HOW THE HELL IS EUROPEAN DEBT CRISIS STILL GOING ON?

Sarah,

This one is a doozy.  The basic story is that several countries in Europe (Greece, Spain, Portugal, Ireland and Italy) cannot pull themselves out of financial crisis.  Here is why:

The Euro:

The core countries of Europe use a single currency called the Euro.  The Euro helped relatively poorer countries (Greece, Portugal, Spain, and Ireland) borrow at lower rates.  The Euro helped richer countries (France and Germany) make money by lending money to the poorer countries.  This lending also allowed the poorer countries to buy more exports from the richer countries.  Germany, for example, is a huge exporter and the Euro allowed them to sell more products to countries like Greece

The Crisis:

After a couple years it became apparent that Greece was overspending and over borrowing at spectacular rates.  Other countries such as Spain, over invested in real estate, and a property bust leveled their economy.  It also became clear that the rich countries were lending rather recklessly.

The Fallout:

Soon investors realized that countries such as Greece might not be able to repay their loans and started demanding higher interest rates.  This made borrowing difficult.  In exchange for bailouts, France and Germany demanded that the troubled countries balance their budgets by making budget cuts.  These cuts terminated government jobs, creating higher unemployment and massive unrest.  Note however, that the alternative of running massive deficits would probably have been just as problematic.

Why Do Germany and France Keep Bailing These Countries Out?

The main reason Germany and France continue to issue bailouts is that German and French banks hold the debt of the troubled countries.  If these countries default on their loans, then the German and French banks take the loss.  Further, countries like Italy (which is in a precarious but not yet dire economic position) also hold Greek debt.  If Greece defaults, that could cause Italy to default, and holders of Italian debt will be screwed as well. (there are a lot of scenarios involving domino analogies)

So Now What?

For now, the struggling countries are pretty much spinning their wheels.  The public sector (government) continues to be cut and the private sector (business) remains reluctant to invest.  None of the troubled economies are growing and debt remains.  Thus far, none of the massive bailouts extended by France or Germany have really fixed the problem.

Bottom Line: There is no end in sight.  Europe is screwed.

WHAT THE HELL IS LIBOR; UNDERSTANDING THE LATEST BANKING SCANDAL

Sarah,

The latest banking scandal revolves around a “benchmark rate” known as LIBOR.(London Interbank Offered Rate)  What hell is LIBOR?  I didn’t know either.  Here is the basic breakdown.  In the 80’s there arose the demand for a uniform interest rate.  A company in London started asking each major bank what their current interest rates were and then calculated an average interest rate based on these estimates.  Other banks and financial institutions then based their interest rates on the LIBOR average because it was deemed to be reliable.

So what’s the problem?  First, starting as early as 2008, there were indications that big banks were providing LIBOR with artificially low interest rates so they could borrow at lower rates and turn a profit.  These low rates also worked to make banks appear healthier financially. 

More recently, regulators have accused the bigger banks of colluding to manipulate their interest rates.  In the last year, Barclays, a British bank, was caught giving false rates to increase profits and manipulate the picture of its financial health.  The bank has since negotiated a settlement with authorities. 

Now, in the wake of the Barclay’s settlement, banks are scrambling to protect themselves from accusations of rate fixing.  Some are even turning on each other in exchange for immunity from regulators.  Expect other banks to be caught and fined in the near future.

Bottom Line: Banks are a joke.