Sovereign Debt and the European Crises

The USA sub prime mortgage crises was a set of events that created a financial crisis in the USA and by contagion lead to recession in the world. A rise in the defaults on sub prime mortgages created this crisis. The main reason was private competitive mortgage securitization.

When excessive lending to sub prime customers began a decline in housing prices was observed. This lead to rising delinquencies in payments by borrowers.  Parallel to this disaster sub prime mortgage backed securities.  These were sold to investors world wide. The problem began when people stopped paying. This caused the investors to lose confidence. Which further lead to the American recession. People pulled money out of the banks and stopped investing in them. The fuel which was required to give momentum to banks was dried up. It was then that the government thought of opting for the last resort of QE.

Screen Shot 2016-03-05 at 8.54.56 PM

America loves giving presents to the world. The recession was just the beginning.Screen Shot 2016-03-05 at 8.52.20 PM.png



Let b1, b2…… be banks. You can see the inter dependence on each other. Imagine if one of these banks undergo a run on the bank situation, what will happen to the other banks? They will be drastically affected. This is the gift USA gave to Europe.


To understand what happened in Europe we have to go in its past.

  1. 1942 – world war 2
  2. 1990 – cold war
  3. 1990- 92 – collapse of E. European communism
  4. 7th February 1992 – Maastricht treaty
  5. 1992 – Creation of Euro
  6. 1992 onwards – Monetary union EU
  7. 2000- My birth year
  8. 2000 onwards – Problems begin, period of high accumulation
  9. 2000 – 2008 – Securitization of future government revenues to reduce debt. Property bubble- Spain and Ireland, high social spending- Greece, Uncontrolled government expenditure- Portugal (PIGS- Portugal, Italy, Greece, Spain)
  10. 2000 – 2009 – Inter bank lending and banks holding govt. debt
  11. 2008 onwards – Global recession sub prime crises

Thunder falls on Euro- a. High debt levels in Portugal, poor demand in Greece, high bank exposure in Cyprus, property bubbles in Spain and Portugal

  1. All this lead to nations inability to service debt
  2. 2010 – 2012 – EFSM, EFSF
  3. 2012 – ESM 500 billion euros.
  4. 2012 – 2013 – Pressure on top performers
  5. 2016 – Political fall out in Germany and France.



The problems faced by EU were

  1. Many govt. kept spending heavily on social sector programs due to easy credit, example is Greece (LMP)
  2. In Spain and Portugal huge property bubbles were formed and they were financed by banks. Banks demanded bail out. Government had to recapitalize banks and had to go to ECB
  3. In Portugal decades of extravagant government spending had destroyed balance.
  4. Cyprus was favorite destination of Russians to invest in but unfortunately Cyprus banks funded Greece. Banks holding Greece debt were hit hard.
  5. The best part was that all of this happened when USA was facing sub prime mortgage crises.


Let me tell you a story of a son who was very sweet, sincere and extremely stupid. One day his father asked him to come home before 10 PM every day. He promised he would. The next day he came back at 7PM. After that 8, 9, 9:45, 8 and one day he came back at 12. His father said, “I asked you to come back before 12 why didn’t you.” The son said sorry. The next day the son came back at 12:30. His father was left with three options, he could beat his son and knock some sense of responsibility in him, kick him out of the house or forget what happened and let the child do whatever he wants.


These were the actual solutions by EU.

The could go bust and let the banks drown, severe austerity, nail out at tax payers expense, ECB + IMF bail out.


To measure health of an economy various ratios can be created. Here are two of those.



X axis: Deficit to GDP %

Y axis: Debt to GDP %


6.8, 177 – Greece

1.9, 21 – LuxembourgScreen Shot 2016-03-05 at 8.52.10 PM

See, taking debt is not bad. It is necessary for developing countries. After a while saving replace debt and are used to pay back net debt.

(Net debt = Sigma deficits)


Year Deficit Debt
2014 D1 ND2= ND1 + D1
2015 D2 ND3= ND2 + D2
2016 D3 ND4= ND3 + D3
. . .
. . .
20xy S1 NDm= NDm-i – S1



But Eu really messed up. I don’t see savings in the near future. So I would propose these solutions.


1)Creation of European fiscal union is a must if nations aberrations are not to affect the entire Eurozone.

2)Strict penalties for nations who breach the Maastricht criteria.

3)Strong austerity measures.

4)High GDP growth though increase in productivity per person.

5)Imposition of a one-time wealth tax to garner extra revenue

The rest is up to you EU.




One comment

  1. Neeraj goel · March 6, 2016

    Very informative.


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