O dominó

Belgium Is the One to Watch .

In the mid-1990s a senior credit quant friend at a major investment bank, with direct experience of the Belgian government’s operations in the market, called me up.

Belgium’s positions are not only massive but probably toxic, he said, albeit in more colorful language.

Senior officials at the Belgian Treasury who took my call denied that the government was dangerously exposed, adding that the credit quant had only seen a part of the position and that the rest had been hedged out. Besides, the Belgian government wasn’t doing anything different from other European governments.

For want of documentary evidence, I couldn’t go anywhere with it.

But it came out in 1997 that the government was running losses running to 44 billion Belgian francs (around $1.2 billion, or 0.5% of GDP) at the time on its debt management policy.

Now, in the context of the 2008 credit crunch and subsequent financial disasters, that seems peanuts. But at the time it was seen as a shockingly large gamble.

Since then, it’s become apparent that some European governments have used derivatives to hide the magnitude of their public debts, by using the equivalent of the sort of off-balance-sheet instruments that brought the banking sector to the edge of meltdown during the credit crunch.

Greece did, with the help of Goldman Sachs. Is it far fetched to believe Belgium might be doing the same?

Belgium’s publicly admitted gross debt to GDP ratio already stands at 100%. In 2008, before Greece had to ‘fess up to the true size of its public debt, it had a ratio of 99%. This year, Greece’s ratio will be above 130%, on its way — probably — to 150% over the coming couple of years.

OK, so on many of the other metrics, Belgium doesn’t do (quite) as badly as the peripheral Europeans currently in crisis.

But the numbers are nothing to cheer about. Belgium’s government deficit is expected to come in at 4.8% this year, according to the IMF, and is seen rising for the coming few years.

True, the structural deficit, at 3.5%, is about half of Greece’s level.

But given Belgium has been without a government since April and is riven by deep tensions between its French- and Dutch-speaking communities, the prospects of strong, clear-sighted economic policy any time soon seems far fetched.

The cost of insuring Belgian government debt is rising fast. Belgian credit default swaps are starting to blow out.

They’re now at an all-time record of 160 basis points, up around 10 bps today alone.

True, that’s well below the CDS of countries in crisis, like Ireland, which is above 600 bps. Even Spain’s are double Belgium’s level. But it’s also worth remembering Irish CDS were trading at 150 bps at the start of the year.

The real risks for Belgium, however, are likely to come through its financial sector’s exposure to peripheral European debt.

Belgium is exposed to Ireland to the tune of $29 billion, which is more than 5% of GDP, according to Simon Johnson, a professor at MIT and formerly the IMF’s chief economist, writing on his Baseline Scenario blog.

With the Germans once again talking about creditors taking their share of pain alongside (German) taxpayers, Irish default would very likely take Belgium down too.