US & World Economies US Economy Fiscal Policy Debt Crisis Causes and Cures How a Country's Debt Crisis Is Different From Yours By Kimberly Amadeo Updated on October 29, 2021 Reviewed by Robert C. Kelly Reviewed by Robert C. Kelly Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital. learn about our financial review board Fact checked by Julian Binder Sponsored by What's this? & In This Article View All In This Article Household Debt Crisis Sources of Household Debt Business Debt Crisis Sources of Business Debt Sovereign Debt Crisis Sources of Sovereign Debt Photo: fotog / Getty Images A debt crisis occurs when an entity has more debt than they can pay off. Individuals, businesses, and countries all experience debt crises. However, a country has a significant advantage over individuals and businesses—it can print its money. Find out why cutting expenses, which is the best way for you to get out of debt, might be the worst way for a country to resolve its debt crisis. Household Debt Crisis A household debt crisis occurs when a family starts falling behind on monthly payments. There are three types of household debt: Home mortgages, including both first and secondary mortgages, and home equity lines of credit. Credit card debt (also called revolving credit). Auto, furniture, and student loans (also known as non-revolving credit). Both revolving and non-revolving credit are types of consumer debt. Sources of Household Debt Any sudden loss of income—or an increase in costs—can cause a household debt crisis. The biggest reason is medical expenses, which generate half of all bankruptcies in the United States. Other reasons include extended unemployment or uninsured losses. A household debt crisis can also creep up slowly. One cause is poor debt management, such as only paying the interest on credit cards. Another is economic change, such as when the housing asset bubble burst in 2006. Many homeowners had interest-only loans with teaser rates that reset after the first year. Note The housing bubble was caused by runaway mortgage investment practices on home loans with a high risk of default. They had planned to sell their home before then, but now the house was worth less than the mortgage. A third example is families who get in over their heads with education loans. The price of education keeps going up, and parents don't want to tell their children they have to drop out. The 2005 Bankruptcy Protection Act also caused many household debt crises. The law made it more difficult for families to declare bankruptcy on their consumer debt. Homeowners instead used the equity in their homes to pay off the bills. As a result, mortgage defaults rose 18% in 2006, and 200,000 more families lost their homes. Settling Household Debt Once a household debt crisis occurs, there are only three ways to resolve it. First, increase income through a second job, a raise or promotion, or selling assets such as a home. Second, cut expenses. That includes switching to a lower interest-bearing credit card, using cash instead of credit, and paying extra on your debt. Third, declare bankruptcy and start over. Business Debt Crisis A business debt crisis is when a company has trouble repaying its loans, known as bonds. They get downgraded as a poor investment by a credit rating agency such as Standard & Poor's. Note Debt isn't necessarily detrimental for a business. Some run higher levels of debt due to their industry's nature, e.g., airlines, large manufacturers, and banks. Once this happens, it becomes more expensive for the company to issue new bonds. Unless the company can convince creditors it has made the changes to do better, it can go into a downward spiral where servicing the debt takes up the cash flow that would otherwise go into new business development or operations. Sources of Business Debt Many factors cause business debt crises. Many small businesses wind up with too much debt because they didn't have enough capital to cover operating costs through the first unprofitable years. Sometimes the company has a flawed business model or a product that doesn't have a strong competitive advantage. Last but not least, the company's leaders may not have good general management skills. Note An economic downturn can put many otherwise profitable businesses into a debt crisis. Settling Business Debt The solution to a business debt crisis depends on its cause. Sometimes lenders require new management before agreeing to lower payments. If a recession has occurred, the company may need to scale back, cut costs and improve customer service. Often it can hire a turnaround consultant who can identify better business models or products. Sometimes the company must declare Chapter 11 bankruptcy to give it relief from creditors and enough time to reorganize and stay in business. If it files Chapter 7 bankruptcy, that means it goes completely out of business. The owners may also sell the company, in which case the new owners assume the debt. Sovereign Debt Crisis A sovereign debt crisis occurs when a country can no longer pay the interest on its debt. Just like a business, the nation finds that worried lenders demand greater interest payments on new debt. There are three critical differences between sovereign debt and household or business debt that lays the groundwork for this crisis: There is no international bankruptcy court that lenders can go to for fair adjudication. That makes it easier for countries to default.Sovereign debt is not secured by any collateral. In that regard, it is more like credit card debt than a mortgage or auto loan.Most countries can print their currency to pay off a debt. That's why the Greek debt crisis escalated into the Eurozone crisis. In 2001, Greece had exchanged its drachmas for euros. It had to rely on the European Union to print more euros to pay off its debt. In return, the EU demanded that Greece cut costs to stop racking up more debt. That slowed its economy, making debt repayment even more difficult. Greece entered a deep recession with a 27.5% unemployment rate, political chaos and a barely functioning banking system. Concern over whether the EU could pay for the Greek crisis soon affected all European bonds, especially Italy, Spain, and Portugal. Within a few years, the EU itself had slipped back into a recession. That's another difference between sovereign debt crises and the other forms. If a household or business cuts costs, it will have more money to pay its debts. Since government spending is a component of gross domestic product, it also reduces economic growth when it cuts costs. It would be as if a household stopped eating to pay for its debt. Soon, it would run out of energy to work, making debt repayment even more unlikely. Note Foreign investors can also influence sovereign debt by reducing the capital they have invested in a country. The EU debt crisis was unusual. It was caused by lower-income countries, like Greece and Italy, enjoying the benefits of low-cost debt due to their inclusion in the higher-income EU. That wasn't a problem until investors lost confidence in the Greek government's ability to repay. Sources of Sovereign Debt Sovereign debt crises are usually caused when countries rack up too much debt to pay for wars. When they print too much money to pay off the debt, they create an even worse problem of hyperinflation. A recession can also cause sovereign debt crises. The 2008 financial crisis was the primary reason for Spain's crisis. Even though it had been fiscally responsible, its banks were heavily invested in real estate. When the bubble burst, the government took over its banks' debts. Note The recession also caused Iceland's debt crisis. Icelandic banks invested heavily overseas. When the government nationalized the banks and printed the money to pay off the debt, the value of its currency fell drastically. The U.S. debt crisis was self-inflicted. Unlike Greece and most other countries experiencing a debt crisis, interest rates on U.S. Treasuries weren't rising—they were at historic lows. Instead, the U.S. debt crisis was caused by Congress's refusal to raise the country's debt ceiling in 2011. They thought it was the only way to force reduced spending and lower the national debt. Their refusal almost made the U.S. default on its debt. They finally raised the ceiling, but only after installing mandatory spending cuts, called sequestration. Congress narrowly avoided falling off the fiscal cliff. Resolving sovereign debt is one of the most challenging scenarios a country faces. Emerging and developing countries need to find capital to continue to grow—if they are low on natural resources, the only way to do it is through increasing their level of debt. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. United States Congress. "S.256 - Bankruptcy Abuse Prevention and Consumer Protection Act of 2005." Federal Reserve Bank of St. Louis. "Delinquency Rate on Single-Family Residential Mortgages, Booked in Domestic Offices, All Commercial Banks (DRSFRMACBS)." Statisa. "Greece: Unemployment Rate From 1999 to 2020." Trading Economics. "Icelandic Krona." Federal Reserve Bank of St. Louis. "3-Month Treasury Bill: Secondary Market Rate (TB3MS)." United States Congress. "S.627 - Budget Control Act of 2011."