Question

Case Study IV: The European Financial Crisis Financial crises occur over time, all over the world, for different reasons but in most cases with similar consequences. Questions: 1. Describe in detail the European financial crisis. Explain how it relates to the financial crisis in the U.S. 2. Taking into account what we have studied in class, what is (are) the main cause(s) of this crisis? Justify your answer. 3. What are the effects of the crisis on countries in the Euro zone? And, what might be the effects on the global economy? Are there any effects on the Egyptian economy? Support your answer with relevant examples.

Answer 1

1. The European financial crisis has been taking place in the European Union since the end of 2009. In several European countries, private debts had been rising from a property bubble and were subsequently transferred to sovereign debt via banking system bailouts. This culminated into negative yields on Government bond for many countries. The crisis began in 2009 when Greece was expected to default on its debt, when Greek Prime Minister George Papandreou announced that Greece’s annual budget deficit will be more than double the previously announced figure. In three years, it swelled into the potential for sovereign bond defaults from Portugal, Italy, Ireland, and Spain. The European Union, drove by Germany and France, battled to help these members. They started bailouts from the ECB and the IMF, yet these measures didn't shield people from scrutinizing the feasibility of the European Union itself.

The US crisis was due to due to substantial purchases of subprime securities. The high delinquency rates led to a rapid devaluation of financial instruments (mortgage-backed securities including bundled loan portfolios, derivatives and credit default swaps. Both the Fed and the ECB reacted to their respective crises by injecting liquidity and generally loosening monetary policy.

2. The eurozone (debt) crisis was caused by:

• Lack of effective mechanisms to prevent the build-up of macro-economic and fiscal imbalances
• Eurozone institutions weren't able to effectively absorb shocks

3. The main effects of the Euro-zone financial crisis on the Euro zone were:

• High public deficits with a very difficult environment in the country forced to correct their public deficits (Greece, Portugal, Spain) which led to government’s changes
• Very large current account deficit due to loss of competitiveness
• Loss of growth and therefore job losses, low salaries, especially in Italy, Greece and Spain
• Despite near-zero inflation, the purchasing power decreases, due to rising of unemployment, and the tendency to precautionary savings

Effects on Global Economy:

• Rising of defaults on mortgages, world over, is also both a consequence and a cause of the crisis
• Governments finances have also been affected due to the deterioration in the received taxes