Satyajit Das: “Progress” of the European Debt Crisis

By Satyajit Das, the author of Extreme Money: The Masters of the Universe and the Cult of Risk (forthcoming August 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

In Oscar Wilde’s Importance of Being Earnest, Lady Bracknell memorably remarks that: “To lose one parent… may be regarded as a misfortune; to lose both looks like carelessness.” The Euro-zone’s need to rescue three of its members (Greece, Ireland and Portugal) with three others increasingly eyed with varying degrees of concern (Spain, Belgium and Italy) smacks of institutionalised incompetence.

European Debt Crisis Returns

In little over a year since the announcement of Greece’s debt problems, the European debt crisis has ebbed and flowed with markets oscillating between euphoria (resolution) and despair (default or restructuring). The European Union’s (“EU”) “confidence boosting”, short term “liquidity enhancement” programs, unfortunately, have failed to resolve deep-seated structural problems.

The most recent concern about the peripheral countries was triggered by concern about Greece. Having repeatedly failed to meet economic targets prescribed by the EU, European Central Bank (“ECB”) and International Monetary Fund (“IMF”), Greece needs additional financing or a fresh bailout to meet its financial commitment. An immediate concern was the suggestion that a further tranche of Euro 12 billion might be withheld making its impossible for Greece to meet its commitments to repay lenders on a maturing bond in mid-July.

The debate has several separate and conflicting dimensions. The first is whether Greece can or will implement the required actions to rehabilitate its economy and finances at tremendous cost to its population. A related issue is whether the plan, entailing further austerity, even it is implemented will actually succeed. The second is whether commercial lenders, who helped fuel Greece’s debt binge, should accept some losses, bearing some of the cost of the restoration of Greece’s finances. The last is the cost of any default or major restructuring to Greece and the Euro-zone. On the last two issues there are divisions between Germany (investors should take their share of losses) and France and the ECB (lenders should be spared to avoid financial Armageddon). The same issues are relevant ultimately for all the other deeply troubled Euro-zone members.

While an immediate crisis has been avoided, the stage is now set for a slow, “Wagnerian” drift towards a future debt restructuring for some of these peripheral countries and, perhaps, an European banking crisis. Greek interest rates of around 18% (for 10 years) and 30% (for 2 years), Irish and Portuguese rates of over 12-13% (for 2 years) and around 10% (for 10 years) testify to this trajectory. Markets put the chance of a Greek default at 80 per cent chance. The chance for an Irish and Portuguese default is around 40-50 per cent.

Greek Death Watch

The peripheral countries may not be able to ever pay back the debt they have incurred. Greece has a sovereign debt of Euro 340 billion, more than Euro 30,000 per person of its population of 11.3 million. Bailout programs, designed to rehabilitate over indebted economies, have failed, despite protestations from politicians and central bankers that things are “on track”.

The basic plan was temporary loans, combined with some fiscal and structural steps by the countries, would restore growth, competitiveness, financial health and access to commercial financing sources at acceptable costs. The plan was always a case of wishful thinking.

In Greece, the austerity program has led to a deep recession with Gross Domestic Product (“GDP”) falling by 4.5% in 2010 and forecast to fall by over 3.0% in 2011, a result worse than the IMF plan forecast. Unemployment, currently around 15%, is expected to rise further. Greek public finances have deteriorated as tax revenues have fallen faster than government spending. The 2009 budget deficit was revised from 13.6% of GDP to 15.4% and public debt went from 115% of GDP to 127%. Slow progress means that the 2010 budget deficit came in at 10.5% of GDP, against a target of 8.1%. Debt is now close to 145% of GDP, a level above that expected to be reached by 2013 under the EU/ IMF “rescue” plan.

Despite some progress, structural reforms are proving difficult and slow to implement. A plan to privatise Euro 50 billion of assets looks optimistic, with a number of even Euro 15 billion looking difficult to achieve.

In 2009 current Prime Minister George Papandreou vowed to scrap an agreement to sell a stake in Greece’s biggest phone company during an election campaign. In June 2011, under pressure from the EU, Greece, under Papandreou, triggered an option to sell 10% of Hellenic Telecommunications Organization (“OTE”) to Deutsche Telekom AG (“DT”)to raise desperately needed cash. The price was less than one-third of what DT, Europe’s largest phone company, paid for shares in OTE in 2009.

The OTE transaction underlines the difficulties facing Greece and other peripheral countries such as Ireland that are seeking to raise as much as Euro 70 to 100 billion from asset sales and privatisations.

Claims by the intelligentsia of the EU and ECB that Greece is “solvent” assume that most of the desirable bits of Greece, the Parthenon, other antiquities and the nicer Aegean Islands, can be sold to some Russian and Chinese oligarchs.

Pain Sharing

Ireland’s initial self imposed and subsequently EU mandated austerity has had similar effects to that in Greece. GDP has fallen by around 20% from its highest point and unemployment is in the mid-teens. According to optimistic commentators, living standards have deteriorated only to the levels of the early 2000s. Emigration out of Ireland has risen, reversing the trend of recent years.

Ireland’s problems are exacerbated by its ailing banks, whose property loans made at the height of the country’s boom have unravelled. The decision to originally guarantee the banks’ borrowing and also de facto nationalise many of the banks is looking increasingly ill advised. Having already committed around Euro 50 billion, if Ireland commits an additional Euro 50 billion (a not unlikely figure) to support the banks, Irish government debt would increase to Euro 195 billion (130% of GDP). Given projected budget deficits, Ireland’s debt would easily reach around Euro 240 billion (160% of GDP) over the next 5 years. This probably underestimates the real extent of Celtic indebtedness as Gross National Product (“GNP”) (which is about 15-20% lower than GDP) is the more relevant benchmark, given the structure of the Irish economy.

Portugal’s fate, under its still to be settled austerity program required to obtain it own bailout, is unknown but unlikely to be fundamentally different. The early signs are not good. In the course of bailout talks in April 2011, Portugal indicated that its deficit for 2010 was actually 9.1% of GDP, above the 8.6% previously indicated and 25% above the government’s target of 7.3%.

A continued concern is the risk of the contagion affecting Spain – which may be “too big to fail” but may be also “too big to save”. While economic fundamentals are better than some countries that have required bailouts, Spain remains vulnerable.

The Iberians have adopted the “best” of Greece, Portugal and Ireland – low rate of growth, poor competitiveness, significant structural issues within its economy and also potential problems of its banking system. Spain experienced a significant real estate boom in the lead-up to the crisis. Banks, especially the smaller cajas, community savings banks, remain vulnerable as the bulk of the expected property price correction and resulting loan losses are yet to occur. The Bank of Spain’s estimate of bank recapitalisation requirements of Euro 15-20 billion conflicts sharply with Moody’s forecast of Euro 120 billion.

There are other worrying sign of Spain’s potential problems. Reminiscent of announcements by Greece early in 2010, the Spanish Prime Minister claimed that China had committed around Euro 9 billion in Spanish bonds. When the Chinese denied any such commitments, the Spanish sought to explain it away as being a problem of translation. Suggesting significant internal political tensions about policy, Spain’s Prime Minister Zapatero indicated that he would not contest the next election creating a decision making vacuum, strikingly similar to that in Portugal. Most worryingly, Spanish Finance Minister Elena Salgado bravely told Bloomberg on 11 April 2011: “I do not see any risk of contagion. We are totally out of this.”

Observers are closely watching Spain’s ability to continue to raise needed funds from commercial lenders. Steady increases in the cost of borrowing for Spain, now in the 5-6% range for 10 years, and decreasing support for debt issues are evidence of increasing pressure. Spanish banks are increasingly dependent on funding from official entities, such as the ECB, reflecting concerns about their finances.

A Sea of Troubles

The problems faced by the troubled peripheral economies include low rates of growth and high levels of indebtedness with rising debt servicing costs. The combination of reduction of government spending and higher taxes is literally strangling these economies. The austerity programs prescribed by the economic automatons of the EU, ECB and IMF, as a condition of the bailouts, reinforce this pernicious slide into economic oblivion.

The peripheral countries are trapped in a vicious cycle. A weak economy increases budget deficits which, in turn, drives higher government debt. This requires even greater cuts in government spending and higher taxes to reverse the deterioration in public finances, leading to further contraction in the economy. This drives a deteriorating credit rating outlook, reduced access to commercial financing and higher funding costs which contributes to a further declines. As some of these countries are also heavily dependent on external financing from banks and investors, around 60-70% for Greece, Ireland and Portugal, a financing crisis becomes almost inevitable.

The difficulty of escaping this maelstrom is evident by the rising proportion of tax revenue committed to making interest payments on government debt. Greece currently needs over 30% of its tax revenue to meet interest payments. The comparable figures for Ireland, Portugal and Spain are 18%, 14% and 10% respectively. Italy, another vulnerable nation, currently requires 17% of its tax revenue to meet interest commitments.

Ireland illustrates the problem. Assuming its debt peaks at Euro 240 billion (160% of GDP) then financing it at 4% per annum (well below current market rates) would cost nearly Euro 10 billion a year in interest payments, equal to 80 per cent of the government’s income tax revenue. As most of this interest is paid to external creditors, Euro 10 billion in interest every year requires Ireland to grow its GDP (Euro 150 billion) by at least Euro 10 billion each year (6.7%) just to stand still. Unless growth reaches this level, the economy would start to shrink.

Economic growth is unlikely to reach the levels needed to make the current debt burdens on these over-indebted nations sustainable in the near term. This creates new financing problems for these countries, which prevent them from reducing their reliance on bailouts.

For example, Greece’s rehabilitation plan agreed in May 2010 assumed that around 50% of its 2012 borrowing requirement would be raised form commercial sources. Always unlikely, this is now impossible because of the absence of purchasers of Greek debt and the high cost of such financing.

Greece and possibly the other bailout recipients will need open-ended financing commitment from the EU, ECB and the IMF to avoid default. It is possible that over time Greece, Ireland and Portugal alone will need anywhere up to Euro 500 billion in financing to meet maturing debt and also additional financing for its budget shortfalls.

The scale of the problem can be seen from the fact that the most heavily indebted Euro-zone nations (Greece, Ireland, Portugal, Spain and Italy) have to re-finance maturing debt of around Euro 1.6 trillion in the period to 2014.

Road Kill

Banks and businesses located in these countries also need to re-finance existing debt. Maturing corporate bonds and banks loans for corporations in these countries total in excess of Euro 1 trillion during the period to 2014. Problems at the sovereign debt level inevitably affect their ability to finance and the cost of the funds.

Banks located in the peripheral countries face significant challenges. Other than Irish and (perhaps) Spanish banks, the financial institutions have not been a major factor in the sovereign debt problems. However, the sovereign’s problems have hurt the bank’s credit ratings and ability to borrow.

In Greece, public confidence in the government’s ability to protect savings has eroded. Greek corporations and households have withdrawn more than Euro 40 billion from domestic banks (17 % of the banking system’s deposit base) since 2009. Facing difficulties in accessing funds, these banks are heavily dependent on liquidity support from governments and the ECB, perhaps equivalent to almost 20-25% of their total liabilities.

The position is also acute in Ireland where support in excess of Euro 130 billion has been required. Irish banks’ loan to deposit ratios are above 160%, making them heavily dependent on government support for survival.

The funding problems of the banks push up lending costs for businesses. Funding difficulties reduce availability of credit. As banks shrink their balance sheets, the lack of credit adversely affects credit and economic growth, setting off a cycle of business failures and higher loan losses with further cycles of credit tightening.

The longer these economies stay weak, the more difficult and intractable the problem becomes. The governments become unable to adjust public finances rapidly enough to maintain funding access and market confidence. The spiral increasingly gets out of control forcing a debt restructuring or default.

Contagious Diseases

There are numerous channels of contagion. Continued problems of the peripheral economies requiring bailout will lead to the markets becoming reluctant to finance other weak Euro-zone countries, such as Spain and, perhaps, Italy. This may be at the sovereign level or funding for banks, leading to increased reliance to official funding. Concern about access to commercial funding or its cost can quickly become self-reinforcing, resulting in rapid loss of financing ability.

In the second phase, institutions with actual or suspected exposure to the troubled borrower are targeted, with loss of funding access as concern about their financial condition emerges. This process continues until a complete seizure in money markets results.

Some aspects of this feedback loop are already apparent. US money market funds have exposure to European banks totalling about 40% of their total investments of US$2,700 billion. Investors traditionally viewed money market funds as highly secure, near cash equivalents. This perception was destroyed when Lehman Brothers filed for bankruptcy protection in September 2008 resulting in investor losses. These memories and concern about the European debt problems have already led to investors reducing exposure modestly to money market funds with exposure to European banks.

In addition, unsecured lending in the inter-bank money markets has slowed as concerns about risk increase. This is reflected in the increase in the use of collateral to secure inter-bank deposits and loans.

When global markets lose confidence and optimism, things can turn quickly. Greece’s slide from a cherished, solvent member of the European familia took less than six months – in November 2009 Greece was borrowing at low rates; by May 2010 it required a bailout. As investors and markets focus, again and belatedly, on debt-laden and structurally weak economies, contagion effects may gain momentum rapidly. Increasing concern about Spain and Italy testifies to the potential speed of any contagion.

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  1. Hugh

    There is in all these posts by Das, and many others, an inherent logical fallacy. They would have us believe that the system is sound but the execution is bad.

    But we know this isn’t true. The system crashed and burned in 2008. The system wasn’t sound. Three years and trillions in bailouts later, we have the same system. It still isn’t sound.

    This is not incompetence. It is kleptocracy. Solutions, rescues, what you will, are not the goal. Looting is. Das’ analysis is useless because a fundamental presumption is wrong.

    Kleptocratic elites push economies until they crash and then, as per the Shock Doctrine, they use the crash to expand their power and their looting. How is this incompetence, when they consistently advantage themselves to everyone else’s detriment? How can I take Das’ analysis seriously when he refuses to address the principal driver behind this and other crises?

    1. Just Tired

      Right on Hugh. Apparently the Kleptocrats, realizing that there is no cure for stupid, have found a way to profit mightily from their own stupidity…or is it ours?

  2. attempter

    The OTE transaction underlines the difficulties facing Greece and other peripheral countries such as Ireland that are seeking to raise as much as Euro 70 to 100 billion from asset sales and privatisations.

    I think you mean, “…demonstrates that this is nothing but a premeditated onslaught of looting.”

    When global markets lose confidence and optimism, things can turn quickly. Greece’s slide from a cherished, solvent member of the European familia took less than six months – in November 2009 Greece was borrowing at low rates; by May 2010 it required a bailout. As investors and markets focus, again and belatedly, on debt-laden and structurally weak economies, contagion effects may gain momentum rapidly. Increasing concern about Spain and Italy testifies to the potential speed of any contagion.

    What an anodyne (that is, pro-bankster) way of describing the progress of what’s nothing more or less than a kleptocratic assault on civilization itself.

    1. financial matters

      Yes and now Italy is being prepped for the looting chopping block. This should make it very clear that it is time for a big paradigm shift..

      July 8, 2011

      Worries over Italy fuel eurozone crisis

      By By David Oakley in London and Guy Dinmore in Rome

      ‘The eurozone debt crisis intensified on Friday amid signs that contagion is spreading to Italy, the currency club’s third-biggest economy.

      “Italy is increasingly seen for what it always was – a peripheral economy with too much public debt and not enough growth.” ‘

  3. /L

    When global markets lose confidence and optimism …

    Of course “confidence” and psychological factors play, but when economic analyses and models merely is stitched together with economic psycho babble it usually smells like they don’t have a clue.

    The real economy is slumping and automatic stabilizers force up budget deficits the market has every reason to worry about the ability of euro countries to pay back. Especially in a country that already is high on foreign debt. No mysterious psychology there, real hard facts underpin why the market want higher risk premium.

    The Euro/EU system is deliberately made to work that way, it works exactly as intended. The market is “punishing” those who not stick to the illogical and impossible S&G pact that is working pro cyclical. In difference to sovereign nations there is a real risk of default in euro members that are not currency sovereign.

    European politicns should be happy that the system they constructed works exactly as intended, tha market is now punishing and keeping democracy and the will of the People in check. This is the clear and outspoken intention of “independent” central bank and explicit prohibition of so called monetizing public dept. The intention was that letting democratic countries be subject to the vim of the market democracy and the people should be fostered to have the “right” behavior.

  4. /L

    European politicians wining about the wolf pack bond vigilantes and rating institutes is such a immense hypocrisy and falseness that it’s or at least should be in the best of worlds unbelievable.

    They them self did deliberately construct the system this way to make the people of Europe slaves under those market forces, the democratic Europeans have to be reined in by their political masters with the market whip. Those spendthrifts that was lured in to underpin the German export miracle have to be punished, after all they had for a while the luxury to drive a real German WolksWagen such “theft” of German property can’t go on unpunished forever.

  5. financial matters

    Just to reiterate some history on the money market problem.

    In Sept 2008 at the height of the financial crisis, President Bush went on tv to say that the Federal govt would back money market funds similar to it’s backing of bank deposits. This was meant to stop people cashing out their money market funds. That backstop was somewhat quietly stopped a year later in Sept 2009. Money market funds pay a low rate of interest now, less than 1%, but interestingly even that is being subsidized. At Schwab they lost 125 million in one quarter just to keep people from losing money in those funds, which is where investors often park their money.

  6. Valissa

    After having read so many articles like this about the European debt crisis as well as the US so-called budget/debt crisis that the cumulative effect of that has been for me to increase my distrust of bankers and economists. Originally I read the articles to try and learn something about economics and global finance but now I simply see them as signs of kleptocracy gone wild. I have become indifferent to and mostly bored by all the analyses of how the PIIGs need to get their act together… there is a famous story about the boy who cried wolf, which applies quite nicely.

    So Mr. Das, do you think the EU countries are “bad” and the bankers/banksters who loaned them money that couldn’t realistically be paid back “good”? Do you really think Greece and other countries need to liquidate to pay off their international loan sharks? This big international fiat money game clearly needs to have the rules revised. And if the bankers made unwise loans to these countries then they should take some losses. But this isn’t just about paying back the money, is it? It’s about power and domination via kleptocracy.

  7. Rodger Malcolm Mitchell

    All this talk about the EU’s problems and not one word about Monetary Sovereignty, yet Monetary Sovereignty (or rather, the lack of it), is the fundamental cause of all euro nations’ woes.

    Those who do not understand the differences between Monetary Sovereignty ( ) and monetary non-sovereignty, do not understand economics.

    Rodger Malcolm Mitchell

    1. Just Tired

      Rodger — Did you miss the New Global Economy playing at theaters near you? Monetary sovereignty is anathema to the new game. Isn’t it ironic that anathema is derived from a Greek word that means something dedicated to evil?

  8. LRT

    Quite extraordinary, reading these comments. What is happening in southern europe is really simple: its banks and other creditors lending unwisely to silly borrowers. Sometimes its the government, sometimes its companies, sometimes its individuals.

    Lenders generally are becoming clear that this has resulted in a bad debt mountain. They see that it will be written off. So they will not lend any more.

    This is not turning europeans into slaves, this is not conspiracy, its nothing to do with monetary sovereignty. This last simply allows you to call your default by other names, it does not change the underlying situation which is debt which income streams are inadequate to servicing.

    It is quite helpful to ask why countries, companies and people get into these situations, and there are a variety of reasons in history, unaffordable wars being a main one. Government engineered credit bubbles as in the twenties of the last century, the South Sea and Mississipi bubbles, are other examples.

    In Europe we have had a mixture of perverse incentives and pusillanimous governments which have enabled looting. Is it kleptocracy? Yes, there has been a lot of this, by the financial services industry, by the real estate and construction industry, by the public sector unions. Bad news, and there are increasing howls of rage as it all comes home to roost.

    What will happen now is default. However, this will not enslave anyone particularly, though it will impoverish many. It has all happened before. One of the most tedious aspects of comments here is that people seem to have no sense of history. To grow up in France in the middle years of the last century was to be constantly confronted with this kind of thing – the older generation still counting in ancien fracs, the result of a reissued currency. That was a massive default as the result of fiscal irresponsibility, which France in the later years avoided, but which the more southern countries have fallen into yet again.

    You are all looking in the wrong place for the problem and the solution. The problem is debt, the solution is to default, and live more wisely in future.

  9. Hugh

    The problem is debt as policy. The problem is debt as weapon. In terms of policy, the Germans and others are running predatory export sectors. They needed to cycle their positive balance of payments back to their importing clients (as debt) to keep those sectors going. This was never sustainable. But in fact things went much further. Local kleptocratic elites siphoned off much of this flow and used it to fuel bubbles. It was all leverage stacked on leverage. And it went until it fell apart. Now the kleptocrats who created this mess are seeking not simply to make good their losses but profit handsomely from them. They intend for someone’s ordinary taxpayers to foot the bill for all this.

    It is a simplification to say just that the problem is debt. That debt didn’t just happen. There is a whole structure behind it, that depends on it, that feeds on it.

    Similarly, the solution isn’t just default. If the countries involved had their own currencies, this would be a more viable option. But as they exist within the euro framework, their defaults have major consequences for the eurozone as a whole. Then too there are all these CDS floating around out there in the financial ether. A default, especially by a Spain or Italy, could take out the financial system worldwide. Some may welcome this prospect. It may be necessary before we can end kleptocracy and reset the world’s financial and political systems. But it is almost certainly going to be a very destructive process, and most of the pain of it, as it always is, will be visited on we the people.

  10. LRT

    Hugh, the remark that this is ‘debt as a weapon’ is exactly the approach one has trouble with. How can debt be a weapon? In the hands of who? Against who? How exactly do you run ‘predatory export sectors’? What are they? Its so unspecific that even the emotion that it expresses is not clear.

    The thing that is certainly true is that the aetiology of credit bubbles is complex, that a number of interacting causal factors are at work. They are not always due to the same causes, but there are a few apparently essential factors in all of them.

    The trade deficits are not about this however. In the end German companies are better run and produce better products that are better value. There are complex social reasons why this is so, but in the end the solution is for the Italians etc to do better. If they want to. The mistake their choices are leading them into now is to suppose that they can finance German consumption patterns on debt borrowed from Germany. This was bound to end in tears, and has.

    1. financial matters

      predatory lending, predatory securitization, predatory globalization…

      Stiglitz pinpoints ‘moral’ core of crisis
      By Henry CK Liu

      ‘In the United States, although predatory lending is not defined by federal law, and various states define abusive lending differently, it usually involves practices that strip equity away from a homeowner, or equity from a company, or condemn the debtor into perpetual indenture.

      Predatory or abusive lending practices can include making a loan to a borrower without regard to the borrower’s ability to repay, repeatedly refinancing a loan within a short period of time and charging high points and fees with each refinance, charging excessive rates and fees to a borrower who qualifies for lower rates and/or fees offered by the lender, or imposing new unjustifiably harsh terms for rolling over existing deb’

  11. Bearbull

    Can you help explain the statement below? Why would it need to grow 10 bln each year to stay the same?

    Ireland illustrates the problem. Assuming its debt peaks at Euro 240 billion (160% of GDP) then financing it at 4% per annum (well below current market rates) would cost nearly Euro 10 billion a year in interest payments, equal to 80 per cent of the government’s income tax revenue. As most of this interest is paid to external creditors, Euro 10 billion in interest every year requires Ireland to grow its GDP (Euro 150 billion) by at least Euro 10 billion each year (6.7%) just to stand still. Unless growth reaches this level, the economy would start to shrink.

    1. financial matters

      I think it just refers to the fact that that’s the amount of interest being siphoned out of the economy in a nonproductive manner. It’s not paying down any principal or used for any productive investment so it doesn’t allow them to grow or move forward.

      1. bearbull

        But if their interest is fixed at 10 bln, they don’t really need to grow 10 bln each year to STAY FLAT. Or do they?

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