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.

8 comments

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Don’t worry, Irish banks are levered 165:1. What could possibly go wrong?

Posted by MitchW | Report as abusive

“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.” Governmental deposit insurance is the culprit here; it is a tremendously destabilizing factor–a veritable modern curse!

Posted by Philon | Report as abusive

What the relevance of the variable circle sizes in the second graphic? Is the area somehow related to the dollar amount of debt?

Posted by drewbie | Report as abusive

It’s like a horrific version of ‘Rock Paper Scissors Lizard Spock’

http://fc09.deviantart.com/fs40/f/2009/0 20/6/2/RockPaperScissorsLizardSpock_by_i amthemiggy.jpg

Posted by Bergamot | Report as abusive

Yes, 600B guaranteed until October this year.

Posted by BarryKelly | Report as abusive

Felix
As Charles Goodhart once remarked banks are international in life and national in death. Yes, external liabilities matter; so does the extent of financial sector liabilities- they are a contingent claim on the sovereign’s balance sheet. The issue in the post you link to is which sovereign do they belong?
For Irish ‘domestic’ banks this was crystallised for the Irish sovereign with a rather silly blanket guarantee. For large subsidiaries of EU or US banks headquartered in other European countries, this is their respective sovereign’s issues. http://online.wsj.com/article/SB12434608 5723259931.html
In other words, Ireland inc. is not guaranteeing Depfa or US banks subsidiaries located in Ireland, even though they are included in some of the BIS stats.
Of course, the NYT would need to understand the arcane nature of the BIS stats for a start. Tables 9B and 9D.
http://www.bis.org/publ/qtrpdf/r_qa1003. pdf#page=64 Consolidated banking data, the unloved data set of the crisis…

Posted by R_V | Report as abusive

Felix,
Thanks for discussing. I’ve put a comment on my original blog post in response (http://www.ronanlyons.com/2010/05/11/un tangling-europes-web-of-debt/#comment-17 69), but it largely makes the same point as R_V above.

The key point is that while StateStreet, Depfa, Fidelity, et al have liabilities of about $2trn in Ireland, per the Irish Statistics Office, much of which comes under the BIS definition of Irish external debt, none of those financial houses is expecting the Irish government would ever be in a position to rush to its rescue.

And lest anyone think that I’m not worried about sovereign debt, my original point was that Ireland’s government deficit and debt woes – with or even without including the bank bailout for domestic banks – are bad enough without someone producing a tangential chart with a trillion dollars on it!

Posted by RonanL | Report as abusive

Man Ireland has a lot of debt… :( no wonder i lost so much money on my Irish National Bank stock, here is a funny joke I saw about outstanding debts,
http://ponderingstuff.com/2010/07/05/ent ering-the-witness-protection-program-to- get-rid-of-bad-debts/

Posted by travis12543 | Report as abusive