See how Europe’s debt crisis began and evolved.
The euro is introduced with 11 founding countries
Earlier in the decade, in 1992, the European Economic Community was officially formed with the signing of the Maastricht Treaty. The euro was introduced and adopted by 11 countries in 1999. Those countries were Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. Greece joined in 2001.
National currencies began to be phased out in 2002, and the euro became the official currency of the region. Since 2007, five other countries have joined the euro area, including Slovenia, Cyprus, Malta, Slovakia and Estonia.
Lehman Brothers collapses; financial crisis spreads
Though the U.S. economy had officially slipped into a recession in 2007, the collapse of the investment bank Lehman Brothers kicked the global financial crisis into high gear. On Friday, Sept. 12, 2008, the Standard & Poor’s 500 index closed at 1,251.70. Lehman Brothers filed for bankruptcy Sept. 15. Over the ensuing months, the S&P 500 index would lose nearly half its value, bottoming out March 9, closing at 676.53.
Everyone from the Federal Reserve, government regulators, mortgage lenders, the shadow banking industry, ratings agencies and millions of American homeowners were implicated in the growth of the housing bubble and the fallout from the pop. Within days, the crisis spread to Europe, where economies in Russia and Pakistan contracted and governments from England to Germany stepped in to bail out banks. Iceland went bankrupt.
Greece’s budget deficit higher than previously thought
Greece’s budget deficit was revealed to be 12.7 percent of gross domestic product, or GDP, nearly twice what it was thought to be and four times higher than it was supposed to be. In addition, its debt-to-GDP ratio was twice the limit allowed in the treaty, which established the common currency.
In order to become a full member of the euro area, countries had to fulfill the convergence criteria spelled out in the Maastricht Treaty. The agreement required that countries keep inflation in check and their budgets in order. Prerequisites were also set for exchange rates and interest rates.
Originally, member countries were required to have government deficits of no more than 3 percent of GDP. Also the debt-to-GDP ratio was required to be no more than 60 percent of GDP. The Stability and Growth Pact was reformed in 2005 to allow a little more flexibility.
Unfortunately, the budget troubles of Greece surpassed even the widest wiggle room. Though the Greek prime minister at the time, George Papandreou, declared that Greece’s budget deficit was 12.7 percent of GDP, Eurostat later reported that the Greek budget deficit in 2009 was actually 13.6 percent of GDP. Eurostat is the statistical office of the European Union.
Spain and Portugal launch austerity measures
In 2009, Spain’s budget deficit totaled 11.2 percent of GDP.
By May 2010, the country’s economic problems came fully to light and Spain’s Prime Minister Jose Luis Rodriguez Zapatero announced cuts to the salaries of public employees and slashed pension and government funding, the BBC reported in 2010.
Next door, in Portugal, the government announced plans to cut the budget deficit in March and in November passed an austerity budget that cut public spending and raised taxes, the BBC reported in November 2010.
Greece asks for a loan
On April 23, 2010, then Greek Prime Minister George Papandreou announced that Greece would take a 45 billion euro loan from eurozone countries and the International Monetary Fund to avoid default.
The announcement that Greece needed financial assistance followed three attempts at fiscal austerity measures unveiled between 2009 and March 2010. The third was passed in March 2010 and included a plan to raise taxes and cut spending. State pensions were frozen, civil service bonuses were cut and public sector payrolls were slashed.
The ECB begins buying bonds under the Securities Markets Program
On May 10, 2010, the ECB announced the beginning of the Securities Markets Program. The plan was that the central bank would buy sovereign debt to “ensure depth and liquidity in those market segments which are dysfunctional.” For instance, when Italian bond yields would spike beyond sustainability and no investors would buy them, the ECB would step in. The bond purchases were also sterilized, which means that for every investment purchased by the central bank, an equivalent amount of money would be taken out of circulation.
EU takes action and creates special funds to preserve financial stability
In May 2010, the European Financial Stability Facility, or EFSF, was created to provide loans to cash-strapped countries. The EFSF issues bonds that are guaranteed by the euro-area countries. The EFSF also props up floundering banks or financial institutions through loans to governments.
The EFSF is considered a special-purpose vehicle or, in other words, a company designed specifically for a very narrow set of objectives — in this case, lending money to struggling countries.
Established at the same time, the European Financial Stabilisation Mechanism, or EFSM, would also lend to struggling countries. According to the European Commission’s website, the EFSM “allows the Commission to borrow on financial markets on behalf of the EU under an EU budget guarantee. The Commission then lends the proceeds on to the beneficiary member state.”
European banks perform poorly in stress tests, revealing major weaknesses
Banks across the European Union were tested for their ability to weather adverse events in July 2010. Out of 91 tested, seven failed. Some critics noted that the tests did not include the possibility of a sovereign default, which called into question the credibility of the tests.
Ireland applies for and receives a bailout
In November 2010, Ireland reluctantly took a bailout from the IMF, the European Commission and the bailout fund, the EFSF, in the amount of about 85 billion euros.
Portugal requests and receives bailout
On April 7, 2011, Portugal requested a bailout and reached a deal on the bailout package in mid-May. The deal gave them a three-year loan of up to 78 billion euros from the European Financial Stabilisation Mechanism, the European Financial Stability Facility and the IMF.
European Central Bank raises interest rates in April and July
To fight inflation, the European Central Bank raised interest rates April 7 and again in July. In April, the Governing Council raised the interest rate on the main refinancing operations of the Eurosystem by 25 basis points to 1.25 percent. On July 7, the ECB again raised interest rates by 25 basis points to 1.5 percent.
In March 2011, inflation in the eurozone was 2.6 percent, Eurostat estimated. The ECB has a target inflation rate of below 2 percent.
Plans for the permanent rescue fund, the European Stability Mechanism, are launched
July 11, 2011, brought the first signing of the treaty establishing the European Stability Mechanism, or the permanent bailout fund designed to replace the European Financial Stability Facility and the European Financial Stabilisation Mechanism. The new bailout fund would be able to lend up to 500 billion euros and would be funded by euro-area countries. The original launch date was July 2013 , but that was later moved to summer 2012 and then pushed back to launch in late 2012.
EU countries ask Greek bond holders to take a 50 percent haircut. European banks are shored up and lending capacity of the EFSF is jacked up to 1 trillion euros
On Oct. 27, leaders from the 17 euro-area countries met in Brussels and agreed to write down Greek debt by 50 percent. (In February 2012, the Germans register their opposition to the plan but it’s too late — by March, Greek debt is sliced by slightly more than half.)
At the same meeting in Brussels, it was agreed that European banks needed more cash or cash equivalents on hand to guard against shocks from the sovereign debt exposure. Leaders at the Brussels meeting also agreed to increase the lending capacity of the bailout fund, the European Financial Stability Facility, a move that was later finalized by finance ministers in late November.
Hungary requests bailout
In November, Hungary made an official request for assistance from the IMF. Hungary is one of the countries that is a noneuro-area member, defined as countries that have not yet adopted the euro.
(As of October 2012 , negotiations between Hungary and the International Monetary Fund have not been resolved due to the economic conditions attached to the loan.)
U.S. Federal Reserve adjusts dollar liquidity swap arrangement
On Nov. 30, 2011, the U.S. Federal Reserve joined up with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank to make dollar liquidity swaps less expensive for the European Central Bank and arranged for them to be in place until February 2013.
The central bank also established foreign currency liquidity swap arrangements with the five other central banks in case the Federal Reserve needed to offer liquidity in foreign currency to American banks. So far the lines have not been activated .
During the financial crisis, the Federal Reserve authorized swaps with central banks around the world. The swaps make it easier for central banks to provide U.S. dollars to financial institutions in their countries when they can’t get loans from anyone else.
Technically, it is a swap: The Federal Reserve gets euros in exchange for dollars. In May 2010, the swap lines were re-established as things got murky in the euro area.
ECB cuts interest rates in November and December to 1 percent
On Nov. 1, 2011, Mario Draghi took over for Jean-Claude Trichet as the president of the European Central Bank. Right after he took over the post, the Governing Council of the ECB voted to lower interest rates two months in a row on fears that the euro area was being pulled back into a recession.
In December the central bank also embarked on two longer-term refinancing operations, or LTROs, in order to keep banks flush with cash. The terms of the LTROs allowed the ECB to make low-interest loans to banks, maturing in three years, for which the banks could use their country’s sovereign bonds as collateral. Before the debt crisis the maturity of LTROs was three months.
The first LTRO in late December gave 489 billion euros to 523 banks. In March 2012, the second 36-month LTRO allotted 530 billion euros to 800 banks.
ECB buys Italian and Spanish bonds after Italian bond yields rise precipitously
On Jan. 6, 2012, as part of the Securities Markets Program, the ECB stepped in to purchase Italian and Spanish bonds after yields jumped as high as 7.12 percent on 10-year Italian bonds, The Wall Street Journal reported.
Treaty signed that would make the ESM effective by July 2012
On Feb. 2, 2012, following a decision made in December, European leaders sign a second treaty on the European Stability Mechanism, this time moving up the effective date to July 2012. The beginning of the permanent bailout fund would be delayed by a lawsuit in Germany questioning the legality of the country’s participation in the ESM. The hearing would be held Sept. 12.
Greek debt deal is reached; S&P considers it a default
On Feb. 21, 2012, eurozone finance ministers hammered out the final details of writing down Greek debt.
On Feb. 27, 2012, ratings agency Standard & Poor’s dropped the Greek credit rating to Selective Default. In May, the rating was upgraded to CCC, three notches up from default.
On March 9, 2012, one of the conditions of the debt write-down was that enough of Greek’s creditors had to agree to the loss, and they did: 85.8 percent agreed to the haircut of 53.5 percent, “a real loss of 74 percent when the loss in future interest payments is taken into account,” the Christian Science Monitor reported in March 2012.
Hungary fails to hit budget targets; EU finance ministers vote to suspend payments
On March 13, 2012, Hungary became the first country to be rebuked for failing to fall in line with the EU’s budget requirements — the convergence criteria that all the countries agreed to before joining the monetary union. European finance ministers voted to stop the payment of 495.2 million euros to be made in 2013 as part of Cohesion Fund commitments. Payments from the Cohesion Fund are available to countries in the European Union with a lower-than-average gross national income in order to speed up their progress toward joining the monetary union.
In January, Hungary’s prime minister had been accused of trying to nudge the government toward a more authoritarian bent. The European Commission began legal proceedings against the government for trying to pass measures that would have curtailed the independence of the central bank and the judiciary in Hungary.
In June, the payment to Hungary was reinstated after the government produced plans to institute permanent measures that would push the budget deficit below 3 percent of GDP.
Spain requests bailout for banks only, to avoid all the strings that came with bailouts to other countries
On June 9, 2012, Spain announced that it would take a bailout in order to help the flailing financial sector. As the funds would only go to banks, there would be no austerity requirements attached to the 100 billion euro loan.
Cyprus requests bailout
On June 25, 2012, due to exposure to Greek debt, Cyprus became the fifth eurozone country to request a bailout following Spain’s bank bailout request. As negotiations between the island’s government and the troika dragged on into September, it was widely estimated that Cyprus would need a loan of up to 10 billion euros, which represents more than half of its 17 billion euro economy.
ECB cuts interest rates to 0.75 percent
On July 5, 2012, the European Central Bank met and dropped a key interest rate to 0.75 percent, which lowered the cost of borrowing for banks in the eurozone. The central bank also dropped the rate paid on deposits to zero, giving banks little incentive to keep surplus funds on deposit with the central bank outside of the amount that must be kept on reserve. Instead, the money could be used for loans to other banks or businesses.
ECB announces new sterilized bond-buying program
On Sept. 6, 2012, following an August meeting that hinted at the plan, the ECB announced that it would launch an unlimited but sterilized bond-buying program. Sterilizing the purchases means that the central bank would offset bond purchases by taking money out of circulation to avoid increasing the money supply. The new program known as Outright Monetary Transactions will replace the Securities Markets Program.
Under the new plan, the ECB will buy sovereign debt from countries that formally request bailouts. Continued aid will be conditional on adherence to strict budget requirements.
German court OKs participation in the permanent bailout fund, the ESM
On Sept. 12, 2012, the permanent bailout fund, the European Stability Mechanism, got the go-ahead from a German court. The ESM was set to roll out in July 2012 but it was held up by a lawsuit brought by the German citizenry questioning the legality of the fund and Germany’s participation in it. As the primary contributor to the 500 billion euro fund, Germany is slated to kick in 190 billion euros. In March, finance ministers voted to combine the bailout funds committed to by the EFSF with the ESM for a combined capital base of 700 billion euros.
The court hearing was big news around the globe. In a make-it-or-break-it decision, a German judge ruled that there was no reason to block the ESM. The first meeting of the ESM’s board of governors was held Oct. 8.
Following a summit of European Union leaders Oct. 18, 2012, it was announced the European Central Bank would lead supervision of the eurozone’s 6,000 banks
The legislative framework for tying the region’s banks together will be in place by January 2013, and implementation will take place throughout the year.
With that decision in the bag, the European Stability Mechanism can move ahead with plans to directly recapitalize banks, rather than lending money to sovereigns that would then lend to financial institutions.
Protests over austerity measures span Europe
On Nov. 14, 2012, unions went on strike in Spain, Portugal, Greece and Italy to protest austerity measures. The protests didn’t stop with Europe’s southern periphery. Some 50 trade unions in 28 countries participated by striking or protesting.
Euro-area recession deepens
Gross domestic product in the euro area fell 0.1 percent in the third quarter of 2012, Eurostat announced Nov. 15. Growth was positive in the 27 countries that make up the European Union, at 0.1 percent. According to Eurostat, GDP in the second quarter for both areas was -0.2 percent.
Moody’s downgrades French credit rating
France’s government bond rating was downgraded one notch by Moody’s Investor Services, from Aaa to Aa1 on Nov. 19, 2012. The reasons for the downgrade included structural challenges and a loss of competitiveness as a result of rigidities in the labor market. Moody’s also cited a diminishing resilience to future euro-area shocks as a result of France’s large exposure to peripheral Europe through trade and banking. Then there was this assessment: “Unlike other non-euro-area sovereigns that carry similarly high ratings, France does not have access to a national central bank for the financing of its debt in the event of a market disruption.”
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