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Greek Debt Crisis Explained

Understand the Greek Debt Crisis in 5 Minutes

By Kimberly Amadeo | Updated on May 17, 2020

Reviewed by Michael J Boyle

In This Article

Greece Crisis Explained

Timeline

Causes

Why They Didn't Leave the Eurozone

Why Greece Didn't Default

VIEW ALL
PHOTO: THE BALANCE / JULIE BANG

The Greek debt crisis is the dangerous amount of sovereign

debt Greece owed the European Union between 2008 and 2018. In
2010, Greece said it might default on its debt, threatening the viability
of the eurozone itself. [1]

To avoid default, the EU loaned Greece enough to continue making

payments.

Note
Since the debt crisis began in 2010, the various European
authorities and private investors have loaned Greece nearly 320
billion euros.

It was the biggest financial rescue of a bankrupt country in history. [2] As

of January 2019, Greece has only repaid 41.6 billion euros. It has
scheduled debt payments beyond 2060.

In return for the loan, the EU required Greece to adopt austerity

measures. These reforms were intended to strengthen the Greek
government and financial structures. They did that, but they also mired
Greece in a recession that didn’t end until 2017.

The crisis triggered the eurozone debt crisis, creating fears that it would
spread into a global financial crisis. It warned of the fate of other heavily
indebted EU members. This massive crisis was triggered by a country
whose economic output is no bigger than the U.S. State of Connecticut.
[3]

Greece Crisis Explained

In 2009, Greece’s budget deficit exceeded 15% of its gross domestic
product. [2] Fear of default widened the 10-year bond spread and
ultimately led to the collapse of Greece’s bond market. This would shut
down Greece’s ability to finance further debt repayments. The chart
below highlights in red the period when the 10-year government bond
yield passed 35% until vast debt restructuring forced private
bondholders to accept investment losses in exchange for less debt.

10-Year Greek Government Bond Yield (2008-  f 

2018)
Greece’s budget deficit reached 15.4% of their GDP in 2009. This led in
to a panic of default, and widened the 10-year bond yield spread.
From 2010 to 2012 (shaded in red below), 10-year bond rates
surpassed 35%. Rates fell again in 2012 after private bondholders
agreed to a vast debt restructuring that exchanged 77 billion euros in
bonds for 75% less debt

EU leaders struggled to agree on a solution. Greece wanted the EU to

forgive some of the debt, but the EU didn’t want to let Greece off scot-
free.

The biggest lenders were Germany and its bankers. They championed

austerity measures. They believed the measures would improve
Greece's comparative advantage in the global marketplace. The
austerity measures required Greece to improve how it managed its
public finances. It had to modernize its financial statistics and reporting.
It lowered trade barriers, increasing exports.

Most importantly, the measures required Greece to reform its pension

system. Pension payments had absorbed 17.5% of GDP, higher than in
any other EU country. Public pensions were 9% underfunded, compared
to 3% for other nations. Austerity measures required Greece to cut
pensions by 1% of GDP. It also required a higher pension contribution by
employees and limited early retirement. [4]

Half of Greek households relied on pension income since one out of five
Greeks were 65 or older. [5] Workers weren’t thrilled paying contributions
so seniors can receive higher pensions. 

The austerity measures forced the government to cut spending and

increase taxes. They cost 72 billion euros or 40% of GDP. As a result, the
Greek economy shrank 25%. That reduced the tax revenues needed to
repay the debt. Unemployment rose to 25%, while youth unemployment
hit 50%. [6] Rioting broke out in the streets. The political system was in
upheaval as voters turned to anyone who promised a painless way out. 

The results are mixed. In 2017, Greece ran a budget surplus of 0.8%.
[7] Its economy grew 1.4%, but unemployment was still 22%. [8] One-third
of the population lived below the poverty line. Its 2017 debt-to-GDP
ratio was 182%.

Timeline
In 2009, Greece announced its budget deficit would be 12.9% of its GDP.
[2]
That's more than four times the EU's 3% limit. Rating agencies Fitch,
Moody's, and Standard & Poor's lowered Greece's credit ratings. That
scared off investors and raised the cost of future loans.

In 2010, Greece announced a plan to lower its deficit to 3% of GDP in

two years. Greece attempted to reassure the EU lenders it was fiscally
responsible. Just four months later, Greece instead warned it might
default. [2]

The EU and the International Monetary Fund provided 240 billion euros

in emergency funds in return for austerity measures. The loans only
gave Greece enough money to pay interest on its existing debt and
keep banks capitalized. The EU had no choice but to stand behind its
member by funding a bailout. Otherwise, it would face the
consequences of Greece either leaving the Eurozone or defaulting. [9]
Austerity measures required Greece to increase the VAT tax and the
corporate tax rate. It had to close tax loopholes. It created an
independent tax collector to reduce tax evasion. It reduced incentives
for early retirement. It raised worker contributions to the pension
system. At the same time, it reduced wages to lower the cost of goods
and boost exports. The measures required Greece to privatize many
state-owned businesses such as electricity transmission. That limited
the power of socialist parties and unions. 

Why was the EU so harsh? EU leaders and bond rating agencies wanted

to make sure Greece wouldn't use the new debt to pay off the old.
Germany, Poland, Czech Republic, Portugal, Ireland, and Spain had
already used austerity measures to strengthen their own economies.
Since they were paying for the bailouts, they wanted Greece to follow
their examples. Some EU countries like Slovakia and Lithuania refused
to ask their taxpayers to dig into their pockets to let Greece off the hook.
[10] These countries had just endured their own austerity measures to
avoid bankruptcy with no help from the EU. 

In 2011, the European Financial Stability Facility added 190 billion euros

to the bailout. Despite the name change, that money also came from EU
countries.

By 2012, Bondholders finally agreed to a haircut, exchanging 77 billion

euros in bonds for debt worth 75% less.

In 2014, Greece’s economy appeared to be recovering, as it grew 0.7%.

The government successfully sold bonds and balanced the budget.

In January 2015, voters elected the Syriza party to fight the hated
austerity measures. On June 27, Greek Prime Minister Alexis Tsipras
announced a referendum on the measures. He falsely promised that a
"no" vote would give Greece more leverage to negotiate a 30% debt
relief with the EU. On June 30, 2015, Greece missed its scheduled 1.55
billion euros payment. [11] Both sides called it a delay, not an official
default. Two days later, the IMF warned that Greece needed 60 billion
euros in new aid. It told creditors to take further write-downs on the
more than 300 billion euros Greece owed them. 

On July 5, Greek voters said "no" to austerity measures. [12] The

instability created a run on the banks. Greece sustained extensive
economic damage during the two weeks surrounding the vote. Banks
closed and restricted ATM withdrawals to 60 euros per day. It
threatened the tourism industry at the height of the season, with 14
million tourists visiting the country. The European Central Bank agreed
to recapitalize Greek banks with 10 billion euros to 25 billion euros,
allowing them to reopen. [13]

Banks imposed a 420 euros weekly limit on withdrawals. That

prevented depositors from draining their accounts and worsening the
problem. It also helped reduce tax evasion. People turned to debit and
credit cards for purchases. As a result, federal revenue increased by 1
billion euros a year.

On July 15, the Greek parliament passed the austerity measures despite

the referendum. [14] Otherwise, it would not receive the EU loan of 86
billion euros. The ECB agreed with the IMF to reduce Greece’s debt. It
lengthened the terms, thus reducing net present value. Greece would
still owe the same amount. It could just pay it over a longer time period. 

On July 20, Greece made its payment to the ECB, thanks to a loan of 7
billion euros from the EU emergency fund. The United
Kingdom demanded the other EU members guarantee its contribution
to the bailout.

On September 20, Tsipras and the Syriza party won a snap election. [15] It
gave them the mandate to continue to press for debt relief in
negotiations with the EU. However, they also had to continue with the
unpopular reforms promised to the EU. 

In November, Greece's four biggest banks privately raised 14.4 euros

billion as required by the ECB. [16] The funds covered bad loans and
returned the banks to full functionality. Almost half of the loans banks
had on their books were in danger of default. Bank investors
contributed this amount in exchange for the 86 billion euros in bailout
loans. The economy contracted 0.2%.

In March 2016, the Bank of Greece predicted the economy would return

to growth by the summer. It only shrank 0.2% in 2015, but the Greek
banks were still losing money. They were reluctant to call in bad debt,
believing that their borrowers would repay once the economy improved.
That tied up funds they could have lent to new ventures. 

On June 17, the EU's European Stability Mechanism disbursed 7.5 billion

euros to Greece. [17] It planned to use the funds to pay interest on its
debt. Greece continued with austerity measures. It passed legislation to
modernize the pension and income tax systems. It promised to privatize
more companies, and sell off nonperforming loans. 
In May 2017, Tsipras agreed to cut pensions and broaden the tax base.
In return, the EU loaned Greece another 86 billion euros. [13] Greece used
it to make more debt payments. Tsipras hoped that his conciliatory tone
would help him reduce the 293.2 billion euros in outstanding debt. But
the German government wouldn't concede much before its September
presidential elections. 

In July, Greece was able to issue bonds for the first time since 2014. It
planned to swap notes issued in the restructuring with the new notes
as a move to regain investors' trust.

On January 15, 2018, the Greek parliament agreed on new austerity

measures to qualify for the next round of bailouts. On January 22, the
eurozone finance ministers approved 6 billion to 7 billion euros. [13] The
new measures made it more difficult for union strikes to paralyze the
country. They helped banks reduce bad debt, opened up the energy and
pharmacy markets, and recalculated child benefits.

On August 20, 2018, the bailout program ended. [2] Most of the
outstanding debt is owed to the EU emergency funding entities. These
are primarily funded by German banks.

European Financial Stability Mechanism and European Stability

Mechanism: 168 billion euros

Eurozone governments: 53 billion euros.

Private investors: 34 billion euros.

Greek government bond holders: 15 billion euros.

European Central Bank: 13 billion euros.

IMF: 12 billion euros. 

Until the debt is repaid, European creditors will informally supervise

adherence to existing austerity measures. The deal means that no new
measures would be created.

Causes
How did Greece and the EU get into this mess in the first place? The
seeds were sown back in 2001 when Greece adopted the euro as its
currency. Greece had been an EU member since 1981 but couldn't enter
the eurozone. Its budget deficit had been too high for the
eurozone's Maastricht Criteria. [3] 

All went well for the first several years. Like other eurozone countries,
Greece benefited from the power of the euro. It lowered interest
rates and brought in investment capital and loans.

In 2004, Greece announced it had lied to get around the Maastricht

Criteria. [18] The EU imposed no sanctions. Why not? There were three
reasons.

France and Germany were also spending above the limit at the time.
They'd be hypocritical to sanction Greece until they imposed their own
austerity measures first.

There was uncertainty on exactly what sanctions to apply. They could

expel Greece, but that would be disruptive and weaken the euro.

The EU wanted to strengthen the power of the euro in international

currency markets. A strong euro would convince other EU countries, like
the United Kingdom, Denmark, and Sweden, to adopt the euro.

As a result, Greek debt continued to rise until the crisis erupted in 2008.

Why Greece Didn't Leave the Eurozone

Greece could have abandoned the euro and reinstated the drachma.
Without the austerity measures, the Greek government could have hired
new workers. It would have lowered the 25% unemployment rate and
boosted economic growth. Greece could have converted its euro-based
debt to drachmas, printed more currency and lowered its
euro exchange rate. That would have reduced its debt, lowered the cost
of exports, and attracted tourists to a cheaper vacation destination.

At first, that would seem ideal for Greece, but foreign owners of Greek
debt would have suffered debilitating losses as the drachma
plummeted. That would debase the value of repayments in their own
currency. Some banks would go bankrupt. Most of the debt is owned by
European governments, whose taxpayers would foot the bill.

Plummeting drachma values would have triggered hyperinflation, as the

cost of imports skyrocketed. Greece imports 40% of its food and
pharmaceuticals and 80% of its energy. [19]

Many companies refused to export these items to a country that might

not pay its bills. The country couldn't attract new foreign direct
investment in such an unstable situation. The only countries that would
have lent to Greece are Russia and China. In the long run, Greece would
find itself back to where it began: burdened with debt it couldn't repay. 

Interest rates on other indebted countries would have risen. Rating

agencies would worry they'd leave the euro also. The value of the euro
itself would have weakened as currency traders use the crisis as a
reason to bet against it. 

Why Greece Didn't Default

A widespread Greek default would have a more immediate effect. First,
Greek banks would have gone bankrupt without loans from the
European Central Bank. Losses would have threatened the solvency of
other European banks, particularly in Germany and France. They, along
with other private investors, held 34.1 billion euros in Greek debt. [20]

Eurozone governments owned 52.9 billion euros. That's in addition

to the 131 billion euros owned by the EFSF, essentially also eurozone
governments. Germany owned the most debt, but it was a tiny
percentage of its GDP. Much of the debt didn't come due until 2020 or
later. Smaller countries faced a more serious situation. Finland's portion
of the debt was 10% of its annual budget. The ECB held 26.9 billion
euros of Greek debt.

If Greece had defaulted, the ECB would have been fine. It was unlikely
that other indebted countries would have defaulted. 
For these reasons, a Greek default wouldn’t have been worse than the
1998 Long-Term Capital Management debt crisis. That's
when Russia's default led to a tidal wave of defaults in other emerging
market countries. The IMF prevented many defaults by providing capital
until their economies had improved. The IMF owns 21.1 billion euros of
Greek debt, not enough to deplete it. [21]

The differences would be the scale of defaults and that they are in
developed markets. It would affect the source of much of the IMF's
funds. The United States wouldn’t be able to help. While a huge backer
of IMF funding, it's now deep in debt, itself. There would be no political
appetite for an American bailout of European sovereign debt. 

Outlook
Despite austerity measures, many aspects of Greece’s economy are still
problematic. Government spending makes up 48% of the GDP while EU
bailouts contribute around 3%. [22] As of 2017, Greece relies on tourism
for 20% of GDP. Bureaucracy often delays commercial investments for
decades. The government has shrunk, but it is still inefficient. There is
too much political patronage. Government decision-making is
centralized, further slowing response time.

This bureaucracy, combined with unclear property rights and judicial

obstacles, has kept Greece from selling 50 billion euros worth of state-
owned assets. Only 6 billion euros worth of property has been sold since
2011.

Tax evasion has gone underground as more people operate in the black
economy. It now comprises 21.5% of GDP. As a result, fewer people are
paying higher taxes to receive less from the government than they did
before the crisis.

Many of the jobs available are part-time and pay less than before the
crisis. As a result, hundreds of thousands of the best and brightest have
left the country. Banks haven’t completely recuperated, and are
hesitant to make new loans to businesses. It will be a slow road to
recovery.
 Frequently Asked Questions (FAQs)

When did the Greek debt crisis begin?

The Greek debt crisis began in 2009. The country revealed that the
budget deficit had surpassed 15% of GDP. This borrowing spike relative
to productivity caused credit agencies to downgrade Greek debt. [2]

How did the Greek debt crisis affect the American

economy?
The U.S. did not directly assist Greece during its debt crisis, so it didn't
feel an immediate impact. Europe is a major trade partner with the U.S.,
so the severe impact on Europe's economy did pose some threat to
American economic stability, but the Greek debt crisis wasn't a direct
threat in and of itself. [9]

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