Europe: It’s more than just government debt

By Felix Salmon
May 11, 2010
Ronan Lyons is unimpressed by the now-viral NYT graphic showing the web of debt within Europe. It's particularly unfair to his native Ireland, he says:

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02marsh-image-custom1.jpgRonan Lyons is unimpressed by the now-viral NYT graphic showing the web of debt within Europe. It’s particularly unfair to his native Ireland, he says:

Because they didn’t look behind their statistics, however, the graphic is about as informative as CNBC’s now infamous unveiling of Ireland as the world’s most indebted country, with debts worth 1300% of GDP! The point that both miss is that you can’t look at debt liabilities without looking at corresponding assets.

That is why the markets are worried not about all debt. They are worried particularly about government debt, because typically there is no corresponding asset.

PIIGS-debt.pngIt’s true that Spain and Ireland — particularly the latter — have much less of their debt at the government level than, say, Greece. And Lyons helpfully provides a little chart showing how much of each of the PIIGS’ external debt is government debt.

But we’re still a long way from the point at which markets are more worried about government debt than about corporate debt, at least if you’re measuring such things using credit spreads. Investors still believe in the concept of the “sovereign ceiling”, and it’s still extremely rare for any corporate, including a bank, to be able to borrow more cheaply than the government of the country it’s in.

Writes Lyons:

For Portugal and Spain, it’s only one fifth of all debt. In the case of Ireland, just five percent of all its debt is general government debt.

The reason is hardly a secret: Ireland is a major international financial services centre. The international financial services sector plays such a large role in the Irish economy that it even gets its own set of statistics from the Central Statistics Office. At the end of 2008, the sector had debts of almost €1,650bn. Don’t worry though – it also had assets worth about €1,660bn.

Don’t worry? Of course we should worry. We’ve all seen what can happen to bank “assets” in extremis: Lehman Brothers and Washington Mutual both had assets greater than their debts before they collapsed, and then suddenly they didn’t. And in case Lyons has forgotten, the Irish government is still providing an unlimited guarantee on $600 billion of deposits and interbank debts at Ireland’s banks.

Or, to boil it all down into one word: Iceland. Government debt was never much of a problem in Iceland: the problem was bank debt. But bank debt has a habit of becoming government debt when there’s a crisis. And I’ve never seen a sovereign default where the banks of the country in question all happily continue to pay all their debts. When a country defaults, its banks default too.

So I’ll side with the NYT over the FT here: the original graphic is just as informative as it is striking, and it’s important to look not only at direct government debt, if you’re examining a country’s finances, but also the total external indebtedness of the country in question. Which actually helps Greece, a country where a huge swathe of the population owns their home outright, and where credit-card debt and other personal indebtedness never had the kind of bubble seen in places like the UK.

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