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The Cause and Effect of the European Sovereign Debt Crisis

What is the cause and effect of the European Sovereign debt crisis?

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European Sovereign Debt Crisis

Definition of the European Sovereign debt crisis:

The European sovereign debt crisis started in Iceland with the collapse of its banking system and later spread to Portugal, Ireland and Greece. It refers to a time when most of the countries in Europe faced a rapid rise in the yield of bonds, huge debts by the government and most of the financial institutions collapsed. This crisis was brought about by the International Monetary Fund and also came up after the European countries offered financial guarantees. The countries which received the loans had the requirement of meeting measures that would help to slow down the debt in the public as required by the loan agreement and this led to the down grading of the countries with the debt. This later led to the lack of confidence for the economies and the businesses being run in Europe (European Sovereign debt crisis, n.d).

Causes of the crisis:

The cause of the European debt crisis is overspending by the governments in European countries. This overspending was brought about by the low rates that were offered by the European Central Bank. People ended up spending a lot because the tax revenues were reduced and a low growth in the economy which was not enough for the government to pay its debts and its expenditures. The government was concerned about the decline in value of the Euro incase countries such as Spain, Greece, Italy, Ireland and Portugal were not able to pay their debt. The European countries thought that the banks would be safe if the countries with low risk weights held bonds. The bank guarantees and securities given to these countries led to the freezing of banks and the banks also reduced their lending. The government enforced the rules of Recourse and Basel accords even though they did not allow the investment in asset classes by the bankers. They only allowed the banks to invest in low risk weights and this later led to the debt crisis in the Europe because it never led to the conservation of capital (Kelly, 2011).

The bankers took advantage of the Basel rule by buying risky securities and this caused a huge debt that led the crisis. The cooperate compensation also caused the crisis. This is because incentives were provided by the co operations so that the bankers could disregard the risk and this encouraged them to take excessive risks. The companies which provide these incentives end up performing poorly during the crisis. The employees also caused the crisis because they took risks in excess so that they can gain personally even though they knew it would lead to a debt crisis (Kelly, 2011).

The other cause is that some companies paid the executives compensations for high proportions of stock and this affected the performance of those companies that provided huge compensations for the stock. These huge compensations should have been stopped by the executives because the risk that the banks were taking was excessive. This later led to great losses in stock when the banks collapsed. The other cause was that there was a sale of large quantities of stock by the executives before the crisis occurred. Some of the executives believed that they should sell a lot of stock so that they could be rewarded without taking into consideration how risky their actions were. The aim of the Basel regulations was to raise leverage for the assets in commercial banks into approved categories of risks (Kelly, 2011).

The companies which provide incentives end up performing poorly during the crisis. The employees also caused the crisis because they took risks in excess so that they can gain personally even though they knew it would lead to a debt crisis. Incentives affects the way a country will be able to perform in the market because the bankers would be required to work extra hard so as to be able to sell their stock well in the market. There is also competition by the bankers over who will sell the highest stock and this enables the bankers to participate in poor actions that end up ...

Solution Summary

The solution discusses the cause and effect of the European Sovereign debt crisis.

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