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Private Debt Menaces EU Recovery


Europe’s austerity drive has been focused on the wrong kind of debt. According to new research from the IMF, private debt (debt held by households or corporations) is a greater menace to growth than is government debt. While the Eurozone has been trying to reduce high levels of public debt, most notably in the South, countries throughout the continent have accumulated staggeringly high private debt burdens. The Economist:

The malign effect of high private debt becomes apparent in the busts that follow credit-driven booms. Households that have borrowed too much in relation to their income trim their spending, the main component of GDP. Overleveraged firms avoid investing and concentrate on shrinking their balance-sheets by paying off loans. As bad debts erode their capital, banks become more reluctant to lend. These adverse trends reinforce each other, increasing the overall drag on growth….

[In] the Netherlands…private debt is over 220% of GDP mainly because households owe so much. In tiny Malta it is nearly 220%. Private debt is also high in four countries that have had to be bailed out: in Cyprus and Ireland it is over 300% of GDP; in Portugal it is 255%; and in Spain 215%.

As in the US housing crisis, homeowners in countries most afflicted by private debt have fallen into “negative equity,” where the cost of their mortgages exceeds the value of their homes. In Italy, Spain, and Portugal, this is particularly troublesome because the companies that hold the debt are themselves in the red: 30, 40, and 50 percent (respectively) of corporate debt in these countries is held by firms at which costs exceed revenue.

Even in the some of the comparably healthier economies of northern Europe, private debt rates are high. While some of that debt will be written down when banks are forced to make retribution for predatory loans, the vastness of the private debt burdens in the eurozone is impairing sustained recovery. Read the whole thing here.

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  • Bruce

    Don’t diminish the importance of the government debt as well. Regarding the whole worldwide debt situation: “That which is unsustainable will end.” The end will probably be very, very painful.

  • wigwag

    Debt as a percentage of GDP tells a very incomplete story. Remember, solvency isn’t just about debt, it’s about assets as well; the article in the Economist ignores this critical piece of the financial puzzle. Debt isn’t the most telling statistic, net worth is really what you want to know.

    In the United States, for example, total debt as a percentage of GDP increased substantially during the recent economic downturn (although this is now making an about-face). The increase in debt as a percentage of GDP whipped economic know nothing’s into an apoplectic frenzy.

    What these chicken littles never took notice of was the fact that total assets ranged between 1,300 and 1,400 percent of GDP even when things were at their worst. In fact, total debt as a percentage of GDP never exceeded more than 50 percent of total assets as a percentage of U.S. GDP and that was in the worst economic downturn since the 1930s.

    Professor Mead makes a habit of deriding all the chicken littles predicting environmental disaster. It makes me wonder about his penchant for flirting with the chicken littles who believe debt levels presage economic disaster.

    • rheddles

      Both income (GDP) and the balance sheet (assets) are important to determining capital, capacity and collateral. But then there are conditions and character. Neither is positive, particularly in the political arena. What has become habit in the public arena is seeping into the private. No one is ever over-levered until they can neither pay off nor roll over a maturity. Fire sales of assets are not a good way to pay off a maturity, free cash flow from operations is.

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