(This article by Dylan Matthews originally published on August 5th, 2011. But with Europe’s crises nearing a tipping point, it’s worth republishing today. The main update since August 5th is that everything is worse now than it was then. --Ezra)

German Chancellor Angela Merkel on Tuesday sought to calm market fears that Greece is heading for a chaotic default on its debts as Europe struggles to contain a crippling financial crisis. (AP Photo/Michael Sohn)

Since the financial crisis hit in 2008, a wave of debt crises have swept the European Union, threatening various countries with default and putting the future of the euro in danger. Here’s what's happened, by country.

Greece: Greece had a debt load of over 100 percent of GDP in 2001, when it joined the euro. But joining the euro lowered interest rates on its debt, because the bond markets no longer worried about inflation or a devalued currency. The result was an economic boom fueled by low interest rates, and ever-increasing debt due to a lower cost of borrowing. Greece hired Wall Street firms, most notably Goldman Sachs, to help hide its debt so as not to run afoul of E.U. rules. In October 2009, the conservative government was voted out, and the new socialist government announced that deficits were more than double previous estimates. Greek debt was immediately downgraded. The situation worsened in February 2010, when institutional bondholders started selling off Greek debt and ratings agencies kept downgrading it. Greece responded with a round of austerity measures.

In April 2010, Greek Prime Minister Georges Papandreou asked the International Monetary Fund and the EU to put together a rescue package. This was quickly followed by S&P downgrading Greek debt to junk status; a few months later, Moody’s did the same. The European Central Bank moved to shore up Greece, and the E.U. and IMF settled upon a $145 billion bailout, conditioned on Greece adopting austerity measures worth a staggering 13 percent of GDP. The E.U. also created the European Financial Stability Facility (EFSF), a body intended to streamline future country bailouts.

The bailout/austerity package was a failure, leading to plummeting growth that actually worsened Greece’s financial situation. This past June, S&P reduced its rating of Greek debt yet again to CCC, the lowest rating of any government in the world. This spurred Papandreou to reshuffle his cabinet and force a confidence vote for his government. If the vote succeeded, it would have signaled Papandreou had enough support to pass additional austerity measures needed to ensure a second bailout. If it failed, the government would have fallen. The measure passed. As it was being debated, France and Germany hashed out another bailout package, which was finalized by the E.U. last month, that would provide another $145 billion and encourage private bondholders to help out. Moody’s responded by downgrading Greek debt yet again, and declaring that default was “virtually 100 percent” certain.

Ireland: Unlike Greece, Ireland had a balanced budget before the crisis hit. However, it also had a huge real estate bubble even larger than the one in the United States. Before the crisis, 25 percent of its economy was involved in home construction compared with less than 10 percent in normal economies. When the financial crisis hit in September 2008, the bubble burst and the government announced it would cover all banks’ losses, in an attempt to calm the markets. The promise turned out to be disastrous, as the banking sector continued to implode. In January 2009, Ireland nationalized one of its major banks, and in October 2010 conducted a bailout of some others. At this point, its budget deficit had grown to 32 percent of GDP. The following month, the E.U. and IMF launched a $90 billion bailout of Ireland. This past March, the government was swept out of power, and the new government pledged to reduce the interest payments required under the E.U./IMF bailout, a promise they made good on in July. On July 12, Moody's downgraded  Irish debt to junk.

Portugal: Unlike Ireland and Greece, Portugal had one of the best recovery records during the first part of the economic crisis. However, panic due to the Greek debt crisis hit the country in late 2009 and early 2010, due largely to concern that the country could not grow over the long term, as well as higher deficit forecasts. It has below-average productivity, a legal structure some condemn as outdated, and strict labor market regulations that some say hobble growth. By November 2010, the market had pushed interest rates to a point where the country was under pressure to ask for a bailout. Concern increased when the parliament failed to pass budget cuts in March, and European leaders met to discuss the possibility of a rescue package. Finally, the Portuguese government requested an E.U. bailout in April. It was approved in May and totaled $116 billion. Portugal’s center-right party came to power in elections in June and remains committed to the bailout. Last month, Moody’s downgraded Portugal to junk status, saying there was a high risk of a second bailout.

Spain: Like Ireland, Spain experienced a real estate bubble leading up to the crisis, which hurt its growth despite the country’s unusually safe financial sector. Facing higher than expected deficits, Spain adopted austerity measures in May 2010. Fitch responded by downgrading its debt a notch from AAA, out of fear these measures would hurt growth. Moody’s followed suit in September. In March, Spain announced it had met its deficit reduction target for the previous year. Moody’s downgraded again, citing concern over slow growth. In recent days, as fears of Greek default have increased, borrowing costs for Spain have spiked, spurring fears that it may require a bailout that other European governments cannot afford. Spanish leaders say they are considering more austerity, and Moody's has put Spanish debt on warning for another downgrade.

Italy: Due to its huge debt load and slow growth, fears that Italy would develop a debt crisis have circulated for months, but they grew more pronounced after S&P downgraded its outlook on Italian debt in May. In June, Moody’s also threatened a downgrade, citing rising borrowing costs and the possibility that Italian Prime Minister Silvio Berlusconi, who is currently on trial for paying an underage girl for sex, might be forced out out. The next month, Berlusconi pushed through an austerity package intended to stave off a crisis as investors started selling off bonds. In recent days, interest rates have shot up amid fears that a Greek default would cause a domino effect, causing Spain and Italy to fall as well. The EFSF probably has enough funds to support Spain for a short time, but Italy, the euro zone’s third largest economy, would be incredibly expensive and perhaps impossible to bail out.

What it means for the euro zone: Many experts argue that the E.U.’s model, which concentrated monetary policy in the European Central Bank (ECB) while leaving fiscal policy to individual member states, is inherently unsustainable, as it denies member states monetary policy levers with which to help their recoveries. This also makes deficit-funded fiscal stimulus harder, as monetary policy can be used to keep borrowing costs low. When different countries are hit differently by a recession, as has happened now, the common monetary authority will act in ways that help some countries but not others. The ECB has pursued tight monetary policy that may prevent inflation in high-growth states like Germany but could also be worsening the recession in Greece, Spain, and other struggling states.

Most view one of two options going forward as likely. One is that the euro zone will lose members like Greece, Spain and Italy, either by them just leaving or by a default by any one of them, which could unravel the whole monetary union. Barry Eichengreen, a Berkeley economist, has said this would lead to a huge bank run and the “mother of all financial crises.” Another option is closer European fiscal union, so that fiscal policy can be coordinated at the continent level as well as monetary policy, bringing the E.U. closer to being a sovereign state.

What it means for the U.S.: U.S. financial institutions hold considerable European financial assets that could plummet in value if the euro zone enters a full-on crisis. For example, European debt makes up almost half of all money-market fund holdings. Direct exposure to the so-called PIIGS countries profiled above is limited, but exposure to France and Germany is high, and given, for example, France’s tight linkages with the Italian financial system, a Italian default could roil France and the U.S. in turn. The crisis is also leading to heavy spending cuts and reduced borrowing that hurts U.S. exports to Europe, further endangering the American recovery.

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