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17th November 2011

Greece’s gloom explained

“it is like asking Student Finance to accept that they’ll only be receiving half their initial loans that they lent all students.”

Greece has been experiencing one rough rollercoaster ride, generating a lot of noise within the euro zone lately with its lingering debt problem spurring greater attention. But what exactly has been going on in the euro zone?

Debt being the obvious problem, Greece has been bailed out twice in the past and investors still fear a third rescue is required. These problems are widely known in Europe now, and if a Greek default is largely anticipated given the size of its economy, it has been considered manageable for the euro zone.

Following the G20 Summit in October, EU leaders announced greater measures to expand the bail-out fund known as the European Financial Stability Facility (EFSF) in their three point plan, along with other plans to force banks to raise greater capital in the case of any defaults in the future. This should prevent banks from collapsing, providing greater protection.

Furthermore, banks also had to accept a loss of 50 percent of their loans to Greece. This is an extremely painful amount as many of Europe’s banks are big holders of Greek debt. Another way of putting this, is like asking Student Finance to accept that they’ll only be receiving half of their initial loans that they lent all students. As for the other half, well, the students just can’t pay it back. As a result, Student Finance would have little left to fund future university students.

The Greek government is in a sticky situation trying to rake in public spending while increasing taxes to try and pay off debt. The public opposition against austerity measures have been causing greater protests, and political turbulence means European cooperation is difficult to establish. The Greek Prime Minister announced a referendum on the EU’s efforts to bail out its troubled economy earlier last week while the question of whether Greece may be forced to leave the euro zone still persists. He later cancelled this referendum under mounting political pressure.

So what does all this mean for the UK? Well, the UK banks don’t hold a relatively large amount of Greek debt (in comparison to the amount which Germany and France hold) and thus are less exposed. However, Greece’s troubles can still have a knock-on effect on the UK banks, amplifying their exposure to Irish debt, which is larger.

More importantly, the issue of concern now is the fear that such a toxic debt problem will spread across the entire euro zone, creating pressure for the bigger economies. Taking centre-stage now is Italy, with warning bells ringing over its debt problems as well.

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