The European Debt Crisis: A Smoke Screen For Bigger Problems

Peter Cohan
Updated

The European Union agreed to a 750 billion euro bailout plan in May to restore confidence in its economic structure. In light of the ongoing instability in global financial markets, that plan doesn't seem to have worked. But a look at how much money the three most-often-cited EU basket cases owe, suggests that the global market sell off must be a response to a different set of problems. Meanwhile, no additional bailouts are needed for now.

That diversified bailout plan (which comes to nearly $1 trillion) is mostly debt guarantees. As I explained in a May 11 article on DailyFinance, the European bailout money will come from three sources: 439 billion euros in potential loans, made as needed, through so-called Special Purpose Entities, 251 billion euros in potential loans from the International Monetary Fund, and 60 billion euros under an existing lending program. Only 8% of the EU bailout involves actual cash loans. The remaining 92% comes in the form of potential loans.

Greece needs a bailout, Spain and Portugal may need a backstop

Greece, Portugal and Spain are often mentioned as the economically sickest of the EU's southern countries but they are not equally sick. The economy in the worst health is without question Greece, and its problems are largely covered by a separate bailout. Meanwhile, Spain and Portugal's combined debt obligations between 2010 and 2013 total about 26% of the 750 billion euro bailout.

Greece, which -- thanks to an S&P rating of junk bestowed on April 27 -- is clearly the most financially unstable of the three, owes €123 B. According to Barclays Capital, Greece needs around 30 billion euros for 2010; for 2011-2012 debt and interest payments alone total €93 B." But EU leaders passed a €110 B plan to cover Greece's debt problems back on May 2.

Spain, the strongest of the lot with a AA rating from S&P, owes €163 B. According to Economic Policy and 2010 Funding Strategy of Spain €34 B of that is due in 2010, and the other €129 B is due between 2011 and 2013.

Portugal, with an S&P A- rating, owes a mere €31 B between 2010 and 2013. According to Portugal's Treasury and Government Debt Agency (IGCP), €6 B of that is due this year, and the balance must be repaid or refinanced between 2011 and 2013.

Clearly these three countries do not account for all the problems facing the Eurozone. But all of them have taken steps to get their fiscal houses in order. For example, Spain has taken steps to reduce its budget deficit to 6% of GDP by 2011; Portugal opted for €2 B in pay cuts and tax increases on May 13. And Greece's parliament passed a measure May 6 to reduce its budget deficit by €31 B by 2012 through pay cuts and tax increases.

And of the three, it looks like Greece is the only country with an immediate need of a bailout. The €750 B bailout fund is more of a backup that Spain and Portugal might need to tap but not for the time being.

Another bailout not needed, but big questions remain unresolved

There is no doubt that investor sentiment is bearish on stocks and that markets are moving skittishly. But the crescendo of fear that keeps building in the media must be based on something other than the ability of Greece, Spain, and Portugal to utterly destabilize the Eurozone.

As far as another bailout is concerned, the answer for now is that it's not needed. The reason is that the current bailout looks to be much bigger than needed to backstop the debt repayment needs of the most vulnerable countries. To be fair, there are some major uncertainties out there.

For example,

  • Will other countries besides Greece, Portugal, Spain, Italy and Ireland end up costing the Eurozone more than expected?

  • How likely is it that countries like Portugal and Spain will really need to draw down the bailout funds rather than refinance their debt in the public markets?

  • How likely is it that Europe's banks will need to raise more capital as a result of their exposure to the bonds of governments whose debt repayment ratings have been downgraded?

  • If so, how much capital would those banks need to raise?

  • What is the exposure of non-European banks to these weaker governments' bonds?

  • What is the chance that the Eurozone will be dismantled and what would that cost?

I am not sure anyone has the answers and that may be why the market remains so jittery. But for now, the current bailout package looks more than adequate to cover the short and medium term risks of debt default among those weaker players.

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