Europe’s other debt crisis

Mutahir Hussain Butt – 533502News article presentation

December 19, 2013

B29 International EconomicsProf. Dr. Thomasberger

Europe’s other debt crisis

Debtors’ prison

Europe’s other debt crisis

It’s not just sovereign borrowing; there are too many

zombie firms and overindebted households

Debtors’ prisonThe euro zone is blighted by private debt even more than

by government debt

Debt Crisis

Private Debt

Total DebtSovereign Debt

Corporate DebtHousehold Debt

Country Examples

• Greece : Government debt• Ireland : Mortgage debt• Spain : Mortgage debt + Corporate debt• Portugal : Corporate debt

Academic Research

• High private debt is more detrimental to economic growth than high public debt

• Excessive sovereign borrowings reduce growth only when households and corporate sectors are heavily indebted too

Asset Quality Review

• Inspection of the Balance Sheets of 128 biggest banks to determine which banks:

• 1. are viable?• 2. need more capital?• 3. should be closed down?

Why private sector deleveraging has been disappointing?

Less progress in reducing private-debt

burden

European bankruptcy laws

Bad loans

Fiscal Austerity

When does debt become excessive?

• EC uses a figure of 160% of GDP for private debt

• More realistic trigger would be 200% of GDP

Over-indebted Households

• 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.

Zombie Firms• 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.

• Portugal, Spain & Italy have firms that owe significant % of corporate debt which cannot cover interest payments from pre-tax earnings

Next steps proposed

• Take private debt burden seriously• Steps by governments to increase spending

(move away from tough austerity policies)• ECB’s asset quality review• Sell or restructure mortgages & bank loans

(bad banks, distressed debt market, reform bankruptcy laws)

Academic Research“Dealing with Household debt”, World economic

outlook: Growth Resuming, Dangers Remain, IMF, April 2012

In Graphs

In Graphs

In Graphs

In Graphs

Academic Research“Household Debt and the European Crisis”, ECRI, June

2013

Lessons from the crisis

• Ill-informed or irrational income expectations lead to over-indebted households

• Tackling household over-indebtedness through legislation is difficult

Academic Research“Dealing with Private debt distress in the Wake of the

European Financial Crisis”, IMF, February 2013

Conclusions of the research

• In corporate debt restructuring, experience to date shows that an effective insolvency regime is critical to facilitate the early rescue of viable firms and the speedy exit of non-viable ones.

• Voluntary out of court restructurings provide a speedy, cost-effective and market friendly alternative to court supervised insolvency proceedings.

• Direct government involvement in private debt restructuring has been relatively rare

Questions/Discussion