Europe: Boom Reawakens the Ghost of Crisis Past : Debt

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04/09/2018 | 09:44 am


By Patricia Kowsmann and Tom Fairless



LISBON -- Filipe Garcia e Costa had never borrowed from a bank when ultralow interest rates tempted him to take out a EUR185,000 ($226,000) loan to buy an apartment here.



The caveat: The 32-year-old real-estate manager won't finish repaying the debt -- worth seven times his annual salary -- until he is 75.



Mr. Garcia e Costa isn't alone in ramping up debt. Across the eurozone, economic optimism, ultralow interest rates and fierce competition among banks have helped push private-sector lending to its highest level since the financial crisis. That would be good news if it wasn't for one big problem: the region's already high debt.



Over the past decade, the debt held at eurozone firms and households rose around 12 percentage points to 160% of gross domestic product, according to data from the Bank for International Settlements. In the same 10-year period, U.S. private-sector debt fell around 14 percentage points, to 152% of GDP.



The borrowing binge is seen as one adverse effect of almost a decade of easy money from the European Central Bank, which slashed interest rates below zero and bought bonds to reignite an economy reeling from a crisis that was triggered in the first place by over-indebtedness.



As the ECB moves to unwind those policies, the debt they contributed to could hurt overleveraged companies and consumers, hurting the region's now booming economy. Rising interest rates make it harder for people and companies to borrow and serve existing debts, crimping their ability to spend and invest, while pushing some into bankruptcy.



"There has been no meaningful decline in private debt in the eurozone since 2008, as a share of gross domestic product, which is remarkable," said Joerg Kraemer, chief economist at Commerzbank in Frankfurt.



At 1.5%, the interest rate on Mr. Garcia e Costa's loan was less than half the average being offered for house purchases in Portugal a few years ago. But it is tied to market interest rates, so could rise substantially. The ECB's key interest rate is currently minus 0.4%.



"I'm just confident about my professional future and my country," Mr. Garcia e Costa said.



But national regulators are increasingly concerned that low interest rates might be stoking unsustainable asset-price bubbles. By imposing limits on borrowing, they now hope to discourage households and firms from taking on debts that are only sustainable because interest rates are so low. That task is particularly important in a currency union like the eurozone because national authorities face differing business cycles but can't set interest rates to cool or stimulate the economy.



In the Netherlands and Portugal, authorities have told banks to limit mortgages to 90% of the value of a house. In Finland, authorities recently lowered that limit by 5 percentage points to 85% for home loans, excluding first home purchases. The Dutch are also considering the end of tax relief for mortgage loans, while in Portugal banks must offer loan maturities of no more than 40 years.



In the real-estate sector, "we do see signs of overvaluation in certain areas and large cities, where housing prices have increased at a faster pace than household incomes," Vítor Constâncio, the ECB's vice president, said last month.



House prices rose an annualized 10% and above in Ireland, the Netherlands and Portugal in the third quarter of last year, according to the European Union's statistics agency. Much of the money behind those house purchases is borrowed. In the Netherlands, household debt stands at 270% of net disposable income -- higher than in 2007.



U.S. households by contrast have reduced their debts to 112% of net disposable income from 144% in 2007, according to the Organization for Economic Cooperation and Development.



In Ireland, where a burst housing bubble cratered the economy in 2011, mortgage approvals rose 23% last year, while issuance when the mortgage is taken reached levels last seen in the third quarter of 2009, according to the Irish Banking and Payments Federation. It expects residential property prices in some areas to return to their 2007 peak level within two years.



Since 2015, the Irish central bank has tightened lending rules, but David McNamara, an economist at Irish bank Davy Capital Markets, said credit figures suggest latest moves have done little to dampen the market.



"Real-estate prices are always more worrisome than any other form of asset prices," said Adam Posen, director of the Peterson Institute for International Economics in Washington. That is because of the size of the sector and its importance for the broader financial system.



Companies also binged on debt. Loans to businesses across the eurozone increased in January at their fastest rate since the financial crisis, rising 3.4% on the year. Of course, policy makers want companies to borrow so they can invest. But they worry that low borrowing costs might encourage investment in projects that are only profitable at low interest rates, and that such loans risk turning sour as interest rates rise.



In France, corporate debt has risen to around 134% of GDP from 104% a decade ago, according to data from the Bank for International Settlements.



Altice NV racked up more than EUR50 billion in debt to finance a raft of acquisitions that made it one of the world's largest media and telecom companies over the past four years.



"I bought everything on credit," Patrick Drahi, the company's founder and chief executive, said in a 2016 speech. "I didn't take much risk. It's the banks that lent everything."



Since then, Altice's fortunes have turned. Its stock has fallen more than two-thirds over the past nine months as the company struggled to retain customers and generate new sales in Europe, forcing it to put some businesses up for sale to pay off debt.



French authorities recently limited the exposure of banks to highly indebted large companies, and suggested they might force lenders to increase their capital levels.



"We consider that there is a risk that big companies in particular are going too far," Bank of France Gov. François Villeroy de Galhau said.



Leverage is building even as many European banks continue to deal with debt accrued from the financial crisis. Over $1 trillion of loans outstanding are considered nonperforming and continue to weigh in on the books of European banks, which have assumed actual losses half of that amount.



ECB President Mario Draghi has defended the low-rates policy, saying it has boosted the local economy and created jobs.



"The distortions may be there, but sometimes the trade-off is so powerful that you just ignore them and do the right thing," Mr. Draghi said in October.



--William Horobin in Paris contributed to this article.



Write to Patricia Kowsmann at patricia.kowsmann@wsj.com and Tom Fairless at tom.fairless@wsj.com





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