Potential losses on European government bonds could cost banks in the region $400 billion and threaten to wipe out several major insurance companies, the International Monetary Fund said on Wednesday in its first effort to quantify the costs of Europe’s debt problems.
The potential losses represent a major share of the capital held by some banks, and in the case of the insurance companies involve risks to the broader economy that the IMF acknowledges are not fully understood.
In the U.S. financial crisis, the insurance company AIG played a major role in broadening the problem because it had absorbed so many different types of bad investments and had extensive ties with other financial firms.
IMF and European regulators said that they are fairly confident no equivalent exists in Europe and that the risks faced by insurance companies and other firms is “manageable” by European governments.
Still, the study laid bare some of the ways in which problems in Greece and elsewhere are dragging down the European economy and putting a tepid global recovery at risk. The United States is encouraging Europe toward more forceful action to address the debt problems.
The IMF has suggested banks raise more capital to prepare for possible losses on government bonds, saying they should aim to set aside an amount equal to 10 percent of their assets. On that basis, many of Europe’s core banks fall short, according to recent analysis by the European Banking Authority, suggesting they are not fully prepared for one of the chief risks they are facing.
The estimated losses took into account both bank holdings of government bonds in six “high-risk” countries — Greece, Ireland, Portugal, Spain, Italy and Belgium — and bank investments in other banks located in those countries. All told, the IMF estimated that about half of the euro area’s $9 trillion in outstanding government debt was now at “heightened credit risk.”
The study was released as the country at the center of Europe’s crisis, Greece, pledged further spending cuts to convince an international group of creditors that Athens is meeting the conditions of an international bailout program.
Without an $11 billion installment of bailout funds, Greek officials have said the Mediterranean nation will go broke by the end of October. But some analysts said Wednesday that the potential economic maelstrom from a sudden Greek default was so strong that it was unlikely that Germany and other euro zone nations would withhold the funds, at least this time around.
Greek Finance Minister Evangelos Venizelos told the nation’s parliament Wednesday that “we are doing and will do whatever it takes. We won’t put the country’s fate at risk.” The new cuts will slash government pensions, extend a property tax hike and put 30,000 civil servants on notice that they will lose their jobs in a year, a government spokesman said after a cabinet meeting Wednesday.
European financial officials said last weekend that they would decide in early October whether to release the money.
“It’s very clear that the German government would only allow the country to default if they thought the damage would be limited,” said Clemens Fuest, an Oxford economist who is on an advisory panel to the German Finance Ministry. Whether the damage would be containable right now, he said, was unclear.
Greek debt now trades at prices far below its face value, a sign investors don’t expect to recover all their loans. The question for many is how a Greek default would be managed.
If Greek coffers ran empty in October, banks around Europe — as well as the viability of the economies of struggling countries like Portugal and Ireland — could be in serious danger, several analysts said. Concerns about global consequences were serious enough for U.S. Treasury Secretary Timothy F. Geithner to fly to Europe last week to urge finance ministers to do more to save Greece.
If Greece defaulted, “we don’t really know what would happen because we’ve never seen this before,” said Carl Weinberg, chief economist of High Frequency Economics. But “when Greece eventually does fail, there will be a banking crisis in Europe of historic proportions,” he said. Banks would be forced to write off Greek debts and recapitalize; some banks could fail; and the existing European bailout fund, the European Financial Stability Facility, would face major stresses.
But the economic rescue has proved deeply unpopular with German voters, who shoulder much of the bailout’s financial burden. German taxpayers feel that they scrimped over the past decade while the Greeks enjoyed rocketing salaries and generous government benefits.
“The Greeks must really be serious, and the German citizens must feel that the Greeks are serious,” said Ulrike Guerot, the head of the Berlin office of the European Council on Foreign Relations. She said that forcing private investors to take a loss is “too risky” right now, even if they eventually will need to do so.
French banks are heavily involved with Greek debt. German banks are less so, but much of the debt exposure is concentrated in the state-owned banks and could put additional pressure on taxpayers in the event of a failure.
The European Central Bank said Wednesday that it had loaned $500 million to a single, unidentified bank for a week, raising concerns that European banks are too scared about each other’s viability to extend the short-term loans that help provide liquidity to the economy.
Greece discussed its austerity measures with the so-called troika of creditors — the International Monetary Fund, the European Union and the European Central Bank — in late-night telephone conversations Monday and Tuesday.
An inspection team sent to Greece this month left suddenly when it discovered new shortfalls. The European Commission announced Tuesday that the review would resume early next week, and German officials have said they will approve the newest $11 billion bailout payment only if the review gives a green light.
German Chancellor Angela Merkel will have dinner with Greek Prime Minister George Papandreou in Berlin on Sept. 27, her spokesman said Wednesday.
“We are not really prepared for a crisis of this sort in our euro area,” said Christoph Schmidt, a member of the German Council of Economic Experts, a panel that meets with Merkel regularly. “Everybody is hoping” that the creditors will decide that Greece’s reforms are “still online,” he said. But if they don’t, he said, the money should be cut off.
Birnbaum reported from Berlin.