Debt crisis unsettles European economy

By Anthony Faiola
Washington Post Foreign Service
Saturday, February 6, 2010; A01

LONDON -- Governments in Athens, Madrid and Lisbon struggled on Friday to quell fears of a looming debt crisis in Europe that is pummeling the euro and rippling across global markets, as authorities vowed to impose fiscal austerity and plug their yawning budget deficits. The problem, however, is that investors don't appear to believe them.

Senior officials at the major rating agencies on Friday played down the risk of an immediate debt crisis, saying even nations such as Greece have enough reserves to put off for months a day of financial reckoning. Yet investor doubts over the will of Greece, Portugal and other nations to right their accounts have sparked a crisis of confidence that is seeping into stock and corporate bond markets across Europe and beyond. It is especially hitting banks and other institutions with broad exposure to the sovereign debt of the "PIGS" of Europe -- Portugal, Ireland, Greece and Spain.

Investor panic is threatening to drive up the cost of borrowing for myriad nations around the world and to destabilize global currency markets, with the falling euro and strengthening dollar already hitting U.S. exporters by making such items as American beef and U.S. steel more expensive overseas. The euro, the principal European currency, fell Friday to its lowest level in eight months, tumbling almost 1 percent against the dollar.

The crisis unfolding in Europe has some parallels to the debt crises that hit Latin America and Asia in the past, particularly in how Greece's problems have spread so quickly to other countries in the region with similar economic woes.

But there are major differences. Analysts said the healthy, large economies of the "eurozone" -- namely, Germany and France -- are likely to step in to prevent a default in a weaker neighbor, if only to head off the turmoil it might cause in the value of the euro.

Still, analysts remain concerned that the problems in Europe could spread to emerging markets. And although the chances of a default by Greece may be low, its impact would be felt by investors worldwide, including in the United States; roughly 70 percent of Greek bonds are held by foreigners, from pension funds to global commercial banks.

Investors also drove up to fresh highs the cost of insuring against a default in Greece, Spain and Portugal. In some instances, analysts say, those fears may not be wholly misplaced.

Portugal, in recent days, has been swallowed up in the debt market panic that began in Greece late last year. Portuguese officials have pledged to slash spending. Nevertheless, opposition lawmakers on Friday pushed through a controversial bill funneling tens of millions of euros to the Azores and Madeira islands in a move the country's finance minister openly warned could have "grave consequences for Portugal's public accounts."

In Greece and Spain, analysts additionally fear bouts of civil unrest that could roll back attempts to address the fiscal problems. The Greek government's pledge to slash spending and curb public- sector pay sparked protests in Athens on Thursday; customs officials and tax collectors walked off the job in the first of a number of planned mobilizations against government austerity measures set to continue next week.

Though E.U. officials demanding tighter spending have signed off on Greece's plan, they are dispatching a team to review government accounts, which were found late last year to have been grossly underestimating the extent of the country's economic woes.

In Spain, government union leaders on Thursday also vowed a series of protests against planned cuts, while opposition parties have threatened to hold a no-confidence vote on Prime Minister José Luis Rodríguez Zapatero. So far, analysts note, only Ireland, whose bonds have been less hard-hit by the current turmoil, has pushed through the serious cuts that have demonstrated its willingness to deal with its huge deficit.

"The fix of this problem needs to be a political solution, and you can't easily persuade people or politicians to accept this kind of medicine," said Steven Bell, chief economist of GLC, the London-based hedge fund.

Analysts said some institutional holders are dumping Greek bonds in particular because stricter borrowing rules are coming back into effect later this year at the European Central Bank. The ECB has been allowing banks, including those holding significant portions of Greek bonds, to put up riskier investments as collateral for loans to help them through the financial crisis.

But the ECB is tightening those standards later this year, when banks will be allowed to use only top-rated bonds as collateral. Fears that Greek bond ratings may lose their investment-grade status in the coming months have led some banks to sell them at a loss.

"As they see the ratings on these bonds going down, investors can't wait anymore -- they are acting now, liquidating them at huge losses into the market," said Steven Major, head of fixed-income research at London-based HSBC.

A default by Greece or any other country in the 16-nation eurozone would be potentially catastrophic to the region, leading, analysts say, to possible eviction from the monetary union and severely testing the soundness of Europe's integration. Most analysts believe the eurozone's economic powerhouses might ultimately come to the aid of Greece, currently the most troubled nation in the region, in much the way Washington bailed out Mexico in the 1990s. European officials have offered mixed signals about their willingness to do so.

But analysts say the alternative -- having the International Monetary Fund rescue a eurozone country -- would be so deeply embarrassing to Europe's major powers that they would opt to aid Greece.

Analysts are also growing more worried about the U.S. budget deficit, which remains higher than that of most eurozone nations. But Greece, Spain and other troubled countries in Europe do not command the kind of economic clout the United States does and, in many cases, have yet to escape the Great Recession.

Spain, for instance, reported Friday that it has yet to climb out of the recession, announcing that its economy contracted by 0.1 percent in the fourth quarter of 2009. Its unemployment rate is hovering near 20 percent and is still foundering amid a U.S.-style real estate bust.

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