Just How Much Debt Are We In?

After The New York Times revealed on Saturday that Wall Street banks helped Greece keep its mounting debt off the books for many years, Edward Hugh at A Firstful of Euros explains how shady financial constructions allowed several European governments to hide part of their financial trouble.

Eurostat, the EU’s agency for statistics, has been grappling with asserting just how much in debt the union’s member states really are. In 2002, writes Hugh, they found themselves forced to change their accounting rules, in order to try to enforce the disclosure of off-balance sheet entities that had previously escaped detection. European governments responded by simply reformulated their suspect deals.

In 2008, Eurostat reported that, “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”

Many European governments have been using a system known as “factoring” to finance public projects. Factoring is a financial transaction whereby a business sells its accounts receivable (or invoices) to a third party (which is called a factor) at a discount in exchange for immediate money with which to finance continued business. Unlike regular loans, this setup involved three parties which allows the financing of public projects without upfront public funds.

So-called private finance initiatives were originally developed by the Australian and British governments and are now common in Canada, the Czech Republic, Finland, France, India, Ireland, Israel, Japan, Malaysia, the Netherlands, Norway, Portugal, Singapore, and the United States, among others. These contracts are currently off-balance-sheet, meaning that they do not show up as part of a country’s national debt.

Hugh identifies at least three problems with this arrangements. First, they assume a certain level of headline GDP growth to furnish revenue growth to the public agencies committed to making the payments. “Following the crisis,” he notes, “these previous levels of assumed growth are now unlikely to be realized.”

Second, they assume a growing workforce in spite of Europe’s aging populations. And lastly, they assume unchanging dependency ratios between active and dependent populations, “but these assumptions,” according to Hugh, “are no longer valid, as our population pyramids steadily invert.”

Given all this, a very real danger exists that what were previously considered as obscure securitisation instruments, so obscure that few politicians really understood their implications, and few citizens actually knew of their existence, can suddenly find themselves converted into little better than a glorified Ponzi scheme.

Greece, he writes, is just the first state that can’t pay up anymore. Italy and Spain are both in a particularly precarious situation as well.

British economic historian Niall Ferguson agrees and suggests that “the contagion is going to spread” to Ireland, Portugal and Spain while Belgium and Italy “shouldn’t be entirely free from worry” either.

In an interview with Bloomberg Television on February 5, Ferguson stressed that, “a significant number of eurozone members have been plunging into the red with their fiscal policies in the wake of the financial crisis.” The markets have now woken up, he said, realizing “that these were not credible fiscal policies.”

Although European leaders pledged to support Greece if necessary, there is no European structure to effectively deal with sovereign bankruptcy. European budget rules allow deficit spending up to 3 percent of GDP but when a country as Greece, that struggles with a gap of so much as 13 percent on its budget, violates rules, “there is no bailout on offer.”

The United States, warned Ferguson, “is not that far behind Greece in terms of the size of its debt and the problem it’s going to have getting back into any kind of balance in the foreseeable future.”