Introduction market value of incredibly less than they borrowed.

Introduction

 

The Financial Crisis began during September 2008, the fall
of the Lehman Brothers Bank caught the world by surprise, it led to the banks
being seen as unreliable and thus caused a ripple around the world that caused
the worlds financial institution to shatter. The Financial Crisis showed the
world that the financial institutions are not the most secure places to hold
money, the dropping of the Lehman Brothers Bank made that very apparent to the
world.

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There are many roots of the Financial Crisis, many people
around the world feel that it was the generous lending of banks to consumers in
America, lending to ‘subprime’ borrowers with poor credit history. Buying and
owning a home is part of the ‘American dream’ and when the option, in the early
2000’s, of mortgages at a lower interest rate became available, many first time
buyers, subprime borrowers, multiple homeowners were attracted to these
mortgage’s. With a lot of consumers buying into property, house prices started
to rise and consumers that had purchased ARM’s (Adjustable rate mortgages)
began to suffer, as they couldn’t afford to pay their increasing mortgage
payments. ARM’s for the first few years have a consistent interest rate, which
steadily begins to increase and some lenders who may have been subprime
couldn’t cope and, consequently, default of their payments. When people
defaulted, there became more houses for sale on the market, however there was a
fall in buyers in the market, therefore causing a surplus in supply of houses,
leading to a fall in house prices as supply
outpaced demand. For some borrowers they had a mortgage for more than
their house was actually worth, thus they stopped paying their mortgage as
there was virtually no incentive to pay for a property that was worth a market
value of incredibly less than they borrowed. Many lenders started to receive
less and less on their investments and then started to lose money on their
investment. When investors started to lose their investments the housing system
collapsed on itself and the financial crash quickly followed as investors
quickly pulled out of American markets. 

 

Another reason for the Financial crash is that, Banks would
sell these loans on to third parties, through their financial products such as
CDO’s and mortgage backed securities. The creation of these financial products appealed
to investors as they were presented as risk free investments (banding AAA to BB),
investors invested and thought that AAA was the safest investment for them and
BB was the riskiest. Pension funds and investors had invested in these
financial products as they were presented as risk free and that they would
guarantee a return on their investments. However, they didn’t know that;
Lenders, Investment banks and Credit Rating agencies all became lazy and cared
more about selling on the debt and making a profit, regardless of the amount of
risk the debt carried.  The ‘Big 3′
credit rating agencies Standard & Poor, Moody’s, and Fitch, at the were
market monopolies, having a combined market share of roughly 95%, and thus
creating an overreliance on these credit rating agencies. When they provided
their seal of approval to investors, regarding the risk of CDO’s and Mortgage
backed securitises, they practically allowed the housing crisis to unfold,
leading to the financial crash of 2008.

 

In this essay, I am to explore and compare the
varying levels of difficulties that both Greece and Germany experienced during
the period of the Financial Crisis, and look in great detail what happened
before the Crisis, what happened during the crisis and consider the
aftereffects the crisis created (both positive and negative).

 

Problems in Greece

 

Advantages of joining the EU include; reductions in business
costs; greater business efficiencies; greater competition (which can be
beneficial for both consumers and producers); no tariffs on goods on both
exports and imports have to be paid by member countries; people are able to
move to member countries freely, these are few of the many advantages of being
in the EU. Greece saw these advantages and was instantly appealed to the
unification of EU. On the 1st January 1981,Greece joined the EU.

 

Much later, on the 1st January 2001, Greece
adopted the Euro along with adopting it gave many benefits not only for Greece
but Europe as a whole, making the union of the countries more closer.  At the time being part of the euro was hugely popular in Greece, with
polls implying that nearly two-thirds of the population are in favour of the
move. Greece, at the time, couldn’t the first wave of countries
in 1999, as they didn’t meet the requirements to join the Euro, specifically
the low inflation and low government debt and deficits. They were the 12th
and the last country to join the euro and many countries were very hesitant
about Greece joining the Eurozone as they couldn’t maintain a low inflation,
even the president of the European Central Bank at the time, Wim
Duisenberg, warned that Greece had much to do in terms of improving its economy
and controlling inflation, at the time inflation in Greece was an unacceptably
high 4%..

 

The countries adopting the Euro have a chance to start
afresh as the plan was that a united currency would make it easier to trade
with countries in EU through the removal of trade barriers. When Greece took
the euro as their currency they experienced a boom in their nominal GDP per
capita, they felt more closer with Europe and, to this very date, have relied
heavily on trade with surrounding countries such as Germany, Italy, France and
Spain and the united currency has made trade significantly easier with those
countries.

 

Another advantage of joining the Euro for Greece was that
they were able to borrow money from investors at lower interest rates, as
investors were under the assumption that if Greece were unable to pay the loans
off other countries such as France and Germany would come to the aid of their
partner nation. Greece took advantage of this by borrowing money, by using the
power and backing of Germany, Greece spent investors’ money with little care of
returning their investment. Investors have invested with the intention that if
Greece cannot afford to pay their money back then the other countries in the
Euro can help Greece to pay back the money. But with Greece’s big public
spending and loose rules on tax collection it would be near impossible to get
investors their money back from Greece.

 

So what happened to Greece during the Financial Crisis of
2008? For the past decade Greece kept their spending increasingly high, for
reasons unbeknownst to most sane countries. So when the financial crisis came
along, they were unprepared for the effects it would create. In 2008, the
European Central Bank raised their interest rates to 4.25%, this lead to an increase
in private debt and deficits increased. 
Greece was in a position where it couldn’t devalue its currency or
reduce interest rates to stimulate economic growth, by being part of the single
currency and being the poorest and the most indebt the monetary policy decided
by the European Central Bank didn’t help a country like Greece but helped
countries like France and Germany.

 

Greece were also very heavily dependant of loans from
investors but when the Financial Crisis hit, investors were very hesitant and
many refused to lend to countries like Greece and therefore raised the interest
rates on the loans if they did lend money. The IMF and the Euro funded Greece
through bailouts, altogether 3 bailouts,  the first in May
2010 a €110 billion bailout loan, second in February 2012 a €130 billion and a
third in August 2015 €86 billion, placing total debt at €326 billion.
However, the bailouts came with conditions and strict terms, which include 14
austerity measures that contributed to a reduction in Greece’s economy during
six years of recession and leading to unemployment rising to record levels of
almost 28%. Some of the austerity measures include pay cuts/ pay freeze for all
government workers, also including job cuts with public sector workers. Another
austerity measure would be to stop early retirement and a rise from 37 to 40
minimums of years needed to work to qualify for a full pension. Privatisation
is another austerity measure that will be increased, in order to do this
sufficient growth will need to be achieved in the private sector and possibly
privatisation of some sectors. Reasons for doing this is to reduce the reliance
of the Greek economy on the public sector and thus cutting the number of people
on the public payroll. By doing this they would be cutting public expenditures
and thus needing less money to spend on governmental services this would slow
down the rate of the amount of debt currently being accumulated by the Greece
public spending. Protesters in Greece blamed Germany for imposing fiscal
austerity, occasionally likening Germany’s Chancellor Merkel to Hitler.

 

The reasons behind the financial crisis negatively affecting
Greece a lot include the fact that Greece altered their statistics by totally transforming
its figures in order to be part of the Eurozone. Concealing their
figures and ‘cooking’ their books in order to join the Euro, gave the countries
in the Euro the wrong idea of the Greece economy. The Budget deficit figures
(according to Greece financial minister, 2004) were altered at the time, it was
a requirement in order to join the Euro budget deficits should be below 3% of
GDP, however Greek press reports suggest the
country’s budget deficit in 1999 was 3.38%.  Yiannos Papantoniou Minister of Economy and Finance,
reassured the world that they weren’t going to fiddle with the statistics in
order to join the Euro, but when the Greece Press did an investigation in to
this matter, in actuality that’s exactly what they did.

 

Another reason for the financial crisis negatively affecting
Greece is that it had led to Greece having a very high government debt
(approximately 180.8% of GDP, 2016), and to pay off this debt tax collection
revenues have been consistently low in Greece, the enforcement of the law on
tax has been very loose and is one of the biggest contributors to why Greece is
unable to pay off its debts. Hosting the Olympics
cost Greece approximately €9 billion (€11 billion in today’s rate), followed by
increase in public spending, was not backed up by a sufficient level of tax
revenues needed to be raised. By living beyond their means, one
of the main troubles was the level of corruption and tax evasion occurring this
was leading to big governmental budget deficits. Tax evasion has, in
essence, become a way of life not to pay taxes and would be out of the norm if
you do pay, many citizens do not pay taxes as they don’t see the effects it makes
to their standard of living.  Corruption
is very high in Greece and therefore citizens would prefer to pay bribes
instead of taxes. For example;
people, in the prosperous and affluent area of Ekali, checked the box on their
annual returns had owned up to having a pool. Tax inspectors were suspicious of
this number and launched their own investigation and discovered there were in
actuality 16,974 swimming pools in that district. Another tax investigation was
that doctors were declaring small amounts of incomes, but were living lavish
lifestyles, far beyond the means they had declared.

 

Government debt, European Commission

 

A
socio-economic effect of the negative decisions during the financial crisis has
been austerity. Austerity by definition is Difficult economic conditions created by government measures
to reduce public expenditure. But really it has caused a brutal
circle of recession. The continuous drop in GDP and lower production
has led to loss of thousands of jobs, further causing recession.
Unemployment had
already more than doubled within the first three years of austerity and reached
its peak of 28% in 2013.  The highest unemployment rate of 39.5% (2017)
was the 15-24-age range, while thousands of jobs have been lost under
conditions of inadequate social protection and fall of labour demand. Suicides
hit record levels, research shows a 35% jump in suicide rates
during the first two years of austerity programs, with
researchers linking every suicide to unemployment. Highly educated younger people
are migrating to other countries causing an affect known as ‘brain drain’.
Family owned enterprises, consisting of small and medium sized businesses are
closing down. More
than 65,000 of them closed down in 2010 alone, resulting in a “clearance” of
medium and small enterprises and estranging the people dependent on them. Homelessness
increased during the period of 2009-2011 by 25% and has increased further to
present day. Public health has fallen depression rate have increased from 3.3% to 8.2% between 2008 and 2011. To
counter the problems of austerity, Greece has elected Syrizia government led by
Alexis Tsipras- and his main aim is to end austerity

 

 

 

 

 

Germany and the financial crisis

 

Germany had their own, very different, version of how the
financial crisis affected them, with Chancellor Merkel leading them in a
coalition government. Germany was one of the hardest hit economies by the
financial crisis; this was due to their strong dependence on exports. However,
despite the slumps in global financial markets, for the past 20-22 years,
Germany has been running a positive trade in balance, as of 2016, $273 billion
in net exports. In Germany, the crisis was transferred through trade. The first
affects of the Global Financial Crisis were first seen and evident when, in
2009, there was a steep decline in exports. However, Germany was able to mount
a strong recovery and increased their trade amount in USD.

Blue line- Exports

Red line- Imports

 

To explore the Germans response to the recent Global Financial
Crisis of 2008, its vital to look at the crises they have experienced in the
past, and how those experiences have taught them vital lessons about how to
pull an economy through a crisis. In 1923, a crisis began in Germany, when they missed
a reparations payment, which they were ordered to pay after the failures of World
War 1. This condition ascended out of control and once again the German people
were extremely unhappy and in financial difficulty, this consequently led to
uprisings occurring throughout the country. The sudden flood of paper
money into the economy, on top of the general strike across Germany – which meant fall in goods
being manufactured. Thus, there was more money that was paying for fewer goods
and services – combined with a weak economy that was ruined by the war, all
resulted in hyperinflation. This led to prices running and spiralling out of control and the German currency
becoming practically worthless. The German government decided to ditch the
Papiermark and form the new Retenmark, its value was the same as 1 trillion
Papiermark. Germany learnt from this experience, and it’s had an impact on how they
structuralise their monetary policy and their priority, in a crisis, to
maintain a stable currency.

 

Before the
financial crisis, Germany, in the early 2000s, embraced a pro-growth
deficit-reduction course alongside structural labour market reforms. It decreased
income taxes to lead to further growth and employed critical labour market
reforms in order to improve boost industrial productivity and increase work
incentives. To decrease the cost of the public pension program, it increased
the age for retirement. As well as getting rid early retirement clauses and
changed the way it calculates pension payments. Germany also adopted cuts to public-sector
pay and reduced subsidies for specific industries that they thought didn’t need
their extra funding. In the build up to the financial Crisis, these decisions
that were made built the strong foundations that meant that Germany was about
to cope when faced with economic downturn that was heavily exposed to Europe.
Economies that followed this model/guidelines and kept their budgets in order
before the Financial Crash of ’07-’08, arose in a better condition that
countries such as Greece that kept spending recklessly high

Short-term sacrifices were extremely necessary for the
long-term success, the sacrifices; Germany’s Eurozone partners did not partake
in. These sacrifices include strict wage control, a retirement age rising to 67 from 65,
lower welfare payments and eased hiring and firing all, all of these sacrifices
led to German products being more competitive and further helped the country
outperform its Eurozone partners who were suffering in their debt-fuelled
consumption. Germans steered clear of the debt-fuelled consumption boom that
many believe contributed to the financial crisis, they felt that spending and
borrowing would not be the way to beat this Financial Crisis.

 

During the recession, Chancellor Angela Merkel resisted the temptation of spending their way
out of the Financial Crisis, which their European partners in the Eurozone felt
was crucial to restoring growth. When the Financial Crisis hit Germany,
the German Chancellor Merkel preferred an austerity driven Europe and Germany,
for decades policy makers have preached austerity and structural labour market
changes as a model for other European countries to lead to further
competitiveness, boost growth and increase employment. Germany’s plan was to keep their exports high and funded programmes to
keep workers employed (they decreased unemployment benefits so more people were
in employment, this step was taken at the prime of the crisis) , by doing this
they ensured that they exported their way to growth through producing goods
that major economies around the world needed such a cars, machinery and
technology related goods.  Germany
was able to mount a strong recovery, which was to a large extent created by
trade. The majority of trade during this period was with non-EU countries such
as China.

 

So
what were the affects of the Financial Crisis on Germany? In the years before
the financial crisis, prices of houses in Germany were stagnant and had not
been of particular interests to overseas investors. However, along came the
financial crisis and an unintended effect occurred in the real estate of
Germany. Overseas investors perceived German real estate as a ‘safe haven’ in a
time of economic uncertainty and low interest rates. German workers may also be more willing to buy
houses, as they would have kept their jobs during the crisis and even received increments
in wages after the financial crisis. In 2009 price index for houses fell by
1.9%, however in 2010, (2010,
the country was broadly seen as having recovered from the crisis, experiencing
GDP growth and falling unemployment)

prices bounced back and raised by 3.6% currently Germany’s house
prices are raising in value. This was an unintended affect of the financial
crisis but one which has greatly helped Germany and is one which to this day
attracts immigration, investment and, possibly, tourism to Germany bringing
revenue stream to Germany and further building their economy and making them a
stronger nation.

Another effect of the Financial Crisis, the debt crisis triggered
an arrival of skilled immigrants, this is a inverse to ‘brain drain’ also known
as ‘brain gain’, from crisis-ridden countries after long shortages of skilled
labour in the country’s manufacturing sector. This is a surprising affect given
Germanys reputation as a country that is not overtly welcoming to immigrants
from other nations. However this was a very obvious affect, skilled and
unskilled workers were attracted to Germany’s export driven growth and German’s
attitude to employment (the fact they want more people employed rather than
calming unemployment benefits). Greece a country that was suffering with severe
unemployment suffered a ‘brain drain’, and thus migrated to countries such as
Germany that there are a range of employment opportunities and financial
stability.