How the Greek & European Debt Crisis Impacts Consumer Bank Rates

Over the past two years, the news has occasionally focused on the slow-moving debt debacle that is taking place in Greece and several other members of the European Union. It's easy to dismiss what is happening in Europe as something going on far away that doesn't impact the economy here in the United States. Nothing could be further from the truth. What is happening in Greece is having a direct impact on the US and even more so on US banks and bank rates.

First, a little background for those who are not familiar with what is happening in Greece and the EU.

The epicenter of the European debt crisis is Greece although the problem and bigger than just one country. When Greece joined the European Union in 1981, it immediately benefited in one large way. It was able to borrow money at EU rates rather than Greek rates (which were much higher). As a result, the country went on a borrowing binge, racking up some of the biggest budget deficits and debt in the developed world. When the economic crisis struck in 2008, it became clear that Greece did not have the means to pay back this debt. Before it joined the EU, when it was still using the drachma as its currency, Greece could manage its budget deficit by printing money to pay its debt (as long as a percent of debt was denominated in drachmas). But once it was part of the EU, it no longer had control over its own currency, using the common Euro. End result, Greece had no way out.

Banks in Europe and the U.S. held Greek debt. If Greece defaulted, it would wipe out capital in all of these banks. Even worse, it might cause investors to question other countries in Europe with big debt problems - Italy, Ireland, Portugal, and Spain. Italy, as the third largest economy in the EU is a particularly big problem. If investors make a run on Italy, the whole EU could collapse.

So, the EU, the European Central Bank, the IMF, and other big financial institutions have worked over the past six months to develop a package that will resolve the Greek crisis and also create a broader solution to prevent debt fears from spreading to Italy and other countries. The solution is not an easy one. The Italians and especially the Greeks will have to accept pretty strict austerity programs that will strip away much of the government services and perks they have become accustomed to and that might also tip their economies into a deep recession. Large and violent protests have broken out in each country. German's will have to cough up billions of dollars to pay for the excesses of the Greeks. Banks will have to take losses on some of their loans. Everyone needs to come out a loser so that everyone can win in the long-run. But agreement on this has been very difficult.

Impacting Your Rates

So, back to the original question. How does all of this impact your interest rates and your wallet? There are three main ways this impacts your wallet:

• Depending on the negotiations to resolve this crisis, the stock market and bond interest rates rise and fall, sometimes quite dramatically. When it looks like negotiations are breaking down, money flows into safe haven US Treasuries and interest rates on mortgages, home equity lines, and other loans go down. On October 6, the rate on a 30 year mortgage dropped below 3% for the first time ever, just as Greek default concerns mounted. When it looks like a resolution is reached, as it did last week, the stock market soars along with rates.
• Europe is the largest market in the world. A Europe racked with default worries will not buy as much from the U.S. and further weaken the U.S. economy. This will put a damper on interest rates.
• The Euro will weaken against the dollar, making U.S. exports less competitive and further slowing the American economy. A slower economy means lower interest rates.

For Savers

So, the bottom line is that a European debt crisis is bad news for those looking to deposit money into a CD or savings account. The problems in Europe will only exacerbate and extend the current low rate environment.

For Borrowers

Europe's problems though, may lower rates on mortgage debt, benefiting those who want to purchase a home or refinance.

If not accord is reached, the Greece defaults on its debts, the initial impact will be a sharp lowering of rates. Greece will be forced out of the EU. At that point, it's difficult to judge what will happen next.

Note: Even as I write this, Greece has called for a referendum on the debt deal and the acceptance of a strict austerity program. The referendum could unwind the debt deal, making a Greek default and exit from the EU likely. The referendum is currently front page news on all of the major news outlets. See WSJ story.