For anyone wondering why Europe’s leaders are so determined to avoid a restructuring of Greek sovereign debt, I recommend a remarkable piece of research published on Monday by Jacques Cailloux, the Royal Bank of Scotland’s chief European economist, and his colleagues. (Unfortunately, it seems not to be easily available on the internet, so I’m providing links to news stories that refer to the report.)
The RBS economists estimate that the total amount of debt issued by public and private sector institutions in Greece, Portugal and Spain that is held by financial institutions outside these three countries is roughly €2,000bn. This is a staggeringly large figure, equivalent to about 22 per cent of the eurozone’s gross domestic product. It is far higher than previous published estimates. It indicates that, if a Greek or Portuguese or Spanish debt default were allowed to take place, the global financial system could suffer terrible damage.
As the RBS analysts say, the problem isn’t – as some commentators have suggested – that Europe’s troubles would trigger an economic downturn or trade conflicts that would depress demand for US and other foreign goods. These are legitimate concerns but, relatively speaking, fairly trivial.
“Any assessment of the economic impact of a sovereign default of these economies through trade linkages or through their GDP size misses entirely the point,” the RBS report says. “It is the financial linkages that suggest that these economies are too intertwined with foreign financial institutions to default, a phenomenon largely reminiscent of that of subprime … in terms of the potential ramifications that a default would have across the global financial system.”
The €2,000bn estimate is based on data compiled by the Bank of International Settlements, the International Monetary Fund, the Organisation for Economic Co-operation and Development, and the World Bank. It differs from earlier estimates in that it includes not only foreign bank exposure to Greek, Portuguese and Spanish debt, but the exposures of other institutions such as insurance companies and pension funds.
What is the breakdown? Foreign foreign institutions are estimated to have held €338bn of Greek debt at the end of 2009 – equivalent to 142 per cent of Greek GDP. In Spain’s case, the figure is €1,500bn – also 142 per cent of GDP. For Portugal, the figure is €333bn, the equivalent of twice its GDP. The combined amount for the three countries is €2,171bn, but the RBS authors think the total exposure of foreign institutions has declined a little in the first five months of this year.
Even so, the report provides a fairly compelling case for an all-out effort on the part of Greece, other eurozone countries and international financial institutions to prevent a default. The trouble is, however, that – as many commentators have pointed out – the chances look pretty slim that Greece will be able to restore order to its public finances by means of austerity measures and structural economic reform. Putting it bluntly, Greece partied for too long and has almost certainly left it too late to deal with the hangover.
The urgent task facing international financial policymakers and bankers is therefore to anticipate the potential fall-out from a Greek default and take steps to keep the damage as limited as possible.
Across the globe: Gideon Rachman and his FT colleagues debate international affairs on