued that the predicament some EU countries find themselves in is the result of a decade of debt fueled Keynesian policies pursued by local policy makers and complacent EU central bankers, and have recommended the imposition of a battery of corrective policies to control public debt. Some senior German policy makers went as far as to say that emergency bailouts should bring harsh penalties to EU aid recipients such as Greece. Others argue that an abrupt return to "non- Keynesian" financial policies is not a viable solution and predict the deflationary policies now being imposed on countries such as Greece and Spain might prolong and deepen their recessions. The Economist has suggested that ultimately the Greek "social contract," which involves "buying" social peace through public sector jobs, pensions, and other social benefits, will have to be changed to one predicated more on price stability and government restraint if the euro is to survive. As Greece can no longer devalue its way out of economic difficulties it will have to more tightly control spending than it has since the inception of the Third Hellenic Republic. Regardless of the corrective measures chosen to solve the current predicament, as long as cross border capital flows remain unregulated in the Euro Area, asset bubbles and current account imbalances are likely to continue. For example, a country that runs a large current account or trade deficit (i.e., it imports more than it exports) must also 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 also borrow to pay for those imports. Conversely, Germany's large trade surplus (net export position) means that it must also be a net exporter of capital, lending money to other countries to allow them to buy German goods. The 2009 trade deficits for Spain, Greece, and Portugal were estimated to be $69.5 billion, $34.4B and $18.6B, respectively

($122.5B total), while Germany's trade surplus was $109.7B. 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 broad. 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. 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. However, many of the countries involved in the crisis are on the Euro, so this is not an available solution at present. Alternatively, trade imbalances might be addressed by changing consumption and savings habits. For example, if a country's citizens saved more instead of consuming imports, this would reduce its trade deficit. Likewise, reducing budget deficits is another method of raising a country's level of saving. Capital controls that restrict or penalize the flow of capital across borders is another method that can reduce trade imbalances. Interest rates can also be raised to encourage domestic saving, although this benefit is offset by slowing down an economy and increasing government interest payments. The suggestion has been made that long term stability in the euro zone 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.

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