European Debt Crisis

One of the fastest growing problems we now face is the amount of money that certain european countries owe.  Two that are in the most debt: Greece and Portugal.  They owe money to countries all over the world.  Why is it a growing problem?  Let's take Greece... Greece is now currently financing their obligations with more debt.  In other words, the only way Greece can pay back loans that are due today, is to borrow more money... today (which the United States is currently doing, as well).  The only way they can back the "maturing" loans is to borrow money to do so.  Does this seem like a good idea?  No.

As other countries continue to lend them more money, their chances of defaulting on some of those obligations will rise.  When international organizations (like the International Monetary Fund, IMF) see that Greece may not be able to honor the loans they took out, their only solution is to lend them money so that they are able to pay back those loans.

Credit Default Swaps:  In finance, there is a product that allows you, as a lender, can protect yourself against "counter-party credit risk".  You can buy insurance, with a third party, on the loans that you give to your customers. If someone, who you lent money, can't pay you back, your insurance pays for the loan.  This is called a credit default swap, CDS.  The CDS is based on knowing what the probability of default is.   Both buyers and sellers of CDS want to know what the exact chances of default are(in reality you can only guess this number, but estimating it is a pretty reasonable thing to do).  Today, 6/16/11, the CDS market said that there is a 78% chance that Greece won't be able to pay off the loans they have.

What happens when a country cant pay back their debt?  Everyone else stops lending to them.  When that happens, the government can't fund the expenses.  Government workers stop getting pay checks, pension funds dry up, social security checks stop being sent to Grandma, there is no more medicare/medicaid etc. etc.  The country falls apart.

What happens when Greece defaults their debt?  It spreads like fire through the international banking industry. Approximately $1 trillion dollars does not get paid back.  Banks see a massive blow to their balance sheets.  Some banks, that lent a large amount of money to Greece, will go bankrupt.  This is the same idea that broke Lehman Brother's, which sent the country into a recession for 2 years.  If multiple banks we're to fail, the problem clearly grows.