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The Eurozone Financial Crisis

Presented By:Shardul Churi

Satish Chavan

Namita Mahtre

Jaydip RavalAsha Tilwani

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The Eurozone Financial Crisis

Transmission from the United States

Housing Price Bubble and Collapse

Financial Market Freeze and Collapse

Policy Response Support for Financial Sector

Monetary Policy

Fiscal Policy Effect of the Euro Currency Zone

Greeces Problems

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Transmission from United States

US Housing Bubble created by

Low interest rates

Lax regulation of sub-prime mortgages with

adjustable rates, two year teaser rates Securitization of mortgages, sold to unwary

buyers as highly rated

US Bubble popped when

Interest rates rose in 2006, housing prices fell

Subprime mortgages and securities defaulted

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European Crisis Began Later

US Housing Prices peaked in late 2006

European Housing Prices peaked a year later

Financial Crisis struck Europe & US at same time,

August 2007, after Bear, Stearns, Fannie Mae &Freddie Mac taken over with US Governmentassistance in April and July of 2007

International credit markets froze up in August 2007

when subprime based hedge funds collapsed inEurope and US. No longer able to borrow short-termfunds, banks faced much higher risk premia

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Why did the Crisis Spread?

Subprime Debt Obligations made in USA held around theworld caused global financial shock.

Housing bubbles burst in UK , Ireland, Spain as well as US.

Failure of Lehman Bros in September 2007 caused massive

panic over counterparty risk. AIG required $180 billionbailout to cover Credit Default Swaps, insurance againstbond defaults underwritten without reserves.

Stress on banks around the world led to shrinking creditavailability. Shadow off-balance-sheet banking sector

collapsed as short-term funding vanished. Falling demand spread from US to all countries; as US

imports dropped, other countries exports fell.

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European Financial Institutions under

Stress

BNP-Paribas forced to close funds in August 2007

UK bank Northern Rock taken over by government

German state banks IKB, WestLB, BayernLB and

SachsenLB bailed out by government

Irish banks given government deposit guarantees

Switzerland injects funds into UBS

Icelands banks unable to roll over short termborrowing, default on deposits of foreigners

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Monetary Policy Response by

European Central Bank (ECB)

ECB injected liquidity into European banks

unable to obtain short-term funds in market.

Federal Reserve used Euro-dollar swaps to

make dollars available to ECB to lend to banks.

ECB did not lower interest rates until October

2008 because of its focus on inflation.

Euro fell against the dollar due to safe haven

flight to US Treasury securities.

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Fiscal Policy Responses to Recession

Automatic Stabilizers of falling taxes, rising

welfare and unemployment payments kick in

as incomes fall and unemployment rises.

Discretionary Fiscal Stimulus enacted in most

countries, depending on their fiscal positions.

European countries limited by Stability and

Growth Pact to 3% fiscal deficits, except in

time of exceptional economic distress.

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The Role of the Euro

Previous economic crises in Europe have led

to large devaluations of currencies.

Within eurozone, single currency prevents

devaluation , provides automatic financial

support through capital markets.

Non-euro currencies depreciated sharply in

2008, British pound sterling, Swedish kronor,

Polish zloty, Hungarian forint.

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Greeces Financial Problems

Since joining the euro, Greece has had higher

inflation than other Eurozone members.

Greece has also increased debt faster than others

to finance generous public sector pay, welfare, andretirement benefits, while collecting a lower share

in taxes due to widespread tax evasion.

As a result, Greek goods have become increasinglyexpensive and uncompetitive, causing loss of

market share and further reducing revenues.

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Conclusions

Cautious Eurozone response to Financial Crisis Interest rate policy reaction delayed: concentration on

inflation target

Fiscal policy reaction muted: Stability & Growth Pact

Common currency members avoided largedevaluations and foreign currency debt.

European governments have tried to act together, notalways successfully.

Limited impact of falling exports due to extensiveinternal trade relationships.

Greece facing difficult adjustment problems, Europeanbanks avoiding losses on Greek bonds.