Just What Is The Real Level Of Government Debt In Europe?

“If you don’t fully understand an instrument, don’t buy it”.

To the above advice from Emilio Botin, Executive Chairman of Spain’s Grupo Santander, I would simply add one small rider: Don’t sell it either, especially if you are a national government trying to structure your country’s debt.

In a fascinating article in today’s New York Times, journalists Louise Story, Landon Thomas and Nelson Schwartz begin to recount the mirky story of just how the major US investment banks have been able to earn considerable sums of money effectively helping European governments to disguise their growing mountain of public debt.

Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts.

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting. The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

In fact, concerns about what it is exactly Goldman Sachs have been up to in Greece are not new, and the Financial Times have been pusuing this story for some time, in particular in connection with the investment bank’s ill fated attempt to persuade the Chinese to buy Greek government debt (and here, and here). Nor is the fact that the Greek government resorted to sophistocated financial instruments to cover its tracks exactly breaking news, since I (among others) have been writing about this topic since the middle of January – Does Anyone Really Know The Size Of The Greek 2009 Deficit? – following the arrival in my inbox of a leaked copy of the report the Greek Finance Minister sent to the EU Commission detailing the issues.

What is new in today’s report from the NYT team is the extent to which they identify the problem as a much more general one, involving more banks and more countries, since “Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere”. I very strongly suggest that our NYT stalwarts take a long hard look at what has been going on in Spain, and especially at the Autonomous Community level.

So the question naturally arises, just how much in debt are our governments, really? As the NYT team point out, Eurostat has long been grappling with this matter, and as far back as 2002 they found themselves forced to change their accounting rules, in order to try to enforce the disclosure of many off-balance sheet entities that had previously escaped detection by the EU, since up to that point the transactions involved had been classified as asset “sales”, often of public buildings and the like. Following advice paid for from the best of investment banks many European governments simply responded to the rule change by reformulating their suspect deals as loans rather than outright sales. As we say in Spain “hecha la ley, hecha la trampa” (or in English, when you close one loophole you open another). According to the NYT authors:

“As recently as 2008, Eurostat…. reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.””

So just what is all the fuss about. Well, in plain and simple terms it is about an accounting item known as “receivables”. Now, according to the Wikipedia entry:

“Accounts receivable (A/R) is one of a series of accounting transactions dealing with the billing of a customers for goods and services received by the customers. In most business entities this is typically done by generating an invoice and mailing or electronically delivering it to the customer, who in turn must pay it within an established timeframe called credit or payment terms.”

However, as we can learn from another Wikpedia entry, often the use of “accounts receivable” constitutes a form of factoring, and this is where the problems Eurostat are concerned about actually start:

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.

But how does all this work in practice? Well, the World Wide Web is a wonderful thing, since you have so much information near to hand, at just the twitch of a fingertip. Here is a useful description of what are known as PPI/PFI schemes, from UK building contractor John Laing:

A Public Private Partnership (PPP) is an umbrella term for Government schemes involving the private business sector in public sector projects.

The Private Finance Initiative (PFI) is a form of PPP developed by the Government in which the public and private sectors join to design, build or refurbish, finance and operate (DBFO) new or improved facilities and services to the general public. Under the most common form of PFI, a private sector provider like John Laing will, through a Special Purpose Company (SPC), hold a DBFO contract for facilities such as hospitals, schools, and roads according to specifications provided by public sector departments. Over a typical period of 25-30 years, the private sector provider is paid an agreed monthly (or unitary) fee by the relevant public body (such as a Local Council or a Health Trust) for the use of the asset(s), which at that time is owned by the PFI provider. This and other income enables the repayment of the senior debt over the concession length. (Senior debt is the major source of funding, typically 90% of the required capital, provided by banks or bond finance). Asset ownership usually returns to the public body at the end of the concession. In this manner, improvements to public services can be made without upfront public sector funds; and while under contract, the risks associated with such huge capital commitments are shared between parties, allocated appropriately to those best able to manage each one.

And for those still in the dark, Wikipedia just one more time comes to the rescue:

The private finance initiative (PFI) is a method to provide financial support for “public-private partnerships” (PPPs) between the public and private sectors. Developed initially by the Australian and United Kingdom governments, PFI has now also been adopted (under various guises) in Canada, the Czech Republic, Finland, France, India, Ireland, Israel, Japan, Malaysia, the Netherlands, Norway, Portugal, Singapore, and the United States (amongst others) as part of a wider program for privatization and deregulation driven by corporations, national governments, and international bodies such as the World Trade Organization, International Monetary Fund, and World Bank.

PFI contracts are currently off-balance-sheet, meaning that they do not show up as part of the national debt as measured by government statistics such as the Public Sector Borrowing Requirement (PSBR). The technical reason for this is that the government authority taking out the PFI contract pays a single charge (the ‘Unitary Charge’) for both the initial capital spend and the on-going maintenance and operation costs. This means that the entire contract is classed as revenue spending rather than capital spending. As a result neither the capital spend nor the long-term revenue obligation appears on the government’s balance sheet. Were the total PFI liability to be shown on the UK balance sheet it would greatly increase the UK national debt.

And here are two more examples of what is involved which were brought to light by a quick Google. First of all, the case of Italian health payments. Now according to analysts Patrizio Messina and Alessia Denaro, in this report I found online from Financial Consultants Orrick:

In the last years many structured finance transactions (either securitisation transactions or asset finance transactions) have been structured in relation to the so called healthcare receivables.The reasons are several. On one side, the providers of healthcare goods and services usually are not paid in time by the relevant healthcare authorities and therefore, in order to gain liquidity, usually assign their receivables toward the healthcare authorities. On the other side, due to the recent legislation that provides for very high interest rates on late payments, the debtors as well as banks and other investors have had the same and opposite interest on carrying out different kind of transactions. In this brief article we will analyse, after a quick description of the Italian healthcare system, some of the different structures that have been used in relation to transactions concerning healthcare receivables and, in particular, we will focus on transactions concerning the so called “raw receivables”, which are lately increasing in the Italian market practice, by analysing the legal means through which it is possible to ascertain/recover such receivables.

This system thus has two advantages (apart from the fact that it effectively hides debt). In the first place the healthcare providers gain liquidity in order to continue to run hospitals, pay doctors, etc, while those who effectively intermediate the transaction earn very high interest rates for their efforts, interest payments which have to be deducted from next years health care provision, and so on.

As the Orrick report points out, Italy’s national healthcare service (servizio sanitarionazionale, “nhs”) is regulated by the legislative decree of December 30, 1992, no. 502 (“decree 502/92”).The reform introduced by decree 502/92, as amended from time to time, provides for a three-tier system for the healthcare service, as outlined below: State level The central government provides a national legislation limited to very general features of the NHS and decides the funds to be allocated to the single regions according to specific criteria (density of population, etc.) for the NHS.

As the Orrick analysts note: “the Healthcare Authorities usually pay the relevant Providers with a certain delay”.

Usually, when healthcare funds are allocated, in the national provisional budget, the central government underestimates the amount of healthcare expenditure. Since the central government does not provide regions with enough funds, regions are not able to provide enough funds to Healthcare Authorities, and payments to the Providers are delayed. Since the Providers need liquidity, they usually assign their receivables toward the Healthcare Authorities. To deal with all the above issues, Italian market practice has been developing an alternative system of financing through securitisation and asset finance transactions of Healthcare Receivables.

As the analysts finally conclude:

Despite of the risks concerning the judicial proceedings, Italian market players are still very interested on carrying on securitisation transaction on this kind of asset, principally because Legislative Decree no. 231/02 provides for very high interest rates on late payments (equal to the interest rate applied by ECB plus 7%) – my emphasis

Another technique Eurostat have identified as a means of concealing debt relates to the recording of military equipment expenditure, as described in this report I found dating from 2006. At the time Eurostat were worried about the growing provision of military equipment under leasing agreements. Basically they decided that such provision was debt accumulable.

Eurostat has decided that leases of military equipment organised by the private sector should be considered as financial leases, and not as operating leases. This supposes recording an acquisition of equipment by the government and the incurrence of a government liability to the lessor. Thus there is an impact on government deficit and debt at the time that the equipment is put at the disposal of the military authorities, and not at the time of payments on the lease. Those payments are then assimilated as debt servicing, with a part recorded as interest and the remainder as a financial transaction.

However, a loophole was found in the case of long term equipment purchases:

Military equipment contracts often involve the gradual delivery over many years of a number of the same or similar pieces of equipment, such as aircraft or armoured vehicles, or including significant service components, such as training. Moreover, in the case of complex systems, it is frequently the case that some completion tasks need to be performed for the equipment to be operational at full potential capacity. Some military programmes are based on the combination of several kinds of equipment that may be completed in different periods, so that the expenditure may be spread over several fiscal years before the system, globally considered, becomes fully operational.

In cases of long-term contracts where deliveries of identical items are staged over a long period of time, or where payments cover the provision of both goods and services, government expenditure should be recorded at the time of the actual delivery of each independent part of the equipment, or of the provision of service.

Payment for such items are only to be classifed as debt at the time of registering the actual delivery, which may explain why, if my information is correct, the Greek military as of last December were still officially “testing” two submarines which had been provided by German contractors, since final delivery had still to be formally registered, and the debt accounted.

A lot of information about the kind of things which were going on before the 2006 rule change can be found in this online presentation from Europlace Financial Forum. Here are some examples of private/public sector cooperation in Italy.

And here’s a chart showing a list of advantages and possible applications:

Now, at the end of the day, you may ask “what is wrong with all of this”? Well quite simply, like Residential Mortgage Backed Securities these are instruments that work while they work, and cause a lot of additional headaches when they don’t. I can think of three reasons why debt aquired in this way in the past may now be problematic.

a) they assume a certain level of headline GDP growth to furnish revenue growth to the public agencies committed to making the payments. Following the crisis these previous levels of assumed growth are now unlikely to be realised.
b) they assume growing workforces and working age populations, but both these, as we know, are now likely to start declining in many European countries.
c) they assume unchanging dependency ratios between active and dependent populations, but these assumptions, as we also already know, are no longer valid, as our population pyramids steadily invert.

Given all this, a very real danger exists that what were previously considered as obscure securitisation instruments, so obscure that few politicians really understood their implications, and few citizens actually knew of their existence, can suddenly find themselves converted into little better than a glorified Ponzi scheme.

And if you want one very concrete example of how unsustainable debt accumulation can lead to problems, you could try reading this report in the Spanish newspaper La Verdad (Spanish, but Google translate if you are interested), where they recount the problems being faced by many Spanish local authorities who are now running out of money, in this case it the village of San Javier they have until the 24 February to pay a debt of 350,000 euros, or the electricity will simply be cut off! The article also details how many other municipalities are having increasing difficulty in paying their employees. And this is just in one region (Murcia), but the problem is much more general, as Spain’s heavily overindebted local authorities and autonomous communities steadily grind to a halt.

This entry was posted in A Fistful Of Euros, Economics and demography, Economics: Country briefings by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

39 thoughts on “Just What Is The Real Level Of Government Debt In Europe?

  1. I read with some interest the points you make about PPP/PFI schemes and some of the off-balance accounting that occurs in these cases. In the UK it is common knowledge that a lot of health service capital expenditure has been funded in this way, placing an unquantifiable time-bomb under the NHS budget. Another country where the use of “innovative” forms of financing have been used extensively – is, you guessed it, Hungary! In fact some of the sub-text to the loss of market confidence in Hungary in 2006 was related to disputes between the government in Budapest and Eurostat over whether to place the financing for motorway construction on the accounts with the budget deficit, or off balance. In the early days of spending expansion in 1999/2000 the Orban government used innovative funding mechanisms to finance capital spending and keep the budget deficit down (the hideous National Theatre was funded through such a scheme), and I suspect these schemes have been used on a widespread basis by publicly-owned institutions, local authorities, and the state to lever in European money without placing the domestic contribution on the budget balance.

  2. I think in the UK there is some conscioussness now that PPP/PFI is a form of glorified (and oftenprohibitively expensive) borrowing – affairs such as the collapse of Metronet on the London Underground have shown the problems, as well as some of the outrageous charges the partners in these schemes can make of the NHS for elementary maintenance (changing light bulbs, for example) in hospitals. However, while I’ve seen think tanks like Reform comment on the way in which the costs of maintaining PPP/PFI hospitals will reduce funds available for patient care even with increasing overall budgets, I don’t think we are anywhere near an estimate of how much total debt has been accummulated through such schemes, nor the costs of servicing it.

    In Hungary there is almost no consciousness that this is even a problem, as PPP/PFI and other” innovative” financing schemes are seen as part of drives to reduce spending! The discussion is at the stage it was in the UK 10 years ago, where it is seen as being about the mobilization of “private capital” to ease spending problems in public services; there is no real awareness of the actual financial obligations that the state is taking on under such schemes.

    I suspect when this bubble is punctured, because it will hit people’s hospitals, schools, and basic community services, the political outrage will be phenomenal.

  3. Oh oh. I’ve been googling up PPP/PFI regarding Spain and since 2008 the stats have climbed rapidly. Este no tiene una buena pinta.

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  5. Well, this is what the SAGP/Lisbon agenda hawks wanted – lower headline PSBR through regressive fiscal measures and fancy-dan financing. And they got it. Who remembers the lakes of Carinthia?*

    Obviously, we need more IMF-with-blue-and-yellow-flag.

    * The very, very rectitudinous Austrian finance minister Karl-Heinz Grasser was lionised for balancing the budget in 2002 – after he arranged the sale of the lakes of Carinthia from the Republic of Austria to the Federal Forestry Commission, which bought them for €3bn with a loan from the treasury itself. This permitted both parties to show a €3bn book asset and the treasury to show a €3bn cash inflow and therefore, ta-da!, balanced budget and mucho alpine smug all round.

  6. to be clear, I don’t for a moment accept that KHG actually reduced the government deficit in any meaningful way (as the repayments came out of the forestry budget, after all). But he did succeed in structuring the transaction so as to be entirely “Maastrichtkonform”.

  7. 2 quick points. First, Eurostat plays both sides of this game. For example, it endorsed Ireland’s accounting structure that keeps all the debt issued for the commercial property distress vehicle off the public debt. And it’s done via a wheeze that will have private investors put up a tiny amount of cash but allegedly own a magic 51% of the operation.

    And there often tends to be one little catch with this securitization vehicles — they can suddenly become short-term debt with a ratings downgrade for the issuer. So a lot of this stuff comes out of the woodwork when a downgrade happens.

  8. Super article, thank you. One point, though. You list three reasons why this form of debt might be “problematic”. But, surely the factors you quote apply to long-term government debt of any form?

    Having seen PPP/PFI in several sectors in several EU countries, it strikes me that too much hangs on the contractual detail concerning service quality and levels. These (if they appear at all!) seem to be regarded as of low)grade interest: it’s the money values that matter most. Customer (ie ordinary users of the facility) interests are only sometimes well served.

  9. Enron CFO Fastow hid mountains of debt in SPEs. Did some his shells even pay him compensation? Enron disappeared, along with its auditor, and Fastow did something like 7 years in prison. The evidence that governments have been using similar off-balance smoke and mirrors is chilling. There’s something rational about a corporation collapsing leaving employees and creditors muttering under their breath. But the same thing happening to Greece is numbingly irrational.

    Regarding your 3 warnings: it is widely held that US population will continue to grow robustly, adding tens of millions of residents in the next decades. Some argue, perhaps the Obama administration even, that the US should be able to grow itself out of current problems, for example the housing glut. Wait a few years and the unsold stock will be snapped up. For that to happen though the US must grow a middle class population that can buy houses. The population will grow – I’m willing to bet however that living standards will fall, especially if the financial oligarchy continues to hold the government.

  10. Hi French Derek,

    “But, surely the factors you quote apply to long-term government debt of any form?”

    Yes Derek, they do. That is why we thought we were trying to set strict limits here in Europe to keep total debt to GDP within 60% limits. These off balance sheet techniques have enabled people to get round that, and this is the real reason they are very dangerous. As P O’Neill says, it is when the downgrades come – as they have in Greece – that these things become really problematic. If you have the skeletons in the cupboard you will be made to pay for them.

    If your economy has a long term sustainable growth outlook debt problems may not be ideal, but they are at least manageable.

  11. Murcia is having problems with its Health receivables. Only 300 million euros, but one year four months delay in payment:


    Check it out in Google translator if you want. This will be more general in Spain, and was certainly one of the Greek issues.

    And these people put the current debt for all autonomous communities in health receivables at 2.5 billion euros:


    With up to 500 days in payment delay. This is small beer, but there will be more, a lot more.

  12. But Chile can get a Public Defict of 6,3% and Right and Left agreed to have a superavit in good years.

    Maybe Europe should look to a country in Latin America for some Lessons…

  13. When “big” Eurozone countries can apparently violate the letter of the SGP with impunity, is it any surprise if the “little” ones find ways to violate its spirit?

  14. Incidentally, Mr Botin did not only say do not buy instruments that you don’t understand, he also said “If you would not buy it for yourself, do not sell it”. So no need to add that consideration.

    Here you have him in his painfully appalling broken english (min 1.30):


  15. A very impressive and well documented article… until the last paragraph where we had to jump from previous billion dollars figures relating to many countries finances to a meagre 350.000 euro electricity bill, completely out of context, just to be able to include Spain in this report.

  16. Lawyers for normal people know that, in a transaction between 2 parties, A and B, if A conceals a material fact, he has committed fraud on B. GS aided and abetted the government officials of Greece to commit fraud on the Eurozone, and probably on the Greeks. It is not a defense that Eurozone officials are sophisticated, and might have discovered the concealment with the exercise of more diligence.
    But those are the rules for normal people.
    GS has turned governments and corporations into Enrons everywhere. There is little wonder that the invisible hand cannot regulate the system–the facts are now more invisible than the hand.

  17. How interesting it is to explore the recommended blogs on the side bar of this page! There I found an article that helps put the whole Greek problem in perspective. Funnily enough it comes citing and article from a known eurosceptic newspaper which says:

    “by modern standards Greece does not need that much money. A loan of €20?billion would do the trick — which is significantly less than we in Britain had to put into either Lloyds or Royal Bank of Scotland. Bailing out countries is a lot cheaper than bailing out banks, so the idea that the euro is under threat from Greece’s domestic problems is absurd.
    “After all, in the United States individual cities and states go bankrupt and default on their debts on a fairly regular basis — California doing so quite recently — but no one says it will destroy the dollar. And California is a bigger economy than Greece.”


  18. “GS aided and abetted the government officials of Greece to commit fraud on the Eurozone, and probably on the Greeks.”

    Sure, but what is the rest of Europe to do? Short of throwing Greece out of the Euro anything needs Greek cooperation. If the rest of the EU wants Greece to cooperate, it will have to make cooperating the better option to Greece, not just the EU as a whole. Threats will work only so far.

    Now we could go after GS, but that’s a matter for the courts and you can be sure that their lawyers went over the contracts very carefully.

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  20. Help. Can anyone give me an actual figure in Euros for Italian GDP for 2009. I’m fed up with % on % etc. on figures for 2008 in dollars. Bloomberg give 2009 on 2008 as -6% beyond even my gloomy 5.1% prediction. Is the the gvt. debt at ‘only’ 114.5% of gdp (economist, FT) etc.? I’m sure they’re wrong and it’s more like 120%+ before taking the points raised in your excellent article on PPP and the health service inter alia.

    Thanks in advance and could you tell me where you got the figure.

    Yours, not quite disgusted of Pievebovigliana

    Nic Mudie

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  28. It makes no sense to hide growing debt, it is still there, it is the elephant in the room and the sooner governments take the responsibility of transparency, the sooner we can eject the elephant in the economic system.

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