Great Decisions 2011 Fall Updates: Banks, governments and debt crises
After weeks of rancorous negotiations, U.S. congressional leaders and President Obama finally reached an agreement on the debt ceiling on August 1, hours before the U.S. government threatened to default on its debts. With a surprise appearance from Congresswoman Gabrielle Giffords, who has been absent from the House since being critically injured by a gunman in January, the House voted 269–161 in favor of the plan, and the Senate followed with a vote of 74–26. The plan cuts $2.1 trillion from the budget over the next 10 years and calls for a bipartisan Joint Select Committee on Deficit Reduction. Both parties expressed deep dissatisfaction with the agreement that was reached by President Obama and House Speaker John Boehner.
The last-minute compromise, however, failed to avert the stock market from taking a dizzying tumble after Standard & Poor’s downgraded the U.S. from an AAA to an AA+ rating on August 5, for the first time in history. The ratings agency cited the political squabbling over the debt ceiling as one of the reasons for the downgrade. The fallout was drastic: the Dow Jones industrial average dropped by 5.6 percent on August 8 as investors fled the uncertainty of the stock market in an unprecedented sell-off and poured their money into U.S. Treasury securities instead. The wild swing of stocks, which spread to international markets quickly, continued for a volatile week. Aided by the Federal Reserve’s announcement on August 9 that it would hold interest rates at exceptionally low levels for at least the next two years, by August 16 the markets recovered overall to the levels seen prior to the downgrade.
France and Germany continue to lead debate about charting a new course for the eurozone, which is weighed down with the floundering economies and sovereign debt crises of Greece, Ireland and Portugal. On August 16, French President Nicolas Sarkozy and German Chancellor Angela Merkel reaffirmed their commitment to European unity, the shared currency, and further integration. However, both leaders also called for more discipline—with respect to reducing sovereign debt and balancing budgets—from each member of the eurozone. Sarkozy and Merkel also resisted calls for the creation of eurobonds, collective bonds that would formalize the sharing of sovereign debt across all eurozone members. This announcement came on the same day that weak growth figures for the second quarter of 2011 were released. In the eurozone, GDP increased by only 0.2 percent, far less than in the first quarter of the year.
On July 21, European leaders agreed to ease the terms of Ireland’s bailout. The interest rate has been cut on the bailout loan, valued at 85 billion euros, that Ireland received earlier this year. Ireland now has 15 years to repay the loan at an interest rate between 3.5 and 4 percent, down from the original 6 percent rate.
Europe approved another Greek bailout of $157 billion in July after growing volatility in the markets persuaded Merkel to relent partially on her insistence that Greece’s debt load should not be shifted to more prosperous EU countries, such as Germany. In the end, the deal—which has been described as a new Marshall Plan—expanded the European Financial Stability Facility, which buys sovereign debt and which resembles a European monetary fund, and is a step toward burdening all eurozone taxpayers with ensuring the debt of the weakest countries, such as Greece and Portugal. The plan also restructures Greece’s debt, with private lenders expected to contribute a massive amount of the financing. However, as the contagion from Greece weakens the economies of the other 16 European nations that use the euro, some critics are calling for Greece to exit the eurozone—permanently or temporarily—in a move that would fracture European unity.
Italy and Spain have depleted their resources and are facing the possibility of catastrophically defaulting on their debt obligations. Italian Prime Minister Silvio Berlusconi, who has been battling personal and political scandals at home, has been criticized for his insufficient response to Italy’s economic crisis. On August 13, the Italian government approved $65 billion in austerity measures—including job cuts and tax hikes—over the next two years as the country struggles to reduce its budget deficit. The deficit, which currently amounts to 3.9 percent of GDP, is to be eliminated entirely by 2013. Italy’s public debt currently exceeds 120 percent of its GDP.
Although investors remain wary about Spain’s financial health, government officials insist that the country will not require a bailout. In the second quarter of 2011, Spain’s economy slowed and growth was only 0.2 percent. However, the government is forecasting that growth this year will be 1.3 percent.
Portugal, the third eurozone country at the brink of default, received a $109 billion bailout loan from the International Monetary Fund and European Union in May. Immediately following the bailout, voters in a snap election on June 5 moved Portugal decisively toward the right. The governing Socialist party, helmed by José Sócrates, managed to pull in only 28 percent of the vote. The Social Democrats, a center-right party led by Prime Minister Pedro Passos Coelho, gained control with 39 percent of the vote and formed a coalition with the conservative People’s Party.
As part of the bailout agreement, Portugal must reduce its budget deficit to 5.9 percent of its GDP and implement a variety of other financial reforms. Officials from the IMF have been positive about Portugal’s progress and do not predict that the country will require a second bailout.
Note: The Great Decisions fall Updates were researched as of 8/25/2011.