If a person was to ask me, define the financial crisis in a few words. I would tell him; it is a worldwide financial fiasco in which it includes terms such as:
1. Subprime mortgages
2. Collaterised debt obligations
3. Frozen credit markets
4. Credit default swap
Peter Praet, who is a member of the Executive Board of the European Central Bank (ECB), said that the Eurozone crisis was initiated when the US mortgage market crumpled as:
“A complex network of financial derivative products held globally, started to un-ravel, US mortgage crisis was only the tip of the iceberg”.
Before 2007, Europe was enjoying a long period of:
• Swift credit progress
• Low risk premiums
• Good level of liquidity, high leveraging
• Increasing asset prices
• Development of bubbles in the real estate sector
So you may ask, how could this even happen?
At primary stages, they thought that the European economy, not like the US economy, would be resistant to financial turmoil. Right now, as a EU citizen, you may have a sight of relieve. But slow down. It did not take long until in September 2008, the bailout of Fannie Mae & Freddy Mac, the bankruptcy of the Lehman brothers and uncertainties of the insurance giant AIG took down the main US & EU financial organisations.
If non-technical people would see this graph, they would surely say something is going wrong. Economists or statisticians would say that, GDP in 2009 is estimated to fall by 4% in the euro area and European Union as whole, with a slight chance of a positive activity expected in 2010.
Peter Praet in a speech in 2013 compares the euro debt crisis to an ongoing finding of an iceberg. In secondary school, I have been taught in physics, that the density of ice is lower than the density of the seawater; that is, only 1/9 of the volume of an iceberg is above water. He devides the iceberg, into 4 layers:
1. Tip of the Iceberg: Liquidity between interbank markets became low, as market investors were uncertain whether to hold their securities or sell them. For some institutions this was a major blow, others had to close their doors.
2. Second layer: Later on, the failure of the Lehmann brothers in fall of 2008 initiated an “abrupt re-pricing of risks globally” – Peter Praet. This caused a temporary freeze in trade financing, a decline in transactions and ultimately it was noticed that demand & output on a worldwide scale dropped as well.
3. Third layer: Another bad news was revealed. Some companies and banks were not able to meet their long-term financial obligations, that is, solvency. This is a very important element to stay in the business environment. Peter Praet said that this was caused in 2 ways. First, banks were heavily exposed to national debt and declines in the value of government bonds. Secondly, when governments offered bailouts, they continued to add up to their own liabilities.
4. Last Layer: This is the most unanticipated layer of the iceberg, called...