The European Union (EU) has settled the Irish debt matter, at least for the time being. It was more difficult than it might have been because of domestic Irish political issues. But now that it is complete, Europe still cannot rest on its laurels. It now must look to Portugal, Spain and Belgium. The continent's sovereign debt crisis seems determined to roll on, threatening the euro and even the European Union itself.
Confidence, or the lack of it, is such a big part of these debt matters, that all forecasting-short-term and long-term-is problematic at best. Still, prospects yield at least some tentative conclusions. First, Europe's existing rescue resources are more than ample for Greece, Ireland and Portugal. Second, the great danger lies with Spain, less because of government profligacy and more because any problem with the Spanish government's ability to borrow would raise doubts about the viability of private Spanish real estate debt held widely throughout Europe.
And finally, although the stronger nations of the EU dithered initially when the Greek crisis broke this past spring, they have shown a remarkable determination to deal with the problem, protect the euro and the Union.
This latest Irish encounter should have been easier to deal with than Greece was. With Greece last spring, the EU was taken completely by surprise. For a while, the EU and its member states vacillated, and it looked as though they would let Greece fail. Germany in particular, chafed, since as Europe's largest economy, it had to bear the lion's share of the cost of any rescue. The country's population understandably resisted, a feeling captured in Chancellor Angela Merkel's remark: "Germans are not going to retire at 67 so that Greeks can retire at 58." But the downside, a dissolution of Europe seemed too big to refuse assistance. Europe established a huge €750 billion pool of money, with funding from the members of the union (Germany prominent among them), the International Monetary Fund (IMF), and the European Central Bank (ECB). In response, Greece bound itself to EU demands on its budgeting and fiscal policy.
When Ireland faced its acute debt problem this fall, the EU sought to make similar arrangements. But the Irish resisted. Its leadership was concerned that EU demands would force Dublin to raise Ireland's attractively low corporate tax rate and the basis, many believed, for the economy's impressive past economic progress.
Even more fundamental were Irish concerns about sovereignty. More than one Irish politician complained that the small nation had fought too long to gain its independence from Great Britain to now yield to the EU. In the end, however, the debt pressure was too great and Ireland took union help, though for the time being, the nation can keep its low tax rates.
Because the Irish difficulties revealed the long-term nature of these debt problems, the EU decided to create more durable institutions to take over the debt relief effort after 2013. These arrangements will establish a new, joint EU-IMF lending facility that will determine, on a case-by-case basis, whether a nation's financial problems are a matter of illiquidity or insolvency. If the problems are a matter of liquidity (such as a nation with fundamentally sound finances that is having trouble meeting immediate cash needs), the central lending facility will simply extend the necessary credit. But if there is a solvency problem (such as a fundamental flaw in a nation's finances and something that will likely cause repeated borrowing problems going forward), the EU would insist that sovereign bondholders take a loss in the final solution. This way bondholders will watch for fundamental financial problems, grow wary and subject each nation to financial discipline before it needs to use the EU-IMF Fund.
The resources available at present, and into the more distant future, should prove more than adequate to deal with Greece, Ireland and Portugal. Combined, these economies amount to less than 5% of the EU's overall gross domestic product (GDP). The loans to Greece amount to some €110 billion, more than enough to cover the country's €20 billion annual borrowing needs, but still only about 14% of the overall lending facility. Ireland, because its government guaranteed all bank debt after that country's real estate collapse, is borrowing at more than 30% of its GDP a year. But the economy is so small that EU loans of about €85 billion, or about 12% of the lending facility, will cover the country's debt needs. These, like the Greek loans, will only get drawn down over time. For all this trouble, Ireland and Greece are already funded until spring 2011. Even if these nations draw down the entire amount immediately, more than €500 billion would remain available to deal with other shortfalls, in Portugal, perhaps, or Belgium.
Spain, however, is where the danger lies. It is the fourth largest economy in Europe-more than twice the combined size of Portugal, Ireland and Greece. That makes Spain more of a potential burden, should matters deteriorate.
Still, not all the news is bad. Spanish government finances are in better shape than in these other countries. Spain's current budget deficit of about 11% of GDP, though disturbingly high, falls far short of Irish, Greek or Portuguese figures. At the same time, Spain's outstanding public debt, at some 53% of GDP, actually compares well with France, Germany, and the United States. What's more, Spain, like Italy, sells most of its debt domestically, and Madrid does not face a major refinancing until April.
Even if Spain were to fail, its government would require, according to consensus estimates, about €350 billion over the next three years, well within the resources of the EU's existing fund. The country's real danger lurks less in immediate government budget problems than in the economy's collapsed real estate bubble.
To some extent, Spanish government finances look as good as they do, and better than Ireland's, only because Spain has refused thus far to assume real estate debts, as Ireland did. The threat expands because so much paper backed by Spanish real estate is spread throughout the major financial institutions of Europe. Should Spain have to ask for help, all this debt would likely fall under suspicion, making the sovereign debt crisis a more general European financial crisis and burdening the stronger governments of Europe, Germany in particular, with their own domestic rescue needs.
Against this threat is Europe's clear determination to hold the union together, avoid expelling members and continue with the common currency. This clearly is a political decision, and no doubt reflects the vast political capital already sunk into the experiment. It would seem that the odds favor successful rescue, especially now that the ECB has shown less reluctance, if not outright enthusiasm, for the effort.
Still, no one will find a way to rest easy about European finances for a long time to come. In the meantime, union uncertainty may rise, as German ambivalence will likely push for a new EU structure in which states are no longer equal, but rather the stronger states, like Germany, exercise more relative power.
Milton Ezrati is the senior economic strategist at Lord Abbett and affiliate of the Center on Economic Growth in the Department of Economics at The State University of New York at Buffalo.
