The Origins of Greece's Debt Crisis

The Greek debt crisis originated from heavy government spending and problems escalated over the years due to slowdown in global economic growth. When Greece became the 10th member of the European Union (EU) on January 1, 1981, the country's economy and finances were in good shape. By 1999, the country had a respectable a debt-to-GDP ratio of less than 60% and a budget deficit below 3% of GDP. In 2001, Greece joined the Eurozone and adopted the common euro currency.

But the situation deteriorated dramatically over the next two decades fast due to fiscal profligacy, which is defined as wasteful and excessive expenditure, caused deficits and debt levels to explode.

The Road to Debt

In October 1981, the Panhellenic Socialist Movement (PASOK), a party founded by Andreas Papandreou in 1974, came into power on a populist platform. Over the next three decades, PASOK alternated in power with the New Democracy Party that was also founded in 1974. In a continuing bid to keep Greek voters happy, both parties lavished liberal welfare policies on their electorates, creating a bloated, inefficient, and protectionist economy.

But that growth came at a steep price in the form of rising deficits and a burgeoning debt load. This was exacerbated by the fact that these measures for Greece had already exceeded the limits mandated by the EU's Stability and Growth Pact when it was admitted into the Eurozone. For example, Greece's debt-to-GDP ratio was at 103% in 2000, well above the Eurozone's maximum permitted level of 60%. Greece's fiscal deficit as a proportion of GDP was 3.7% in 2000, also above the Eurozone's limit of 3%.

Unsustainable Ambitions

The jig was up shortly after the financial crisis of 2007-2008, as investors and creditors focused on the colossal sovereign debt loads of the U.S. and Europe. With default a real possibility, investors began demanding much higher yields for sovereign debt issued by Portugal, Ireland, Italy, Greece, and Spain (the so-called "PIIGS") as compensation for this added risk.

Up until then, the sovereign debt risk for those countries had been camouflaged by their wealthy neighbors in the north, such as Germany. By January 2012, however, the yield spread between 10-year Greek and German sovereign bonds has widened by a whopping 3,300 basis points, according to research by the Federal Reserve Bank of St. Louis. As Greece's economy contracted in the aftermath of the crisis, the debt-to-GDP ratio skyrocketed, peaking at 180% in 2011.

The final nail in the coffin came in 2009, when a new Greek government led by Papandreou's son George came into power and revealed that the fiscal deficit was 12.7%, more than twice the previously disclosed figure, sending the debt crisis into a higher gear.

The Bottom Line

The Greek debt crisis had its origins in the fiscal profligacy of previous governments, proving that, like individuals, nations cannot afford to live way beyond their means. As a result, Greeks may have to live with stiff austerity measures for nearly a decade.