Overview of the Debt Crisis

The New York Times

The roots of the crisis go back to the strong euro and rock-bottom interest rates that prevailed for much of the past decade. Greece took advantage of this easy money to drive up borrowing by the country's consumers and its government, which built up $400 billion in debt. When the global economy crumpled, those chickens came home to roost.

The trigger for the crisis was Greece's admission in late 2009 that its government deficit would be 12.7 percent of its gross domestic product, not the 3.7 percent the previous government had forecast earlier. Investors were stunned. In early 2010, fears over a potential default grew into a full-fledged financial panic, as investors questioned whether Greece's Socialist government could push through the tough measures it has promised to reduce its budget deficit. As the fear spread to Portugal and Spain, leaders of Europe's more affluent countries like Germany and France, worried about lasting damage to the euro, stepped in with a pledge to defend the currency but stopped short of an outright bailout for Greece.

As part of an austerity plan, the Greek government in early March 2010 approved a round of tax increases and pay cuts for public employees. The steps were met with a series of angry but peaceful protests by civil servants and others that seemed to suggest a limit to the extent to which the country could cut its way out of the crisis.

After months of fractious debate, in late March the 16 countries that use the euro agreed on a financial safety net for Greece, combining bilateral loans from those European nations with cash from the International Monetary Fund. But the vague assurances were not enough by themselves to reassure the bond markets, where investors steadily raised the interest rate on money they were willing to lend Greece. On April 11, European leaders announced that they would make $30 billion available to Athens, along with up to $15 billion from the I.M.F., in the form of loans with an interest rate of 5 percent -- lower than the 7.5 percent Greece had been paying, but high enough that German officials could insist that it did not constitute a subsidy or bailout.
But the markets remained skeptical, and investors pushed interest rates on Greek bonds above those of emerging countries like India and the Philippines, leading to talk of a potential default, years of stagnant growth and to Mr. Papandreou's decision to request the delivery of the promised aid.

Tensions in the Euro Zone

For Greece -- and for Spain, Italy, Ireland and Portugal -- the financial crisis has highlighted the constraints of euro membership. Unable to devalue their currencies to regain competitiveness, and forced by E.U. fiscal agreements to control spending, they are facing austerity measures just when their economies need extra spending. Other economies like Germany, the Netherlands and Austria have kept deficits down while retaining an edge in global markets by restraining domestic wage increases. France lies somewhere between the two camps.

The chief difficulty in working out a package to support Greece was the popular sentiment in Germany, deeply concerned about becoming the answer to the debt problems of all of Europe's endangered economies, that Greece should pay a penalty for its former profligacy.
Since the euro's inception in 1999, no member has sought support from the I.M.F., which typically comes to the rescue of emerging-market economies rather than developed countries. Beside unsettling the markets, Greece's troubles have undermined the common currency it and 15 and other European nations share.

Meanwhile, questions were widely raised about the role played by banks, including Goldman Sachs, in constructing elaborate financial deals that helped the previous government hide the extent of its deficit. At the same time, some of those same banks were using credit default swaps to bet on the likelihood of a fault, trades that had the effect of making it harder for Greece to borrow, thereby pushing it closer to a financial cliff.

Three-Year Package

Faced with the prospect of economic contagion spreading to the wobbly economies of Spain and Portugal -- and the potentially devastating effect of a Greek default on French and German banks, which hold billions in Greek debt -- the I.M.F. and the euro zone countries quickly worked out the larger aid package. In return for assistance in meeting debt deadlines over the next three years, Greece agreed to austerity measures that are likely to cut its budget deficit sharply -- and may well produce a new round of recession.

The finance minister, George Papaconstantinou, said Greece had agreed to raise its value-added tax to 23 percent from 21 percent, to freeze civil servants' wages and to eliminate public sector annual bonuses amounting to two months' pay. In addition, members of parliament would no longer receive bonuses. He said special rules allowing for early retirement of civil servants would be tightened and the government intended to increase taxes on fuel, tobacco and alcohol by about 10 percent.

Prime Minister Papandreou's strategy of telling it like it is has worked out for him at home. Despite imposing the harsh cutbacks and telling Greeks they are largely to blame for their own problems, he remains popular with voters who only a few years ago questioned whether he was tough enough for the job.

Whether he will be successful in keeping his country from bankruptcy remains an open question. He concedes that the austerity measures could push Greece into a depression. But the government continues its struggle to overhaul its debt-plagued economy; in July 2010 it forced through a pension bill that would sharply cut the cost of Greece's welfare state by increasing the retirement age and reducing benefits.  

For Prime Minister Papandreou, the bill represented the beginning of the end of the cradle-to-grave state compact that his father put in place in the early 1980s.