How mountains of debt can end in tears

Default is a financial concept that is making front-page headlines around the world as the European debt crisis spreads. Policy makers and investors fear that countries with a high default risk, especially Greece and Italy, may affect neighboring countries and trigger a bigger or global financial crisis.

A country is in default when it fails to pay back the interest or principal of a loan, including bonds and mortgages, before the scheduled payment. It can happen to businesses, institutions and individuals, as well as countries.

A private company is in default when it fails to make payments on a debt to the lender due to poor management or bankruptcy. If an individual is in default, the person may lose any property that he or she put up as collateral to get the loan.

A country can default during a civil war, revolution or depletion of foreign reserves - which is the case for Greece at the moment.

Greece now faces a severe default risk. Its government borrowed heavily to bolster public spending despite the fact that its income had been hit by widespread tax evasion.

When the global financial crisis hit the euro zone in late 2008, Greece was not prepared to cope with it as it lacked sufficient foreign reserves. It received 110 billion euros in the form of bailout loans in May 2010, and another 109 billion euros this July. But it still has more than 340 billion euros of debt, equivalent to around 31,000 euros per person.

Meanwhile, Italy’s enormous debt dwarfs that of Greece and presents a much bigger threat to the Korean economy. Italy, the third-largest economy in euro zone, now has 1.9 trillion euros of national debt. Of this, it owes 510 billion euros to France, representing 20 percent of France’s total GDP. Italy is also deeply in debt to the U.K. and Germany.

Defaulting and the risks tied to this have a negative impact on a country’s credit rating, which makes it harder for the country to borrow capital again in the future.

By Lee Eun-joo [angie@joongang.co.kr]