New York (HedgeCo.net) – Hennessee Group LLC, an adviser to hedge fund investors, voiced concern in early 2009 that the global financial crisis could enter a new and more dangerous phase, one that could push several international countries to the brink of failure and further hinder the global economic recovery.
Of particular concern to the Hennessee Group was the dramatic growth in external debt exposures of G7 and emerging countries and the increasing risk of another outright failure similar to that of Iceland when they had a debt to GDP ratio exceeding 900%. However, Hennessee Group research now indicates that this risk has begun to subside as the majority of countries have experienced a decline in their overall external debt exposure in recent months after reaching all time highs in 2008. That said, the Hennessee Group now believes this development could come at the cost of economic growth as the majority of the decline in external debt has been due to a dramatic drop off in bank lending to foreign institutions.
Charles Gradante, Co-Founder of the Hennessee Group, noted “While the decline in external debt, particularly for countries like the U.K., is a positive development and is likely to reduce the risk of another Iceland, we fear the primary driver behind the external debt reduction, specifically the drop off in external bank lending, could ultimately slow the pace of the global economic recovery.” The Hennessee Group believes it is essential to global growth that banks resume prudent external lending to businesses and individuals to further alleviate the financial crisis and promote economic growth.
In its February 2009 research paper, the Hennessee Group highlighted numerous countries, particularly in the euro zone, that appeared to be building uncomfortably high external debt levels in recent years relative to their economic output. The bright spot, at that time, was the low level of U.S. external debt to GDP output (84%).
The Netherlands reached an external debt to GDP ratio of approximately 328%, while Ireland had a similar exposure ratio to that of Iceland, a staggering 900%. The UK’s debt to GDP ratio reached 456% while Switzerland’s rose to 433%.
Gradante stated, “We believe the build up in external debt was both alarming and unsustainable, particularly for many European countries, and that if the trend continued we could be at risk of a major systemic event.” Gradante continued, “Since our initial analysis, the majority of countries have started to reduce external lending.
The U.K. has decreased its external debt by nearly $3.5 trillion from its high of $12.1 trillion in the first quarter of 2008. While we believe this is a positive development from the perspective that it alleviates our initial concern regarding another Iceland; a closer look at the underlying numbers has revealed a new concern. The vast majority of the reduction is due to a decline in external bank lending, which we believe will present additional challenges going forward. Of the $3.5 trillion decline in the U.K. external debt, $2 trillion can be attributed to a drop off in external bank lending. This could present additional challenges to an economic recovery.”
The Hennessee Group believes this new trend is not just a problem isolated to the U.K. but rather a worldwide issue. In a recent press release by the Bank for International Settlements, they stated, “After a relatively small change in total outstanding stocks in the third quarter, banks’ external claims shrank by 5.4% in the fourth quarter of 2008 ($1.8 trillion at constant exchange rates), to $31 trillion.” They added, “This was the largest reduction ever recorded.” The global economy may very well struggle to recover if the banks remain unwilling to increase external debt lending and may result in a resurrection of protectionism.