The only commodity that has been in short supply in the global financial crisis has been confidence. The origins of the worst depression that the world has seen since the Great Depression in the 1930s can be traced back to sub-prime lending. This masterstroke of financial legerdemain saw loans being offered to people and firms with less than stellar credit ratings in exchange for higher premiums – the current European sovereign debt yield hike for Spain is an almost exact parallel. The risk of lending money to a dubious borrower is that they may default on the loan and leave you holding the bag, but of course, most manage to honour their obligations (as Spain will). So the solution to getting blood out of these particular stones was to “securitize” the loans by bundling them together. In this way, losses from any rotten apples in the barrel would be more than compensated for by all of the good loans.
The wheels came off when the underlying absurdity of offering expensive loans to poor risk customers who could ill-afford standard rates was finally appreciated. The result was a financial meltdown which has shaken financial foundations to the very core and plunged the world into a lengthy depression.
By analogy, sovereign debt mountains in many countries around the world – and certainly not just within the Eurozone – were the next logical “sub-prime” step. In order to stop a financial Armageddon which would have laid global finance low, choked off investment and put the global economy into a nosedive, governments around the world borrowed heavily to cover financial institutions, key industries and arrest falling growth, making the debt problems worse.
When confidence evaporated in marginal Eurozone economy’s ability to honour their commitments, yields on bonds soared and the European sovereign debt crisis was ignited. Despite two bailouts for Greece, (and the election of a government which promises to stay on track), one each for Ireland and Portugal and a banking sector bailout for Spain, the problem refuses to go away. The IMF, the World Bank, the US and UK governments (amongst others) and now the G20 have all called on the Eurozone to take decisive steps to end the crisis. If the Eurozone can re-inject confidence into the system that the Euro is here to stay and that needed, sweeping reforms to the financial system will be put in place, investor confidence (and sanity) may yet return. If this does not happen, then the US and Japanese debt mountains will surely induce a similar catastrophe on global economics in the not too distant future.