Although people around the world are focused on holiday shopping and vacations, the global financial epidemic of too much public debt isn’t taking a break.
Since the beginning of Europe’s financial crisis, its corporate and political leaders told us the problem was contained. But each step of the way, they’ve been wrong. Right now, all signs indicate that Europe’s financial crisis is spreading like gangrene. This is not a scare tactic, but an honest evaluation of the facts. Let’s analyze some of the reasons behind this.
1. Europe’s Banks are Undercapitalized
European banks are facing a liquidity crisis, even though they’ve already received an emergency cash infusion from a coalition of world central banks. The International Monetary Fund in its “Global Financial Stability Report” estimates $408 billion in banks’ risk exposure to toxic government debt from countries like Greece, Ireland and Portugal. Because Europe’s crisis is moving so rapidly, even the IMF is having trouble estimating the true liabilities for European banks. In August, the IMF said it would take only $272 billion to cover banks’ capital shortfall.
2. Borrowing Costs Have Jumped
Italy recently paid almost 8% to auction 7.5 billion euros ($10 billion) in three-year bonds, up about three percentage points from a month ago. The same thing is happening in France, who’s now paying around 1.5 percentage points more on its 10-year bonds compared to Germany. Why is France’s debt not trading like a AAA-rated country? What, besides everything, does the credit market know that credit rating agencies don’t? Rising borrowing costs are a worst-case scenario for already over-indebted borrowers.
3. Credit Downgrades Everywhere
We don’t advocate putting implicit faith in credit ratings, because history has taught us they are nothing more than financial opinions and, frequently, not very accurate ones. Still, a gander at the latest downgrading trend is troublesome. Intuitive observers will note this is not an isolated phenomenon, but a global trend. Sovereign debt from Greece and Portugal, after several downgrades, is now rated “junk,” Ireland has been downgraded, Italy has been downgraded and Japanese along with U.S. debt was lowered in August. The pace at which government debt is being downgraded is accelerating, and reversing this trend won’t be easy.
4. Too Many Cooks in the Kitchen
One of Europe’s problems in solving its crisis is its magnificent bureaucracy. Between the Economic and Monetary Union, European Banking Authority and EU finance ministers, everyone has an opinion on how to fix things, but nobody can execute. Layered on top of this melting pot are individual countries within the euro zone, each with its own distinct set of financial regulators with their own viewpoints. It’s a conglomeration of confusion and the perfect recipe for getting nothing done.