European government debt: Don’t say we didn’t warn you
“Europe’s government bond markets are built on a lie. Ministries of finance have adopted corporate financing techniques to give a false impression of their true debt levels. Regulators appear unwilling or unable to do anything about it. Investors and taxpayers ought to know.”
So wrote Euromoney in our cover story for the IMF/World Bank meetings issue in September 2005. We cautioned that European governments were playing fast and loose with the debt and deficit guidelines that were supposed to be the glue that held the eurozone together. Back then, in the benign environment before the global financial crisis which forced governments to use debt to bail out their banking sectors, and before the subsequent economic crisis depressed state income through lower tax revenues and pushed fiscal deficits to unprecedented levels, European states were already struggling – and sometimes failing, in the case of France and Germany first of all in 2003 – to stay within the confines of the Maastricht criteria.
Euromoney warned at the time: "Traditionally a lack of fiscal discipline by a sovereign has limited their access to international capital, or incurred a substantial cost, but that has not proved the case in recent years. But just because there is a surfeit of capital in desperate search of a home does not mean these fortuitous conditions will exist for ever... It is likely that the markets are fundamentally mispricing sovereign risk."
The repricing has now happened with a vengeance, with Greek bond yields rising to above 20% at one point last month and the sovereign CDS of countries such as Spain rising as high as 250 basis points before the announcement of the EU/IMF bailout plan brought a temporary sense of calm to the market.
The main argument of Euromoney’s story five years ago was to highlight the way European governments were massaging the reality of their overall debt numbers by, among other techniques, putting large chunks of debt into special financing vehicles.
That trend has continued in the intervening period. For example the SFEF, a facility created by the French government to finance the bailout of its banking system, has issued more than €80 billion of debt over the past 18 months.
Now the European Union has its own financing vehicle, the European Financial Stability Facility, which will be mandated to raise up to €440 billion of debt to bail out eurozone countries that cannot meet their debt obligations.
Euromoney’s September 2005 article concluded: "If core Europe continues to treat fiscal rules as burdens to be shirked, one day bond fund managers – and those who have entrusted their savings to them – will have to start asking some very serious questions."
Those questions are now being asked. Europe urgently needs to come up with some answers.
See also: It’s the debt, stupid