Last month, two high-ranking officials in Hungary's new ruling party rocked markets when they blithely proclaimed that their country would be lucky to avoid a Greece-like sovereign debt crisis. The euro and the Hungarian forint both plummeted. For jittery investors, Hungary suddenly loomed as the latest European country in free fall.

Only Hungary's woes, real and in this case exaggerated, aren't new at all. Its time of reckoning actually occurred shortly after the fall of Lehman Brothers Inc. in 2008. European Union member Hungary became the first nation to avail itself of an International Monetary Fund-led standby credit agreement, a $25.8 billion package initialed in November 2008.

While the record since is somewhat mixed, Hungary has done a credible job in managing its financial straits. The Hungarian government met its IMF-imposed budget deficit target of 3.9% of GDP last year and should limit its budget deficit to the IMF target of 3.8% this year. That's a far cry from Greece's 13.6% last year and its IMF-mandated target of 8.1% in 2010. The Hungarian economy is beginning to grow, and exports are picking up. Banks are by and large stable. The mergers and acquisitions market has begun to stir.

"The mood is generally good, although we are walking on a tightrope," says Erika Papp, a Budapest-based partner at CMS Cameron McKenna LLP.

Among the risks: Consumer debt remains perilously high. Banks have yet to address overextended commercial property and residential real estate that is all but moribund. As elsewhere in Europe, Hungarian financial institutions are restructuring and extending bad loans rather than resolving them. That has meant there's little money left for new loans, and small and medium-sized businesses can find themselves starved for capital. It also means banks have not so much solved their lending problems as pushed them off. "Many banks still don't confess to the extent of their distressed local assets," says Papp. "They still manage these loans as if they're solvent."

It's difficult to fathom just where Hungary stands financially. Even some in the government of Prime Minister Viktor Orbán, which took power in May, don't seem to have a good bead on Hungary's finances. Officials have vacillated in statements about whether they'll pursue another IMF facility. (The current one expires at year's end.) Some officials backtracked on the sovereign debt comments of Fidesz party Executive Vice President Lajos Kósa and Orbán's spokesman, Péter Szijjártó, damaging the the government's credibility.

More recently, the government announced an onerous banking tax as a way to reduce the budget deficit and offset a proposed cut in corporate taxes and a new flat income tax. Designed to raise 200 billion forints ($902 million), the bank tax infuriated domestic and international financial institutions.

To make matters worse, the proposal came just as the government prepared to make its case for another IMF-led standby credit. Local press reports say a letter of intent could come any day.

Europe continues to lurch through an extended period of financial instability. Hungary's story provides a useful chronicle of the journey from crisis to workout and the bumps along the way. "Hungary reacted pretty quickly and the Hungarian situation isn't so bad, compared to Greece, even Spain or Italy," says "kos Becher, a Budapest-based partner at Horváth & Partners DLA Piper. "Everyone is more optimistic."

Recent apprehension is focused primarily on Europe's southern economies. The latest concern came July 13, when Moody's Investors Service downgraded Portugal's government debt.

How quickly we forget. In the weeks after the Lehman collapse, attention was trained on Central Europe and the Baltic states. Hungary was dead center. A budget deficit prompted some worry. But Hungary's biggest excess -- like many countries -- was consumer-related. Hungarians binged on mortgages, auto loans and credit for appliances. One study based on Hungarian central bank data says consumer loans tripled from early 2005 until the end of 2007.

The glut was made far worse because loans were almost always denominated in foreign currencies -- euros, Japanese yen and especially Swiss francs. These carried far lower interest rates than forint-denominated loans. According to one estimate, more than 85% of consumer lending was in foreign currency, a majority in Swiss francs. With the onset of the financial crisis, the value of the forint plummeted. In Swiss franc terms, the Hungarian currency has declined 42% since mid-September 2008. Loan repayment became impossible.

Like Greece, Spain and Portugal, Hungary found it difficult and expensive to borrow on the international market.

The IMF and European Union rushed in to help. The standby facility, which provided $6.3 billion immediately and the remainder in five quarterly installments, shored up both the country's reserves and its banks, although there was no need for massive bank bailouts akin to what took place in Western Europe. In return, international banks promised to keep lending to the Central European nation at near precrisis levels.

Foreign institutions control most of Hungary's largest banks. Belgium's KBC Bank NV, Austria's Erste Group Bank AG and Raiffeisen Zentralbank Österreich AG and Italy's UniCredit SpA all own Hungarian bank subsidiaries.

In the aftermath of the crisis, some foreign parents topped up capital, although the amounts are fairly modest. In June, for example, Germany's Bayerische Landesbank announced it had infused a further Ft20.25 billion into its Hungarian subsidiary, MKB Bank Zrt. A year earlier, Italy's Intesa Sanpaolo SpA primed its Hungarian subsidiary, CIB Bank, with Ft42.3 billion.

Head offices are now exerting more control on the Hungarian subsidiaries, according to Papp. That slows down the restructuring process, she says.

According to an IMF report, banks in Hungary have remained profitable. Tier 1 capital now tops a healthy 10%, which should provide a necessary buffer when more loans sour. Profitable banks have also provided an easy target for the cash-strapped government.

In the year and a half since the bailout, the country's economic outlook has improved considerably. According to Tamas Móró, research chief at investment bank and brokerage Concorde Securities Ltd., the Hungarian economy should gain about 0.5% this year and 2.7% in 2011. The country's GDP fell 6.3% in 2009.

One key to recovery is Germany. A good 25% of Hungarian exports go to Germany, accounting for 16% of Hungary's GDP. In Gyor, Hungary, for example, Audi Hungaria Motor Kft. manufactures some €5 billion ($6.3 billion) worth of engines for the German carmaker each year. It's the country's biggest exporter. "We're like a German subsidiary," Móró says. "Hungary is very heavily integrated into the German supply chain." He notes manufacturing orders have picked up in the past two months. The weakening euro and the even weaker forint help keep those products competitive.

M&A is showing a few signs of life, although the deals are relatively small. Last month, for example, a Warsaw-based PE firm named Enterprise Investors paid €23 million for a majority stake in Hungary's largest online nonlife insurer, Netrisk Elso Online Biztosítási Alkusz Kft.

Domestic demand is another matter. Retail consumption remains weak. Hungarians are in no mood to spend. Instead, Hungarian consumers are desperately trying to pay down their debt. Net borrowing plunged from Ft120 billion just before the financial crisis to below zero in early 2009, according to Hungarian central bank statistics. Net borrowing has hovered in negative territory ever since. "People I talk to swear they'll never take out a loan again," Móró says.

The problem is that under Hungarian law, homeowners can't simply default on their mortgages, give back the keys and walk away. Lenders can garnish wages, and even descendants of the debtors are on the hook. According to statistics compiled by PricewaterhouseCoopers, retail mortgage nonperforming loans totaled €1 billion at the end of 2009, equal to just 6.3% of total outstanding mortgages. The percentage of distressed debt is far higher, but banks are in no hurry to foreclose and the central bank isn't pushing the issue.

The government is toying with the idea of using the IMF facility to fund an institution that buys nonperforming mortgages. This would allow banks to get the loans off their books. Details have yet to be thrashed out, and it's uncertain when such an institution could get off the ground. There's talk that homeowners would somehow trade their mortgages with the government and become renters. In the aftermath of the crisis, consumer and corporate insolvencies skyrocketed. The vast majority of insolvent companies were small and medium-sized, and nearly all resulted in liquidation.

"Until recently, bankruptcy [reorganization] procedures were very rare, maybe 10 or 20 every year," says Csaba Vári, a restructuring specialist at Squire, Sanders & Dempsey LLP in Budapest. "Liquidations are much higher, maybe eight to ten thousand every year, and during the crisis, these numbers increased."

Part of the overwhelming dominance of liquidations can be found in the legal code, say a number of practitioners. Part is cultural. "Bankruptcy has a very negative meaning in Hungary. People think it means you're completely out of business," says Móró. "Companies either operate or they file for liquidation."

When a case finally lands in court, procedures can drag on for years. As a result, recovery rates tend to hover in single digits. "Even creditors with good claims get less than 10% recovery," says Vári.

Hungarian law also contains some fairly draconian provisions. If a company doesn't pay an invoice within 15 days of the due date and the bill isn't disputed, creditors can demand payment through the court and put a company into liquidation. The court doesn't investigate assets or balance sheets.

Last September, the government amended the insolvency code to make it easier to reorganize under court protection. Under the old statute, a debtor couldn't obtain a debt payment moratorium until creditors agreed. Under the amended law, either a debtor or creditor could seek court protection for the company. The debtor gets 90 days to fashion a reorganization plan. If a majority of creditors agree, that moratorium can be extended 180 days. If two-thirds of creditors agree, the extension can last a year.

The amendment is making a difference, says Zsolt Füsthy, who heads the Budapest-based Füsthy and Mányai Law Office. "More and more applications are being lodged with the court," he says. "Both debtors and creditors can see the advantages in this law."

While no large corporation has tested the new ruling, many small and medium-sized firms have. Füsthy cites Alfa Busz 2002 Jármgyártó Kft., which went bankrupt in March. After 89 days, the bus maker proposed a restructuring that included debt reduction -- the amount hasn't been made public -- and a repayment extension of at least two years. The judge rejected the settlement. The debtor appealed.

"I see a chance in which more and more companies that go bankrupt can survive," Füsthy says. "It doesn't mean a majority, but if in the past 1 to 5% could, now it might be 20%."

Even with the change in the insolvency code, companies and their creditors continue to favor out-of-court restructuring. "Until recently, businesses had to solve their insolvencies outside court," says Vári. "Creditors and debtor had to find common ground."

Since the crisis, the biggest and most high-profile case involved the chemicals company BorsodChem Zrt. Creditors approved the consensual plan in June after more than a year of negotiations.

London-based private equity firm Permira Advisers LLP and its junior partner, Vienna Capital Partners Unternehmensberatungs AG, or VCP Capital Partners, acquired the isocyanates and polyurethanes producer through a leveraged buyout in 2006. The deal restructures €1.4 billion in debt. Under the agreement, China's Wanhua Industrial Group Co. Ltd. converts mezzanine debt it acquired into a 38% stake in BorsodChem's holding company and provides €140 million in senior debt. Wanhua has an option to obtain the remaining shares in the company from Permira and VCP.

Papp, who worked on the restructuring and represented more than 50 senior lenders, believes it is a model for other workouts. Others, though, point out that BorsodChem, which is in a poor region of Hungary, is heavily freighted politically and that China may be motivated by more than economics.