CALDEIRÃO DE BOLSA

Europe’s other debt crisis

It’s not just sovereign borrowing; there are too many zombie firms and overindebted households
Oct 26th 2013 | The Economist



FIFTEEN months ago, in July 2012, Mario Draghi, the president of the European Central Bank (ECB), promised to do “whatever it takes” to preserve the single currency. Although the bond-buying scheme set up to fulfil that pledge has never been tested, yields on sovereign bonds have fallen. The euro mess has morphed from an acute crisis into a chronic one.

This week Mr Draghi launched what could become the second big turning-point in the euro saga: an inspection of the balance-sheets of the region’s 128 biggest banks which the ECB will supervise from late 2014. As part of its “asset-quality review”, ECB officials, along with outside experts, will start peering into the banks’ balance-sheets and impose common standards for loan quality (see article). This process is supposed to find out which banks are viable now, which will need more capital and which should just be closed down.

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There are some nasty bugs under your carpet, Angela

Europe is always thought of as having a sovereign-debt crisis, and it has. But the origins of the euro disaster lay less with government profligacy than with excessive private borrowing. True, Greece got into trouble because its government spent too much and collected too little in taxes. But elsewhere the bust followed a private-sector binge: mortgage debt in Ireland and Spain; corporate borrowing in Portugal and again in Spain (see article). In all three countries household and corporate debt combined were way over 200% of GDP before the crisis, much higher than in America (175%) or even Britain (205%). (...)


The corporate-debt problem is worst in Portugal, Spain and Italy, where the IMF says that 50%, 40% and 30% of debt, respectively, is owed by firms which cannot cover their interest payments out of pre-tax earnings. These firms are unable to invest or grow. They are zombie companies, much like those wafting through Japan in the 1990s.

he household-debt burden is especially heavy in Ireland and, surprisingly, the Netherlands—exceeding 100% of GDP in both places. Paying the mortgage strains household finances and crimps consumer spending. Whereas in America the share of income that the average household spends on servicing debt is now the lowest in decades, in Spain it is higher than during the boom years.

and, this time, they’re not Barack Obama’s

If the euro zone’s recovery is to strengthen, this burden of private debt must be lightened. According to the IMF, private debt is a bigger drag on Europe’s growth than government debt. One prerequisite, which even Germany’s chancellor, Angela Merkel, is beginning to accept, is less draconian austerity. It is virtually impossible for the private sector to reduce debt when governments try to slash their borrowing too. Another necessity is for banks to recognise, and write down, non-performing loans. That is where the ECB’s asset-quality review will be crucial. The central bank must make sure its assessment is both thorough and credible: Mr Draghi should stand firm against any political pressure to downplay the size of the bad-loan problem in order to minimise potential capital shortfalls. Equally, Europe’s politicians must be willing to provide the resources to recapitalise banks if necessary. (...)

Most countries have already put a few of these reforms in place. Spain and Ireland have “bad banks”. Several countries have streamlined bankruptcy rules. Portugal has pioneered the use of out-of-court settlements. But much remains to be done. In Italy a mere €2 billion ($2.8 billion) of non-performing debts is sold each year, out of a stock of €122 billion. The Bundesbank is prone to lecturing the financial world about everything except the mess in Germany’s regional banks.

Sorting all this out will take time. The euro zone will not look like America, with a debtor-friendly legal system and a big market for distressed assets, overnight. But dealing with the private-debt trap should be a priority for Europe’s leaders. Better capitalised banks would be more able to lend; they would also make it easier to create a banking union. A continent littered with zombie firms and broke households will never prosper. It falls to Mr Draghi to start clearing up.