1st Trigger of Debt Crisis

1st Trigger of Debt crisis

The European debt crisis was first triggered by the 2008 financial crisis in US. Several factors induced by the financial crisis have pushed the spread between German bonds and other European countries upward: Firstly, the global risk aversion, measured by the spread between Treasury bonds and corporate bonds played an important role that decreased as the crisis evolved. Secondly, the crisis triggered a flight to safety whereas investors started to differentiate between countries regarding their fiscal balance (or imbalance) being the increase in the spread larger for countries with larger deficits and debts ratios (Attinasi, Checherita, Nickel, 2009). Thirdly is the transfer of risk from the banking to sovereign borrowers: default of subprime mortgages by households had a huge impact on European banks who had invested in the mortgage market, which by indirect exposure (trough sub-prime related securities) were affected by the devaluation of the house market. In Spain and Ireland was the housing bubble burst which led banks to need rescue. (Norris, 2011)

The Governments took urgent measures announcing they would provide financial support to rescue the major banks in crisis which led to a reassessment of credit risk by the investors as they were worried that government would not be able to support the rescue. The spread between Greek and German Bunds, which had been about 35 basis points since the formation of the EMU until the financial crisis, was about 270 basis points in March 2009. (Attinasi, Checherita, Nickel, 2009). Banking crisis contributed to an increase in debt ratio and budget deficit as public money was being used to prevent banks from failing and shortages in credit were causing economic recession. Spain and Ireland were the most affected and had no longer budget surpluses and low debt ratio. (Afonso, Arghyrou and Kontonikas, 2011)