Opinion

James Saft

Ailing Belgium could be game changer

January 11, 2011

James Saft is a Reuters columnist. The opinions expressed are his own.

Just when it looked like Spain would force the euro zone to get serious about destroying its crippling debts, here comes plucky Belgium, hobbling its way to history.

While some are focusing on whether Portugal will take a bailout (hint: they will) and how to extinguish the burning firewall around Spain,  markets are steadily losing confidence in Belgium, which is big enough, ugly enough and heart-and-soul-of-Europe enough to change the game, potentially forcing sovereign defaults and bank recapitalization.

Investors imposed an all-time-high risk premium on Belgian bonds relative to German ones on Monday amid political chaos. Belgium’s parties have for the past 212 days been unable to agree a government, forcing King Albert II to step in and ask for a cost-cutting budget for 2011. Gross government debt is very high, hovering around 100 percent of GDP, leaving Belgium very vulnerable to a loss of market confidence.

Given that Portugal is likely to soon apply for help and rising concern about Spain, contagion to Belgium could be the catalyst that forces European authorities to rethink their approach.

This latest round of euro zone risk aversion may have been touched off by a proposal released last week that may mean senior lenders to banks would in future be forced to share in losses in the event of failure, so called “burden sharing.”  A feature of the sovereign bailouts thus far, notably in Ireland, is that the authorities have refused to force bank senior creditors to share in the pain, no doubt because to do this would be to reveal many banks as insolvent.

This means Ireland and Greece have not been relieved of debt, only allowed to remain in debt for longer on better than market terms. The budget cuts this impels only worsens their economies, making those debts harder to service over the longer term.

However, investors can read and as soon as they learn that there may be burden sharing, even in the fuzzy future, they react by selling out of current government debt positions in weak countries, potentially increasing the size and scope of the bailout which is needed.

Europe is really a prisoner of this policy. It does not want to acknowledge that many banks are insolvent and need massive new capital, but being unwilling to do this forces it into politically impossible positions and will only in the end lead to sovereign defaults which will, you guessed it, reveal the banks to be insolvent.

CUTTING THE GORDIAN KNOT

If Ireland, for example, had its own central bank and its own currency it could try and inflate its way out of its debt difficulties, a back-door default, but one which would allow the banks to slowly heal. This is the policy of the U.S., where the banks may not fail but the economy will pay a heavy tax while they recover.

This just isn’t going to work for the euro zone, especially given that so much of the debt is held abroad.

“For a number of euro area sovereigns the consolidated position of the sovereign and the banking sector looks unsustainable. This means that either the unsecured debt of the banks will be restructured or the sovereign debt or both,” Citigroup economist and former Bank of England Monetary Policy Committee member Willem Buiter wrote in a note to clients.

The U.S. will hate this, as it goes in the exact opposite direction of its own back-door bailout of the banking system, and will fight it tooth and nail. If you have any doubt of this, note the appointment of Davos Man and J.P Morgan banker Bill Daley as Obama White House chief of staff.

A restructuring of sovereign debt — a polite default, combined with a restructuring of bank debt and a recapitalization of weak banks offers the best hope for the euro zone. Besides being fair, as foolish creditors will share in the pain with taxpayers and citizens, it also has the potential to leave the euro zone on a solid footing, with a level of debt that is manageable and will not sink the economy, and with a banking system that can play its role in a recovery.

This is neither simple nor uncontroversial; huge losses will be taken and it will not be easy either to gain consensus to recapitalize swaths of the banking system, or to turf out current management.

We end in the same place in either event; the debts are unsupportable unless reduced and ultimately the sovereigns and the banks they backstop will fail.

Better to get on with it, get an early start on real recovery and avoid a couple of more years of legal looting by the financial sector.

Let it come down.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Comments
6 comments so far | RSS Comments RSS

An entirely possible scenario. However, given that both China and Japan are now ponying up cash to assist in resolving the Euro-debt crisis – likely after some serious back channel arm-twisting – it’s conceivable these two countries, with their enormous FX reserves, will be buying lots more Eurozone debt in the not-too-distant future, allowing the Eurocrats to avoid needed sovereign- and bank-debt restructuring. It also would not be surprising if the Eurothugs have threatened Chinese and Japanese access to Eurozone markets, certainly not with outright trade bans but non-tariff barriers might go up. China wouldn’t be too pleased with that, now, would they?

Bottom line: Put nothing past the Eurocrats. They will do everything to avoid the collapse of the Euro and thus losing face before the ‘Anglo-American’ economic model. This may get ugly!

Posted by Gotthardbahn | Report as abusive
 

I am a belgian. Here people (economists, politicians) are saying our situation is different because 1. most of our debt is internal (to belgian banks) and 2. we have one of the highest reserves in personal savings in the world.
Is this also said outside of my tiny country, or is it just a way to keep the people & media from panicking? :-)

Posted by Antwan | Report as abusive
 

I honestly believe that investors take the whole picture in consideration, and not only the political crisis at the basis of which lies the age-old contradiction between the large majority of Dutch-speaking Flemings in the north and a minority of French-speaking Walloons in the South. The fact remains that 1) the economic recovery is in Belgium much stronger than in other European countries; 2) it is better to have an efficient Belgian government that tackles accurately the budget deficit, even if it takes a few weeks longer to make such a government, than to have a speedy but incoherent one with no apparent economic vision, which will only aggravate the budget deficit. 3) and, last but certainly not least, citizens of Flanders and Wallonia have enough savings deposits to cover the total national debt several times over. So, if anything, the height of the present risk premium between Belgian and German bonds is actually an excellent buying opportunity.

Posted by Reisdier69 | Report as abusive
 

I honestly believe that investors take the whole picture in consideration, and not only the political crisis at the basis of which lies the age-old contradiction between the large majority of Dutch-speaking Flemings in the north and a minority of French-speaking Walloons in the South. The fact remains that 1) the economic recovery is in Belgium much stronger than in other European countries; 2) it is better to have an efficient Belgian government that tackles accurately the budget deficit, even if it takes a few weeks longer to make such a government, than to have a speedy but incoherent one with no apparent economic vision, which will only aggravate the budget deficit. 3) and, last but certainly not least, citizens of Flanders and Wallonia have enough savings deposits to cover the total national debt several times over – which, by the way, they do so. So, if anything, the height of the present risk premium between Belgian and German bonds is actually an excellent buying opportunity.

Posted by Reisdier69 | Report as abusive
 

Paragraph 8 of the article: ‘Europe is really a prisoner of this policy.’ Exactly, and Belgium as well. But Belgium could be more than a ( financial markets’ ) game changer. It could stop the game.
In fact, the belgian deposits on short and medium term are twice its total public debt, of which even a larger part is internal. So, in of course somewhat simplistic terms, if the Belgians would directly repay the external public debt, the ( markets’ ) game would be over.
This could trigger a dramatic policy shift for the rest of Europe, out of its financial prison, as for the rest of the world.

Posted by BoudewijnDG | Report as abusive
 

I honestly believe that investors take the whole picture in consideration, and not only the political crisis at the basis of which lies the age-old contradiction between the large majority of Dutch-speaking Flemings in the north and a minority of French-speaking Walloons in the South. The fact remains that 1) the economic recovery is in Belgium much stronger than in other European countries; 2) it is better to have an efficient Belgian government that tackles accurately the budget deficit, even if it takes a few weeks longer to make such a government, than to have a speedy but incoherent one with no apparent economic vision, which will only aggravate the budget deficit. 3) and, last but certainly not least, citizens of Flanders and Wallonia have enough savings deposits to cover the total national debt several times over – which, by the way, they do so. So, if anything, the height of the present risk premium between Belgian and German bonds is actually an excellent buying opportunity.

Posted by Reisdier69 | Report as abusive
 

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