There have been a slew of articles recently on the risk of sovereign defaults.
The threat of sovereign defaults is not surprising. In fact, BIS -
the world's most prestigious financial agency, nicknamed the "central
banks' central bank" - warned in December 2008 that the bailouts and
other bank rescue programs were putting nations were transferring risks
from private companies to nations.
As I noted at the time:
points out in a new report that the bank rescue packages have
transferred significant risks onto government balance sheets, which is
reflected in the corresponding widening of sovereign credit default
scope and magnitude of the bank rescue packages also meant that
significant risks had been transferred onto government balance sheets.
This was particularly apparent in the market for CDS referencing
sovereigns involved either in large individual bank rescues or in
broad-based support packages for the financial sector, including the
United States. While such CDS were thinly traded prior to the announced
rescue packages, spreads widened suddenly on increased demand for
credit protection, while corresponding financial sector spreads
In other words, by assuming huge portions of
the risk from banks trading in toxic derivatives, and by spending
trillions that they don't have, central banks have put their countries
at risk from default.
So who cares whether Dubai, Iceland or Bulgaria default on their debt?
It might not be such a small economy which goes down in flames.
As Mitu Gulati notes :
some point, sovereign borrowing inevitably reaches a level at which
repayment becomes difficult (especially when the private sector
bailouts don’t work). That point was perhaps
reached roughly a month ago when Dubai had a default (it was corporate
debt, but of a corporate entity where the government was a major
holder). That produced concerns about the
viability of other nations and the ratings downgrades of the debt of
other nations (Greece being the most prominent).
of this has produced much concern about whether the world is on the
brink of another major financial crisis, this time with sovereigns. And if the sovereigns default, there is no one to bail them out (except perhaps the IMF, but it does not have limitless funds).
In a series of
radio interviews with Bloomberg, Lee C. Buchheit, a partner at Cleary
Gottlieb in New York, and the guru of sovereign debt, explains the
current state of affairs. Even if you have no
interest in sovereign debt or the potential for another global crisis,
Buchheit is worth listening to just for the elegance with which he
delivers his lines. One of the things about
these interviews that stuck out was Buchheit’s explanation for why this
particular sovereign debt crisis, if it occurs, will be different. This
time, it is not the usual suspects such as Brazil and Mexico who are in
the worst positions. Instead, it is the industrialized nations who have
borrowed so very heavily to fund their bailouts.