The various governments largely don't act as lenders. When they say "Portugal owes Spain $86 Billion", they actually mean "The government of Portugal owes various Spanish institutions and individuals, mainly banks and retirement funds, a total of $86 Billion".

None of it cancels out.

That's a very important point. I wish it had been noted on the graph.

That being said, do governments buy bonds of other countries? Or is it just financial institutions and individuals buying them?

Not much in Europe, as they are on the same currency. Indirectly through the European Central Bank and EFSF but almost all is banks and individuals.

Given that it's not entirely one-way why can't it be partially cancelled out? Sure it wouldn't go the distance but why is that step not made?

The hand-wavey text in the top-left explains that "Banks and governments in these five shaky economies owe each other many billions of euros."

So while it does look like "Greece owes Ireland $8.5bn" is at least partially cancelled out by "Ireland owes Greece $0.8bn", I would expect that these statements roughly translate to "The Greek government owes various Irish banks $8.5bn" and "The Irish government owes various Greek banks $0.8bn", which unfortunately don't cancel each other out.

The debts are probably government bonds with different maturities and interest payments being held by different banks.

I'm not sure where the information from this diagram comes from because I didn't think a banks exposure to different countries was public knowledge.

That data was released as part of the European bank stability tests. You can get the spreadsheets here http://www.eba.europa.eu/EU-wide-stress-testing/2011/2011-EU...

Historically it was not available.