Rajandran R Telecom Engineer turned Full-time Derivative Trader. Mostly Trading Nifty, Banknifty, USDINR and High Liquid Stock Derivatives. Trading the Markets Since 2006 onwards. Using Market Profile and Orderflow for more than a decade. Designed and published 100+ open source trading systems on various trading tools. Strongly believe that market understanding and robust trading frameworks are the key to the trading success. Writing about Markets, Trading System Design, Market Sentiment, Trading Softwares & Trading Nuances since 2007 onwards. Author of Marketcalls.in and Co-Creator of Algomojo (Algorithmic Trading Platform for DIY Traders)

Understanding the European Debt Crisis

2 min read

The European debt crisis was a financial crisis that affected several European countries in the late 2000s and early 2010s. It was primarily caused by the sovereign debt crisis in several European countries, including Greece, Ireland, Italy, Portugal, and Spain, as well as the banking crisis in some of these countries.

Timeline of the European Debt Crisis

The crisis was triggered by the global financial crisis of 2008, which led to a sharp decline in the value of assets held by banks and other financial institutions. This, in turn, led to a loss of confidence in the banking sector and a tightening of credit conditions, which made it more difficult for governments and businesses to borrow money.

The crisis was exacerbated by the high levels of government debt in some European countries, which made it more difficult for these countries to borrow money and pay off their debts. This led to a crisis of confidence in the sovereign debt markets and a rise in borrowing costs for these countries.

For anyone who cannot understand the present financial crisis of the UK, the EU, and indeed the whole western world economies:-

Mary is the proprietor of a bar in Dublin. She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem, she comes up with a new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).
 
Word gets around about Mary’s “drink now, pay later” marketing strategy and, as a result, increasing numbers of customers flood into Mary’s bar. Soon she has the largest sales volume for any bar in Dublin.

By providing her customers freedom from immediate payment demands, Mary gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages.

Consequently, Mary’s gross sales volume increases massively. A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increase Mary’s borrowing limit. He sees no reason for any undue concern since he has the debts of the unemployed alcoholics as collateral.

European Debt Crisis 2011 Explained

At the bank’s corporate headquarters, expert traders figure out a way to make huge commissions and transform these customer loans into Drinkbonds and Alkibonds. These securities are then bundled and traded on international security markets. Naïve investors don’t really understand that the securities being sold to them as ‘AAA’ secured bonds are really the debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation’s leading brokerage houses.

One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Mary’s bar. He so informs Mary. Mary then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since Mary cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.

Overnight, Drinkbonds and Alkibonds drop in price by 90%. The collapsed bond asset value destroys the bank’s liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The suppliers of Mary’s bar had granted her generous payment extensions and had invested their firms’ pension funds in various Bond securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.


Bank holdings of Portugal/Italy/Ireland/Greece/Spain debt

Fortunately, though, the bank, the brokerage houses, and their respective executives are saved and bailed out by a multi-billion euro no-strings-attached cash infusion from their cronies in government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in Mary’s bar.

“Now, do you understand economics in 2011?”

Rajandran R Telecom Engineer turned Full-time Derivative Trader. Mostly Trading Nifty, Banknifty, USDINR and High Liquid Stock Derivatives. Trading the Markets Since 2006 onwards. Using Market Profile and Orderflow for more than a decade. Designed and published 100+ open source trading systems on various trading tools. Strongly believe that market understanding and robust trading frameworks are the key to the trading success. Writing about Markets, Trading System Design, Market Sentiment, Trading Softwares & Trading Nuances since 2007 onwards. Author of Marketcalls.in and Co-Creator of Algomojo (Algorithmic Trading Platform for DIY Traders)

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3 Replies to “Understanding the European Debt Crisis”

  1. Very nice ,explanatory article. Whether India is better position or not is not known. Now the GOVT new PRDA bill , which is supposed to govern the pension deployment of GOVT employees is to be watched. In the market oriented Manmohan economics and our corruption Ministers and top officers,newly recruited employees of GOVT future is @ stack,if they recklessly invested in junk securities, as per Minister wish or Minister tainted companiesor bogus companies created by big industrialists etc,

  2. Recently the govt was advising Life Insurance Corporation of India to buy 10% stake in cash- strapped KINGFISHER AIRLINES.Fortunately LICI ,which has successfully withstood competition from foreign private insurers and maintained its numero uno position is unlikely to pickup stakes as it fears losing confidence amongst new and existing customers by venturing in troubled waters.

  3. i son’t think that indian banks could collapse on such basis because lending policies here are very strict, as what is known to common people, but it is to be understood whether crisis happened in europe because of lending to small players or precisely to big players. beacuse if it confines only to big players or lenders than such a crisis is a possibility in india too.. where the actual picture is hidden..

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