Who’s responsible for the current sovereign debt mess?

27th June 2012

The emphasis of the blame for the current financial situation across the eurozone has been put on governments for issuing large amounts of debt, which have become excessive to the point of collapse. However I am not so sure they are solely to blame. There are two sides to a debt contract, one is the issuer and the other is the purchaser. One is not possible without the other. For a government to get into such large amounts of debt not only does the government have to be willing to sell bonds but someone else has to be willing to purchase them.

When you go to a bank and invest money they invest that money elsewhere. Your money will be bundled up with other savers money and used to purchase a myriad of products available in the financial market. The bank serves you and acts as an agent investing in a portfolio of products on your behalf, with the intention of providing the best return at the lowest rate of risk. A successful bank will do two things. The first is investing the funds they have in the best financial products that provide a strong return and security creating a valuable portfolio. The second is managing the size of the reserves they hold to cover the withdrawals of customers who wish to take money out of their account.

If too many people take money out of their bank account at one time the reserve may not be large enough to cover the withdrawals. This will result in bank failure if the bank cannot secure funds elsewhere to cover the size of the withdrawals. This was seen recently in the UK when Northern Rock received a bailout to prevent a bank run. The reserve management failure and the subsequent government bailouts have been the major recipients of the criticism of the problems within the banking system. However the successful investment in a secure portfolio, or lack thereof, has in my opinion been the real failing of the banks and has not received anywhere near the amount of criticism it should have.

The situation in the eurozone is an example of this. The governments who issued the excessive sovereign debt have been criticised and punished through austerity. However the banks and the traders who acted on their investors behalf have not been criticised in the same way. If the traders were researching the products they were investing in properly then they would have appreciated the extent of the sovereign debt in the failing PIIGS member states of the eurozone. The member states of the eurozone have to comply within regulations on sovereign debt levels and how they are reported. These regulations were not met by the eurozone PIIGS member states for various reasons, which you can read about in my book here.

Regardless of the inability of the eurozone member states to report the extent of the debt they issued. I believe the sovereign debt crisis could have been and should have been avoided through the analysis the bond traders were expected to have done before they invested money in these products. As there are two sides to the debt contract I find it hard to believe that trading institutions, such as the Bank of International Settlements (BIS) and the exchanges themselves did not know the volume of trades which were taking place in sovereign debt products.

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More on Mindful Money:

Financial crisis: Alternative routes to recovery

Who's to blame for the Eurozone crisis? We all are

How to survive the Eurozone apocalypse

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