What Happens If A European Country Goes Bust? : Planet Money Private investors may be forced to take losses if they lend money to a Eurozone country that can't pay off its debts.
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What Happens If A European Country Goes Bust?

In yet another round of frantic weekend meetings, EU leaders agreed to the details of a bailout for Ireland -- and they also started to face up to a big, scary question they've been avoiding up until now:

What happens if a country that uses the euro is in so much financial trouble that it can't pay off its debts, even if it gets a bailout loan from the EU?

The answer: Starting in 2013, private investors may be forced to take losses if they lend money to a Eurozone country that goes bust.

This isn't terribly surprising on its face. The possibility of default -- the chance that a borrower might not pay back a loan -- is one of the key risks bond investors always face.

For many years, though, investors largely ignored this risk. They readily loaned money to all of the countries in the Eurozone, as if Greece's risk of default was about the same as Germany's.

That fiction ended this year, of course, as investors began to demand higher interest rates from countries like Greece, Ireland, Portugal and Spain.

But EU officials continued to suggest that bailout loans would be enough to carry troubled countries through to a financial rebound, when the countries would ultimately make good on their debts.

Under the agreement reached this weekend, that will change -- but not for a few years, and only in certain circumstances.

Starting in 2013, if an EU country is deemed to be insolvent -- basically, if it won't be able to pay off its debts, even if it gets a bailout loan from the EU -- then private investors who loaned money to the country may be forced to take a loss on their investments.

The plan is a compromise; Germany wanted stricter rules that would have forced losses on investors automatically if a country became insolvent. Other countries pushed for (and got) a milder version, that gave the EU more leeway.

But the fact that the plan is a bit milder than it might of been doesn't seem to be soothing investors: The cost of borrowing money rose again today for Portugal, Spain and Italy.