The recent sort-of-controversial study by Reinhart and Rogoff, which found that economic growth slows considerably when public debt exceeds 90 per cent of GDP, could soon get an interesting European test case.
BNP Paribas included this factoid in one of their recent credit portfolio strategy notes (emphasis ours):
The bailout of Germany’s banking sector may swell the country’s public debt rate to 90% of gross domestic product, Die Zeit weekly newspaper reported on Wednesday. The weekly based this estimate on a recent decision by Eurostat requiring Germany to include the balance sheets of public-owned bad banks — set up to help financial institutions offload toxic and non-strategic assets — into its overall debt ratio.
Going by the Eurostat decision, EUR54bn of WestLB’s toxic assets transferred to the Erste Abwicklung Anstalt (EAA or ‘bad bank’) must be included in Germany’s overall debt level. Die Zeit said that if nationalized mortgage lender Hypo Real Estate is added to the equation, Germany’s debt level could widen to 90%. While we haven’t seen the precise wording of the Eurostat ruling, there has been a similar report in Irish newspaper over the weekend about suggesting that if Anglo Irish was to be put into a wind down, it’s liabilities would likely be added to the national debt.
However it appeared that this would only be applicable if the entity was not viable (ie in a winddown) and fully owned by the government. In the case of EAA and Hypo Real Estate’s bad bank, this would clearly be the case, and somewhat make sense as the entities are ultimately backstopped by a government entity (in case of EAA, this is the State of North Rhine Westphalia, in case of Hypore’s bad bank, it is Federal Republic of Germany).
The UK and Ireland might be similarly affected by Eurostat’s decision, if recent data and analyst research are anything to go by (and we think they are).
A couple of things are worth noting, nonetheless.
First, nothing has really changed in each sovereign’s fiscal position; this is basically an accounting switch, if one that will bring a lot of attention.
Second, as BNP Paribas’ analysts write, the balance sheets of these state-run banks include not only liabilities but also considerable assets, which will contribute towards paying down the assumed debt in the event of a wind-down.
BNP adds:
The irony here is that the Eurostat ruling basically appears to be penalizing countries that have taken a more proactive approach to bank restructuring (e.g. Germany, Ireland) and reward those that prefer to “kick the can” by drip feeding capital rather than a more obvious solution of cleansing the banks of toxic assets (e.g. Spain). Hence EU countries will probably be reluctant to sponsor similar bad bank schemes in the future.
“Penalizing” is probably overstating things, and it’s also premature to say that a move like this will inspire countries to reconsider their approaches to failing banks in the future. We’ll see, but this may not be that big a deal.
Related links:
Debt and growth revisited – VoxEU
In the long run we’re all…just fine (maybe) – FT Alphaville
Germany’s Bank-Asset-Berg – FT Alphaville
