Capital Markets Lab Weekly Market Wrap Up, February 08–12, 2010

European Union Debt Issues

Markets this week have been extremely tied to debt concerns in the Euro-zone, specifically Greece. After being downgraded in December, the Greek debt crisis has kept unease in the world markets, causing a flight to safety and selling of risky assets. In January, the country came out and exposed that their budget deficit numbers had previously been fabricated, which sent government bond prices plummeting and insurance on those bonds sky rocketing. After this, the government announced what they believed would cure the false numbers, and would impose a new institutional arrangement to take these statistics via a third party. They still announced an unhealthy deficit of 12.7% of GDP, which many analysts are taking with a grain of salt, worried that they still cannot trust the Greek government’s statistics.

The situation is weighing heavy on the entire European Union; leading to the questioning of the Union’s stability, structure, and monetary efficiency. This is unfortunate for the Union, as Greece makes up less than 3% of the entire Euro-zones economy. However, the situation shows the difficulty of surveying multiple countries with different governments and systems. According to the Maastricht Treaty, the EU limits its members to a budget deficit of 3% of GDP; a rule they have been ignoring for some time now.

While in combat with their deficit and making payments on the interest of their outstanding bonds, Greece will be constrained on spending to boost their economy. This predicament makes the crisis urgent and severe for the Union, who discussed this on Thursday at the EU Summit.

As if Greece wasn’t enough, Europe will eventually have to deal with other members of the Union who may be nearing their own debt disasters. Such debt crises have been looming over other EU members such as Italy, Belgium, France, and Spain.

Analysts bring up the issues of dealing with the situation as a Union, rather than separate entities. As noted in the Wall Street Journal “Investors may balk at buying government bonds without a hefty premium that would saddle the countries with even more debt. The countries can’t devalue their currencies to help cope, as they could before joining the euro zone with its shared currency.”

Still, markets were anxious to hear what the EU Summit would propose to mend the situation. They announced, “Countries belonging to the Euro will take determined and coordinated action, if needed, to safeguard financial stability in the euro area as a whole.” Basically saying that they intend on doing something, but are not yet sure what it will be. This temporarily calmed the markets, as the US had a “relief rally” on Thursday, but was not enough to hold investors through the open on Friday. Analysts speculate the EU will agree on splitting the bill between its members and creating a sort of debt agreement with Greece that should temporarily take them out of their mess. The markets will be expecting more details on Monday.


United States Debt Update

The PIGS debt crisis has, over the course of the last few weeks, dominated business media across the globe. Fear that Greece could default on its debt has caused worry to many European Union member states. The Euro, the European Union’s shared currency, has been in a freefall against the United States dollar and Global leaders have begun to question the viability of a European union.

However, it is sometimes best to be introspective. The United States gross debt as a percentage of GDP is the highest it has been since the Great Depression of the 1940’s. Currently the United States is operating at an eighty-seven percent debt to GDP ratio. (This is measured by the IMF and consists of all debt outstanding including Federal, State and Local Government debt.) The IMF forecasts that this ratio will increase over the course of the next four years and believes that at the end of 2014 the United State’s debt to GDP ratio will be at a level of one-hundred and eight percent.

With a corresponding deficit level of 10.2% of GDP, one can only wonder whether or not the United States has the ability to meet its obligation in the foreseeable future. Credit rating agencies have begun to notice and much like Greece before its debt was downgraded, rumors have begun to spread culminating in a public statement by Moody’s rating agency warning the United States about its deficit and debt levels.

Even more alarming is the sheer impact that individual States economies may have on the Global Market. California, by itself, is considered by the CIA fact book to be the world’s eighth largest economy. It too is nearing insolvency. In July of 2009, the state was forced to issue IOU’s in order to continue operating. Other states are having similar issues. Among these are New York, Florida and Michigan.

In times like these, it seems that the government is walking a tight rope between maintaining the recovery and dipping back into recession. Ultimately, the outcome will be determined by whether or not The United States can recover quickly enough to reassure creditors that their money is safe.

R. Belsky

Article submitted by: Alex Tarhini and Robert Belsky of the Capital Markets Lab (CML). To learn more about the Capital Markets Lab please visit

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