European debt crisis 101
Let鈥檚 look at how the European debt situation developed.
When Europe brought out the euro in 2002, it changed everything. All of a sudden, you could lend money to Ireland or Greece without having to worry about the Irish pound or the Greek drachma. They were all using the euro, which was managed by the Germans. So why not lend to one of these peripheral states of Europe and earn a little more interest?
Things began to change fast. Interest rates in Spain and Ireland dropped. People started buying houses. Builders began putting them up all over the place. Prices were going up. It was similar to what happened in the US, but amplified. Ireland, for example, had always been a relatively poor country. But by 2007, rising house prices had turned the Irish 鈥� on paper 鈥� into the richest people in Europe.
Bust follows boom. Always has. Always will. And when the bust came to Europe, its banks were holding a remarkable amount of mortgage debt. The trouble was, debtors didn鈥檛 have enough income to pay it. In a panic, investors dumped bank stocks鈥iguring the banks would go bankrupt.
But in stepped governments. They tried to halt the correction. They gave guarantees. They made commitments. The told the world that they would make sure senior lenders got their money. But how? The governments were deeply in debt themselves. But that didn鈥檛 stop them. They went ahead 鈥� to varying degrees 鈥� and guaranteed bank debt.
And so here we are. Ireland guarantees its bankers鈥� debt. Europe guarantees Ireland鈥檚 debt. And who guarantees Europe鈥檚 debt?
And why do they bother?
Why not just let the speculators take their losses?
鈥淭here will be no haircut on senior debt,鈥� said Olli Rehn, EU commissioner for economic and monetary matters.
They made the decision to invest of their own free will. It鈥檚 gone against them. Shouldn鈥檛 they be permitted to learn from their mistakes? Why not?
We have never heard a good explanation. And we have a suspicion that no one else ever has either. Instead, it is more of an implied threat鈥hispered鈥oo terrible to think about. 鈥淧ssst鈥� They鈥檙e TOO BIG TO FAIL.鈥�
Oh yeah? Why? What, exactly, would happen? Weak banks would fail. They鈥檇 be quickly taken over by stronger banks. Government debt that was too closely connected to the weak banks would fail too. Paper currency may even collapse, if people feared 鈥渢he whole system鈥� was coming down.
Governments may have to come out with a gold-back currency 鈥� one that people could trust. Then, unable to borrow more, they would have to live within their means. And the surviving banks would know better than to take risks bigger than they could cover. Would that be so bad?
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