What is the European Debt Crisis and How Can It Affect You?

For the past several years the European Union — also called the Eurozone — has been enduring a deep financial crisis that has shaken the faith of the markets in the region.

The issue is complicated and difficult to summarize in a basic article, but having even the most basic understanding of how it might impact you personally is important.

The goal of this article is to highlight some of the key aspects of the European debt crisis so you as an individual are better prepared to seek more information on your own and avoid making critical financial mistakes.

What is the European Debt Crisis?

When commentators speak of the European debt crisis they are referring to the problem the European Union has with rising debt levels across several countries.  These debt levels have risen to a point of significantly hampering the economies in those countries and their neighbors within the European Union.

Primarily the countries at risk are Greece, Portugal, Ireland, Italy, and Spain.  At its core these countries went too far into debt, and when one little bump in the road happened, it caused the house of cards to come down in terms of being able to get out of debt.

What has happened in the European Union can happen to individuals as well, so the parallels are important to see.

Essentially the debt levels in these countries have gotten so high that it has become impossible to refinance the debt without having a co-signer.  Just like if you maxed out every single one of your credit cards and tried to go to a bank for a car loan, they wouldn’t lend you the money without someone else agreeing to pay the debt in case you are unable to.

For example, Greece’s debt has risen to a point that it cannot afford to pay it and at the same time it cannot refinance it to a lower, more sustainable level.  Bigger, more stable countries like Germany have had to step in and agree to cover the debt if Greece defaults, but they aren’t doing it nicely.  (I wouldn’t either, if I were bailing out a friend.)

These countries are requiring austerity measures by the impacted indebted governments to cut spending and/or raise revenues to increase the odds that Greece itself can pay off the debt and not rely on its Germany friend to do so.  These austerity measures have come at an inopportune time — when the economy is shaky — and assisted in driving the economy down and unemployment up.

This spiraling circle – worse economy means lower revenues which requires the need for more austerity cuts which means an even worse economy – has hurt the image of Greece and countries in a similar position.  Investors have driven up the yields on the government bonds due to the risk associated with investing in a bond from a shaky economy.

How Can the European Debt Crisis Affect Me?

It is difficult to determine exactly how much of an impact the debt crisis will have on you the individual because the impact of the crisis as a whole is still yet to be determined.

When the risks range from low prices on international bonds (not so bad on an individual level) to the complete collapse of the global financial system (obviously much worse!) it is tough to pin down how you will be impacted.

However, here are a few things to be aware of as the Eurozone crisis continues:

US Treasury Prices

When global investors run from risk and to safe investments, the safest investment on the list is US Treasuries.

As bond prices plummeted in Europe (due to rising yields), investors jumped to US Treasuries which in turn drove their prices down.  If you were heavily reliant on a portfolio of Treasury bonds, you may have felt a hit.

Then again the best time to buy anything is when the price is very low so Treasuries might be attractive to you now.

Bank Failures

You would have to be on the full “I love risk!” end of the spectrum to invest in any individual banks in Europe right now, especially in the impacted countries like Greece and Spain.  There is still a risk of default on the government debt which would have significant impact across the global economy.

If a regional bank is sitting on a large amount of government debt from Greece, and Greece defaults, the value of that asset shrinks to virtually zero.  That, in turn, could put the bank at risk of insolvency and put other banks that might be holding bonds from that bank at risk as well.

It could cause a cascading failure of banks as one domino falls, causing the next to fall, and so on.  (This is what happened that led to Lehman Brothers going under and the US government eventually having to step in to stabilize the financial system in the 2007-2009 time frame.)

Hidden Costs to US Taxpayers

One last cost that may be unavoidable is the hidden costs for taxpayers in the United States.

The International Monetary Fund gets about 40% of its capital from the US and if the IMF is spending cash like crazy in order to stabilize the Eurozone, it will eventually need more capital.  Which means American taxpayers could end up footing a significant chunk of the bill to fix the European Union’s problems.  Unfortunately, there isn’t much you can do as an individual to avoid this.

Now that you have read a bit about the European debt crisis, what do you think about it?