Economics, 3rd Edition

to deal with it’ in managing an 

orderly exit from an EU bailout?

4 

Can any conclusions be drawn 

on the movement of the size of 

the debt in Portugal, its yields 

and the ratings on the state of the 

Portuguese economy?

5 

To what extent do you think 

that the terms of the bailouts of 

 

countries like Greece, Ireland 

and Portugal have been justified?

IN THE NEWS

One of the major fears of the problems 

which originated in Greece was 

contagion – the potential for the 

euro crisis to spread to the weaker 

economies of the euro area and cause 

the collapse of the euro.

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CHAPTER 37  THE FINANCIAL CRISIS AND SOVEREIGN DEBT  803

SUMMARY

 

●

Deregulation of financial markets encouraged new 

ways of lending and made it easier for lenders to access 

funds and the relatively benign economic climate of the 

early 2000s encouraged banks to become more risk 

seeking.

 

●

Banks around the world increased lending rapidly 

and this helped to fuel a rise in property prices. New 

 financial products meant that risk was perceived to be 

lower but many involved did not have a complete under-

standing of the complexity of the products or the models 

on which they were based.

 

●

When central banks began to start raising interest rates 

to control accelerating inflation, the number of defaults 

on sub-prime mortgages began to increase and as the 

web on interconnectivity between financial institutions 

began to unravel, credit became tight.

 

●

The banking crisis led to a sharp reduction in interb-

ank lending as credit dried up which fed through the 

housing market causing a collapse in house prices and 

quickly fed through to the real economy leading to rising 

unemployment, shrinking economic activity.

 

●

When the crisis hit, central banks responded by 

 reducing interest rates and developing new techniques 

to complement fiscal stimuli such as quantitative 

easing.

 

●

Both central banks and regulators have come in for 

 criticism about their role in the crisis and their response 

after and reforms to banking systems and regulation 

continue to be discussed.

 

●

The sovereign debt crisis developed as a result of the 

financial crisis. Countries experiencing economic slow-

down were forced to borrow more and the extent of their 

debt created nervousness of the prospect of default.

 

●

The spreads on sovereign debt widened into 2010 and 

2011 and a number of countries had to seek financial 

assistance from the EU and IMF. The ESM represents 

a permanent mechanism to help support countries in 

financial difficulties.

 

●